January 9, 2015
By Steve Blumenthal
“We shouldn’t be raising rates before 2016.”
Chicago Fed President Charles Evans
Evans, a voting member on the central bank’s policymaking committee, told CNBC this week. The market responded favorably.
Evans said he’s hopeful that inflation will pick up. “I’d like to have more confidence that we’re going to get to 2 percent by 2016” and added, “2017 seems like the minimal allowable. To get there, I think we need more accommodation.”
I believe “Don’t Fight the Fed or the Tape” remains the primary theme for now. In this regard, I share a great chart this week that details the performance evidence behind this important rule. That jingle continues to ring in my head: “It’s all ‘bout that Fed, ‘bout that Fed, no trouble.”
From Evans, “I don’t want to get to a situation like Europe is in,” he added—referring to the euro zone moving into deflation. “I want to make sure to get U.S. inflation up to our objective. If it moves down, that’s a challenge.”
It’s not just Europe of course. Ambrose Evans-Pritchard wrote a piece this week titled, China quietly joins Asia’s currency wars to avert deflation as countries around them devalue, from Russia, to Japan, Indonesia and Malaysia. It is a war dance with the dollar as the global markets cling to every word from the Fed.
I really had fun putting together this week’s piece. I highlight several charts that may help keep us on-sides as the year steps forward. I also include a section on “The Mathematics of Loss”. I believe most individual investors are completely unaware of just how important it is to limit loss. I hope this information proves helpful.
Included in this week’s On My Radar:
• Don’t Fight the Fed or the Tape – A Primary Theme for 2015 and Beyond
• A Summary of 2014 Global Stock Market Performance
• Stock Ownership is High – A Good Predictor of “LOW” Forward Returns
• Global Stocks vs. Bear Watch Indicators – Remains Bullish
• The Mathematics of Loss
• Trade Signals – Over Optimistic Correction on Schedule – 01-7-2015
Don’t Fight the Fed or the Tape – A Primary Theme for 2015 and Beyond
As you probably know by now, my favorite market trend indicator is NDR’s Big Momentum. I’ve followed it for more than 20+ years. The model aggregates the signals of over 100 component indicators and generates a reading between 0% and 100%, reflecting the percentage of the component indicators that are currently giving bullish signals for the S&P 500 Index.
It was designed to look at the overall technical health of the equity market. It’s kind of like you going to the doctor for blood work and a stress test.
The next chart combines trend with Fed policy. When the Fed raises interest rates (takes away the punch bowl), the markets generally do not do as well. In the next chart, the trend is the trend in yields. Historically, when 10-week Treasury Yields are lower than their 70-week linear regression (a moving average trend line), the S&P 500 has produced larger gains.
The boxes in the upper part of the chart shows the return when both trend and Fed policy (10-week Treasury Yield moving average is lower than its 70-week moving average) are favorable as well as when they are not favorable.
Again, historically, the S&P 500 has produced larger gains when the weight of evidence is positive. Don’t Fight the Tape or the Fed evidence remains positive today:
I present the next section just to give you a sense of the range or returns achieved in 2014. I found it a good review myself. Everyone wants to compare everything to the S&P 500 and that always leaves me scratching my head. In our work with thousands of advisors over many years, I have never come across an investor account that is 100% invested in the S&P 500. Not even close. Most are broadly diversified owning bonds, sectors, small cap, mid and large as well as both developed and emerging market exposure.
If we all knew the Chinese market was going to gain over 40% in the final two months of 2014, we would have positioned such. We diversify our portfolio for a reason. Please feel free to share these charts with your clients. Just be sure to include the below disclosure language.
2014 Global Stock Market Performance
Best performer: Shanghai at +52.87%. Worst FTSE 100 at -2.51%
*note the 40% gain in the Shanghai index in November and December 2014.
Performance since the March low in 2009
Best performer BSE SENSEX at +251.6%. Worst Shanghai at +63.8%.
Performance since 2000
Best BSE SENSEX +411.6%. Worst CAC 40 at -27.8%.
*note the S&P 500 Index at just 41.5%. Source
I sure wish I was smart enough to be all in on the Bombay Stock Market (BSE SENSEX) the last 15 years. Didn’t know. We diversify for a reason.
Stock Ownership is High – A Good Predictor of “LOW” Forward Returns
This next chart details the high correlation between the Percentage of Household Financial Assets invested in stocks to the rolling 10-year S&P 500 Index Total Return. Think about it this way: The basic premise is that when investors are fully invested, there is less excess money available to buy stocks; thus, a loss in demand that could push prices higher. When individuals are excessively overweight stocks, the returns from that point forward (the next 10-years) have been historically low.
The dotted line plots the actual return. Look how closely the actual 10-year return (dotted line) tracked the percentage of household financial assets in stocks (blue line). The percentage return figures are along the right hand side of the chart. The orange box highlights where we are today and cautions to expect a low forward total return of just 2.75%.
Let’s take a quick look back in time to March 2000. The S&P 500 Index peaked at 1553.11. Ten years, two recessions and two market crashes later it was at just 1180.61. A loss of 370.10 S&P 500 Index points or -31.55%. Annualize that and your return was approximately -1% per year (total return).
The obvious point is (like PE, price-to-sales, price-to-book, operating revenues or Buffett’s favorite valuation indicator) the data should not be ignored. Risk is high. Expect low returns. Include other return drivers, like Tactical, until ownership and valuation metrics become more reasonable.
What you/we can do: Keep a close eye on the weight of evidence with take action (move to T-Bills or hedge) when the evidences shifts.
Next is another good “weight of evidence” chart I look at each week. I’ll post it more frequently in 2015.
Global Stocks vs. Bear Watch Indicators
I’m a big believe in a weight of evidence approach to help navigate the equity markets. Last week we looked at valuations and what they tell us about probable forward returns (low). This week I highlight data that looks at the global markets as measured by MSCI World.
“When a prolonged global stock market advance is in progress, investors should stay alert to the potential for a market peak and new bear market. With that in mind we developed a Bear Watch list of indicators that have been reliable in turning bearish before double-digit declines in the MSCI All Country World Index.
The top clip in the below chart plots the global stock price index, which is a blend of the MSCI World Index price returns prior to 1988 and the MSCI ACWI price returns thereafter. The bottom clip plots the percentage of Bear Watch indicators that have reached key bearish levels historically. As the mode returns in the top clip show, global stocks start to struggle once the percentage of bearish indicators rises above 20%. Historically, global stocks have performed the worst during periods when the percentage of bearish indicators is greater than 40%.”
The next chart highlights the historical returns. Note the “we are here” arrow on the bottom right.
And if you are a data junky, here is a look at the Bear Watch Indicator “dashboard” through yesterday:
In short summary, the weight of evidence remains favorable, but have a plan and be prepared to execute that plan.
The Mathematics of Loss
Here is how it works:
“If an investment declines 10%, it takes about an 11% gain to break even (assuming you don’t pump in additional dollars). If the drop is 20%, you need a 25% gain to recover.
A fall of one-third requires a rebound of 50%. And if your investment falls by half, “you need a double,” or a 100% return, says Mr. Wiener, the New York-based editor of the Independent Adviser for Vanguard Investors.
The recovery percentages grow exponentially because you have so few dollars working for you after a big loss.
In 2008, the average diversified U.S.-stock fund was down 37.5%—requiring a 60% advance to break even—and plenty of funds were down 50% or more.”
If you understand how this simple math works, then you are in a better situation to appreciate the importance of capital preservation. Source
Here is a quick example: As we saw in the chart above, the S&P 500 is up 41% since January 2000. A $100,000 investment back then is now worth $141,000. Most people believe it will take a decline of 41% to get back to even. Unfortunately, that math doesn’t work that way. A loss of 41% on $141,000 will set you back to $83,190. You will then you need a gain of over 67% to get back to $141,000. This is why risk management is so important.
The math on losses is painful. Risk today is high. Protect your gains.
Trade Signals – Over Optimistic Correction on Schedule
The last several Investor Sentiment extremes (too much optimism) have done a pretty good job at identifying market correction turning points. After peaking at the second highest reading since late 2004, the NDR Crowd Sentiment Poll is now back to neutral. Five days of serious market indigestion has sobered the optimism.
Periods of extreme investor pessimism have also marked some pretty good buying opportunities (October 2014). In short, I remain in the buy the dip camp. In this regard, I believe a spike in investor pessimism may be a useful short-term indicator.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains Bullish
- Volume Demand Continues to Better Volume Supply – Remains Bullish for Stocks
- Weekly Investor Sentiment Indicator:
- NDR Crowd Sentiment Poll: Extreme Optimism (Short-term Bearish for Stocks)
- Daily Trading Sentiment Composite: Extreme Optimism (Short-term Bearish for Stocks)
- The Zweig Bond Model: The Cyclical Trend for Bonds Remains Bullish
Click here for the full link, including updated charts, to Wednesday’s Trade Signals post (trend and sentiment charts)
Summary
Dallas, Chicago and the ETF.com Conference in Hollywood Florida
Loaded with excitement, Susan and I are headed to Dallas on Sunday. We will be attending the Ohio State–Oregon Championship football game Monday night at Cowboy Stadium. Susan and her brother, Jim, have Ohio State roots. Susan was born there, and her father taught and earned his PhD at OSU.
Following the OSU win over Alabama, Jim called Susan with four tickets in hand to the championship game. I’ve been meaning to get to Dallas for business, and the timing couldn’t be more perfect, so off we go.
I’m really excited, but here’s the rub. As you may know by now, I’m a crazed Penn State fan, and no true PSU family member will ever root for Ohio State. Frankly, ask anyone with Big Ten ties, and he or she will tell you there is no rooting for Ohio State (a badge I’m sure they wear proudly.) With family with OSU blood in its veins, I find myself a bit off-sides. I can’t believe I’m saying this, but I think I’m pulling for the Buckeyes. Please don’t tell my kids or my Penn State friends.
I’m speaking in Chicago next Wednesday at the Securities Traders Association of Chicago’s Winter Conference. Later this month, I’ll be heading to Hollywood, Florida, to attend the Inside ETFs eighth annual conference. As you well know, ETFs have become popular, low-fee, simple, and efficient portfolio-building tools. The growth has been amazing. While index-based rules form the backbone of most ETFs, later this year, a growing wave of active ETFs will launch.
More than 1,500 of your colleagues will be attending. It is the world’s largest ETF conference. Look for me, Mike, Andrew and Avi in the ETF Strategist section at the conference in Florida. Stop by and say hi.
Hope to see you in Florida. Let me know if you will be attending. Following is a link to the registration information:
Have a great weekend!
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
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