S&P 500 Index 1874
By Steve Blumenthal
March 5, 2014
Included in this week’s update (the usual weekly charts):
- S&P 500 Index Median PE Overvalued and Undervalued Price Targets (as of February 28, 2014)
- Sentiment Charts – Crowd Sentiment is Extremely Optimistic: Hedge
- Cyclical Equity Market Trend Charts – Both Trend Charts Remain Bullish
- Provided are several links to learn more about the use of options to hedge
S&P 500 Index Median PE Overvalued and Undervalued Price Targets
In the next chart, we look at the median price to earnings ratio (PE) to get a sense of current valuation. Are U.S. equities, in general, inexpensively priced or expensively priced? If we buy an inexpensively priced asset, there is greater future return potential. Stating the obvious, if we pay too much, our return potential is more limited. Not a problem if you have a 20-30 year time horizon and the ability to stay the course when turbulence hits (2002, 2008, etc.). It is a problem when a major correction occurs just prior to your retirement.
There are many ways to measure valuation. I favor median PE for it is a mathematical process based on ACTUAL earnings. History has shown that Wall Street analysts tend to over-estimate future earnings. The challenge for those who favor forward earnings estimates to calculate PE is that there is a long pattern of those estimates subsequently being revised lower. Thus, this is too much of a moving mark for me.
Median PE gives us a very good picture of current market valuation and helps frame short-term to intermediate-term upside and downside price targets vs. historical levels. This understanding can prove valuable in the management of your money. For example, one might wish to hedge downside risk when prices become richly priced. The reverse is true when valuations are attractive.
Here is how to read the chart. The current Median PE is 20.5 (data through 2-28-14). The 50 year median PE is 16.7. If you take the most recent reported earnings (median calculation) and times it by the 50 year average PE of 16.7, you get a suggested fair value of 1517.53. A 1 standard deviation move above 16.7 suggests the market is overbought at 1987.32. This is approximately 18.4% below the current levels. Here is the chart.
The probabilities to me suggest an upside target of 1987 for the S&P 500 Index with a fair value at 1517. Given the current support of the Fed (as in don’t fight the Fed), the downside or undervalued target of 1047.75 is far less probable.
The problem that I see today is that sentiment is very bullish and the crowd is generally wrong at points of optimistic extreme. Thus, my belief that some proactive form of risk management (hedging) makes sense as it relates to your important long-term equity portfolio positions.
Investment Sentiment charts 3-4-2014:
Sentiment Chart 1 – NDR Crowd Sentiment Poll – Extreme Optimism:
We have quickly moved back to Extreme Optimism (Bearish) in this chart. Investor sentiment most recently peaked at 73.9. This is the second highest reading ever recorded – data 1995 to present. I continue to favor hedging long-term equity exposure until extreme pessimism is reached.
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).
Sentiment Chart 2 – NDR Daily Trading Sentiment Composite – Neutral (nearing Extreme Optimism).
Individuals are typically the last to enter the market.
I posted the following last week: While I favor the Crowd Sentiment data, I also look at a few other sentiment charts each week. The following Investors Intelligence Survey of Advisory Services shows the most optimism since 1987 (NOT A TYPO).
However, I will really get concerned when one or both of the following cyclical trend charts turns bearish. For now, the major cyclical trend for equities remains higher. Following are two of my favorite market trend charts:
Cyclical Equity Market Trend Charts – Both Trend Charts Remain Bullish
Cyclical Trend Chart 1 – 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.
Cyclical Trend Chart 2 – The Big Mo Multi-Cap Tape Composite continues to signal a bullish uptrend for the market. The last “B” buy signal was in 2011. Note the 84.6% Profitable Long Trades and the Gain/Annum when “Bullish” investing in the S&P 500 Index and the “Switch” to cash on Bearish readings. While no process is perfect, this is a chart to keep your eye on.
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
Conclusion
The conclusion remains the same (see prior Trade Signal posts here). The cyclical bull market trend for stocks remains in place; however, risk is elevated. A Median PE of 21 based on actual earnings puts the market approximately 20% above its 50 year fair value. Click here for PE and Profit Margin charts.
Sentiment may serve as a guide in determining when to put some form of risk protection in place. Think of it as inexpensive insurance. I will become much more concerned when the cyclical trend turns bearish.
A note on the cyclical trend in interest rates – rates have been moving lower and are nearing a point that may turn the cyclical trend for bonds from bear to bull. While there can be no guarantees in our business, I note that we have begun to see a shift towards bond ETFs in our tactical strategies. We continue to hold mostly long equity exposure in our CMG Opportunistic All Asset Strategies as well as our CMG Tactical Rotation Strategy. The CMG Managed High Yield Bond Program remains in a buy signal as well.
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods.
CMG SR Tactical Bond FundTM , CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM: Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG SR Tactical Bond FundTM, CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456. Please read the prospectus carefully before investing. The CMG SR Tactical Bond FundTM, CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA. NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually mange client assets; and, (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Standard & Poor’s chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, nor the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.
Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).