S&P 500 Index 1835
By Steve Blumenthal
October 15, 2014
The S&P 500 is down nearly 10% from its September high of 2019. The good news is investor pessimism is extreme. I’m going to tilt back the risk meter just a bit as investor pessimism is now at levels of extreme pessimism and the market is testing some technical support.
To that end, the market is currently testing the April 2014 low at 1814. The next support level is 1737 which was the February 2014 low and September 2013 high. There is more significant support at 1661.77 which represents a 38.2% retracement from the October 2011 low to the September 2014 high.
Several other trend charts I favor are turning negative yet my two favorite, Big Mo and the 13/34-Week EMA, remain in a cyclical bull market buy signal. I show a special chart today that looks at advancing volume vs. declining volume which is essentially looking at demand vs. supply. It turned negative yesterday. I highlight that chart below.
On the concern list: QE is ending this month and Europe, Japan and China are in decline (with recession in Europe), commodities are in a steep sell-off (signaling global economic weakness), war risk and add Ebola. We know risk to be elevated – whether a short-term market scare or the beginning of another crisis remains to be seen.
I’ve been advocating “own equities but hedged” and “overweight to tactical strategies” for some time. To that end, our tactical strategies are performing as we hoped. I know several of the large tactical shops are not doing well. Diversify.
If you are a CMG client, know that our overweight to cash and long bond exposure in our CMG Opportunistic All Asset Strategies has helped performance, our 50% SPY and 50% BND (Vanguard Bond Fund ETF) has helped our Tactical Rotation Strategy minimize decline, our overweight to long bond exposure in our CMG Vantage Flexible Bond Strategy has produced unusually favorable returns and our CMG High Yield Managed Bond Strategy moved once again defensively to a sell signal yesterday.
We investors have to take risk. There is no other choice. Putting money under a mattress is risk, buying a CD is risk, a bank account is only insured for so much, bonds are risk, stocks are risk, everything we do is risk. However, we can control our risk exposure. It is the blend of multiple risks that we can control and, fortunately, there are available tools we can all use to build broadly diversified and healthier portfolios.
If your equities are hedged and your portfolio includes good tactical strategies (and other liquid and more flexible return drives), then the storm should be weathered with far less emotional and financial indigestion. If you are John Bogle with millions and a solid buy-and-hold no matter what conviction, then stay the course. Frankly, I don’t think most people hold that depth of conviction. Evidence suggests otherwise and is why many other experts favor broad portfolio diversification.
For the moderate investor, I favor 30% allocated to equities (hedged), 30% to fixed income (flexible and tactical) and 40% to tactical strategies. When valuations become more attractive, then shift back to overweight equities. Key is to have a game plan and the discipline to stick to that plan.
For overall market trend, I follow Big Mo and the 13/34-Week Trend chart. Should either turn negative, then further adjustments in the 30/30/40 mix may be made to reduce market exposure even further. I think sentiment can be used in a helpful way. Neither trend indicators has turned negative and sentiment is now signaling a buy. I continue to favor 30/30/40 and that weighting mix is holding up well.
Trade Signals is my process for thinking about market risk, portfolio structure and forward game plan. It really helps me to go through the charts and to put my thoughts on paper each week. I hope that some of the information can help you and your clients as well.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains Bullish (as measured by NDR’s Big Momentum indicator and separately by the 13/34-Week EMA S&P 500 Index Trend Chart)
- Weekly Investor Sentiment Indicator – NDR Crowd Sentiment Poll: Extreme Pessimism (Bullish for the Market)
- Daily Trading Sentiment Composite: Extreme Pessimism (ST Bullish for the Market)
- The Zweig Bond Model: Cyclical Bull Trend for Bonds (supporting longer-term treasury and Corporate bond exposure)
- Demand/Supply Chart – In a “SELL” Signal for the First Time Since 2012
Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains
Not too dissimilar to a full physical, stress test and blood work to determine the state of one’s health, Big Mo follows a weight of evidence approach to determine the market’s cyclical trend. It measures a number of market internals to determine trend. As of October 10, 2014, the cyclical trend evidence remains up.
Click here to see “How I Think About Big Mo”.
13/34-Week EMA Trend Chart: Cyclical Bullish Trend for Stocks Remains
Favorable trend support can also be seen in the following 13/34-week trend chart. 1900 looks to be the current support level (simply estimating where the current trend may cross lower).
13/34-week EMA – The cyclical bull market’s uptrend remains in place. Note the blue 13-week EMA line remains above the red 34-week EMA line. Also note how well this simple, tactical trend indicator has historically captured the cyclical bull and bear market trends. Signals occur when the lines cross.
I posted the following chart last week and said, “The next chart shows the market’s first technical support at 1900. 1850 is the next followed by 1737, 1662 and 1560.”
Here is the same chart updated through today. As you can see, we moved quickly through 1850 (which represented the January high and April retest of that high). The market is currently testing the April 2014 low at 1814. The next support level is 1737 which was the February 2014 low and September 2013 high. There is more significant support at 1661.77 which represents a 38.2% retracement from the October 2011 low to the September 2014 high.
Here is a look at the same chart but zoomed in to cover just the last year.
I think it also important to remember that fair value based on the following chart is at S&P 500 level of 1571.17.
Here is a Quick Look at Median Fair Value on the S&P 500 Index
Market valuation can help us measure the degree of risk built into current prices and what forward returns might look like. While it is a very poor timing tool, it is a great risk measuring tool. Click here to see the post showing Buffett’s favorite Valuation Measure (hint: “Bubble Territory”)
http://www.cmgwealth.com/ri/on-my-radar-the-secret-goldman-sachs-tapes/
Today, valuations as measured by Median PE shows the market fairly priced at 1571. That would be a great buy entry point. Overvalued puts the market at 2055. Given the recent correction, we are better priced than we were a few weeks ago; however, forward return potential remains low and given the low yields in bonds, expectations should be set accordingly. Overall, risk is high.
Investor Sentiment 10-14-2014:
NDR Crowd Sentiment Poll: Extreme Pessimism (Bullish)
If you are a new reader, the gray area highlights the historical market performance when Investor Sentiment, as measured by Ned Davis Research, moves into the Extreme Optimism (Bearish) Zone (above the dotted black line or a reading of 66).
The weekly NDR Crowd Sentiment Poll (one of my favorite sentiment indicators) is in the Pessimism zone – bullish for stocks. Note the red arrow and the poor historical equity market performance when the majority of investors are bullish.
“The secret to my success is that I buy when everyone else is selling and I sell when everyone else is buying. Sounds easy to do yet it will be one of the hardest things for an investor to master.” Sir John Templeton, the Union League, Philadelphia 1985
Note that the average value of the indicator at Extreme Optimism (1995 to present) is 68.2. The idea here is that one wants to be a buyer when everyone else is selling (Extreme Pessimism) and a seller or equity hedger when everyone is extremely optimistic.
Daily Trading Sentiment Composite: Extreme Pessimism (ST Bullish for the Market)
Of the above two sentiment indicators, the Daily Trading Sentiment has been the better performing indicator the last 18 months.
The Zweig Bond Model: “BUY” Signal – Cyclical Bull Trend for Bonds
Historical performance is summarized in the table on the bottom right. The yellow highlight shows the current buy signal for the strategy and historical performance on signal (the model was established in the 1980s – the data is hypothetical). The blue line shows the growth of $100 since April 1, 1967 in comparison to the black line which is the Barclays Aggregate Total Return index. The table at the bottom left compares the two.
Click here for notes on “How To Track The Zweig Bond Model” on your own.
Given the historically low yield on bonds, it is important to understand what happens to bonds when interest rates rise. However, for now, the weight of evidence continues to support being positioned in longer-term bonds, bond fund ETFs and/or bond mutual funds.
Interest Rate Gain/Loss Per Every 1% Interest Rate Move
*Think about the above chart as it relates to trading bond fund ETFs tied to the Zweig Bond Model signals as well as the current high risk environment tied to ultra low interest rates.
Demand/Supply Chart – In a “SELL” Signal for the First Time Since 2012
One of the charts that caught my eye this week looks at advancing volume vs. declining volume which is essentially looking at demand vs. supply. Are there more buyers than sellers or more sellers than buyers?
Demand/Supply Chart
Concluding Thoughts – CMG Tactical Strategies
The big positive is that investor sentiment is at Extreme Pessimism especially as seen in the Daily Sentiment data. We are near some reasonable technical support and should see a rebound. The sell-off should not come as a surprise though it is never pleasant. Overall, I favor a disciplined game plan with quarterly or yearly rebalancing and strategy shifts based on potential forward opportunity.
As a quick aside: In my more than 20+ years of trading the intermediate trends in the High Yield space, this is the first time we have traded in then out in one week. We moved back to short-term money market exposure and/or Treasury Bill (ETF “BIL”) yesterday – highly unusual. Not sure if this means anything or not. I’m just sticking to the process.
Keep a close eye on Big Mo and the 13/34-week EMA. In regards to total portfolio construction, I favor 30/30/40 with the 30% to equities hedged, 30% to fixed income flexibly managed due to low interest rates and 40% to tactical and alternative strategies. Within that last category, I favor a 10% allocation to precious metals. We privately run a Total Portfolio Solution for our Private Wealth Group clients that incorporate this view. We will likely make a modest weighting shift should Big Mo turn negative.
The Zweig Bond Model remains in a buy and bonds are doing very well. I’m not sure how much room remains on the upside but here too I favor sticking to the process to determine core bond exposure.
Overall, risk remains elevated, the market remains overvalued and some form of risk protection, in my view, continues to make sense.
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
Provided are several links to learn more about the use of options:
For hedging, I favor a collared option approach (writing out of the money covered calls and buying out of the money put options) as a relatively inexpensive way to risk protect your long-term focused equity portfolio exposure. Also, consider buying deep out of the money put options for risk protection.
Please note the comments at the bottom of this Trade Signals discussing a collared option strategy to hedge equity exposure using investor sentiment extremes is a guide to entry and exit. Go to www.CBOE.com to learn more. Hire an experienced advisor to help you. Never write naked option positions. We do not offer options strategies at CMG.
Several other links:
http://www.theoptionsguide.com/the-collar-strategy.aspx
https://www.trademonster.com/marketing/upcomingWebinarEvents.action?src=TRADA2&PC=TRADA2&gclid=CKna3Puu6rwCFTRo7AodRiQAlw
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