March 13, 2015
By Steve Blumenthal
“We’ve gotten used to thinking of a zero interest rate as normal—it’s far from normal.”
Fed Vice Chairman Stanley Fischer
I wrote a piece in Forbes this week titled “Rate Hike Ahead, Bond Model Says Sell”. The gist of the piece is about a tug of war between opposing views on the direction of interest rates. The outcome of this contest will enrich some and demoralize others.
Trend evidence suggests that rates are moving higher. As you may know, we rebuilt a model with the help of our friends at Ned Davis Research that the late great Marty Zweig created in the mid-80s. It signaled this week that the trend in rates has changed, suggesting it is best to shorten maturity exposure. I share a few ideas in the Forbes piece.
I’m not sure just how valuable a 10-year Treasury paying 2.10% is to a portfolio. Yet the total return would be very nice indeed should rates fall to 1% by year end. Conversely, because the starting place is low, the risk of loss is exponentially elevated than if rates were at, say, 4%. I conclude that now, more than ever, is the time to have a tactical process in place that can help you manage your duration exposure.
Included in this week’s On My Radar:
- Rate Hike Ahead, Bond Model Says Sell – Forbes by Steve Blumenthal
- Don’t Fight the Fed or the Tape – Updated Chart
- Trade Signals – Sentiment Neutral, Trend Bullish, Zweig Bond Model “SELL” Signal
Rate Hike Ahead – Zweig Bond Model Says Sell (Shorten Maturity Exposure) – Forbes by SB
In addition to the Zweig Bond Model chart (and process description), there is a great chart we’ve recently updated that shows just how much money is gained or lost for every 1% move in interest rates, i.e. should rates move from 2% to 3%, 3% or 4%… or 2% down to 1%. Feel free to share that chart with your clients if you find it helpful/relevant.
Click here for the Forbes piece.
Don’t Fight the Fed or the Tape – Updated Chart
Along the same lines, let’s take a look at one of my favorite charts.
Here is how to view the chart:
The chart’s upper clip plots the Standard & Poor’s 500 Stock Index weekly close. The chart’s bottom clip plots the Simplified Tape and Monetary Indicators. These indicators are a combination of NDR’s Big Mo Multi-Cap Tape Composite (DAVIS250) and the 10-Year Treasury Yield percentage (S876).
The current reading is “0”. As evidenced by the S&P 500 gain per annum based on composite indicator levels (Orange Highlighted Box), this indicator supports the notion that we should not Fight the Tape or the Fed.
NDR’s Big Mo Multi-Cap Tape Composite Model was created to give a composite reading on the technical health of the broad equity market. 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. The model provides a single summary reading of the U.S. stock market’s technical health based on historical analysis of many trend and momentum indicators. Chart S876 illustrates when 10-week Treasury Yields are historically lower than their 70-week linear regression, the S&P 500 has produced larger gains.
The combined indicator can produce a score from -2 (both indicators bearish) to 2 (both indicators bullish). When these two indicators are used in conjunction, they produce a historically strong timing indicator. Source: NDR
In short, it is a systematic and disciplined weight-of-evidence approach that identifies the stock market’s technical health. Please refer to the disclosure language at the bottom of this email. Past performance cannot guarantee future performance.
The deteriorating in the Don’t Fight the Fed or Tape Model and the Zweig Bond Model, for that matter, is largely coming from the recent rise in interest rates.
Additionally, if you are a true quant geek like me, here is chart S876 that NDR references above. All others, grab a beer and just keep moving – this one, as with too much beer, might make you a bit dizzy. Combine both at your own risk.
S&P 500 VS. 10-YEAR YIELD DEVIATION-FROM-TREND – Explained by NDR (Again, for Quant Geeks Only):
This chart uses a variation on a deviation-from-trend calculation to create an interest rate indicator for the stock market using the benchmark 10-year Treasury note yield. A traditional deviation-from-trend indicator compares the current data (in this case, the current 10-year Treasury yield) to a longer-term moving average (representing the “trend”) of the data and plots the percent difference (the “deviation”) between the two. In this chart, instead of a simple moving average to represent the trend, we use the weekly endpoint of a rolling 70-week simple linear regression trend-line of the T-note yield (dashed line, middle clip). That is, each week we use the last 70 weeks of data to calculate a best-fit linear regression line through the Treasury note yield data and the endpoint of the regression trend-line is plotted for that week. We then determine the percent difference between the actual 10-year yield and the endpoint of the trend-line and that difference is plotted in the bottom clip of the chart.
To determine whether a given differential should be considered high or low, we plot moving standard deviation bands around a three-year (156-week) moving average of the differential (+/- 0.4 SD above and below). By doing this, roughly a third of the time historically is spent above the upper bracket (indicating rising interest rates), a third of the time is spent below the lower bracket (falling interest rates) and a third of the time is spent between the brackets (neutral rates). The use of moving standard deviation brackets allows for longer-term shifts in the level and volatility of the indicator. Our analysis based on data from 1969 to present has found that the S&P 500 has shown sub-par returns on average when the differential has been above the upper bracket, while it has posted strong annualized gains when the differential has been below the lower bracket (neutral readings have been associated with average returns). The results on the chart reflect the full history since 1969, but only the latest 10 years of data are plotted for better visibility.
The concept behind the chart is that the rolling regression trend-line could reflect a simplistic estimate of where investors might think interest rates “should” be and incorporates the tendency for investors to extrapolate an uptrend or downtrend in rates into the future, which a simple moving average does not do. This indicator thus gives a different perspective on where current bond yields are relative to their recent trend and the results show that it has been a useful timing indicator for the stock market. Source: NDR
Trade Signals – Sentiment Neutral, Trend Bullish, Zweig Bond Model “SELL” Signal
While sentiment has improved as the equity market has sold off, it is not yet in the extreme pessimism zone which would suggest adding/rebalancing to increase equity exposure.
Interesting to note this week, the Zweig Bond Model has just moved to a SELL signal. This is following many months correctly positioned in a buy signal. The idea is to have longer-term exposure in Treasury bonds on buy signals and trade to T-bills on sell signals. The model suggests rising interest rates. Bonds generally lose money when rates rise.
Also of note this week, our CMG HY Model has signaled a sell signal.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: The Primary Trend Remains Bullish for Stocks
- Volume Demand Continues to Better Volume Supply: Bullish for Stocks
- Weekly Investor Sentiment Indicator:
- NDR Crowd Sentiment Poll: Extreme Optimism (short-term Neutral for stocks)
- Daily Trading Sentiment Composite: Extreme Pessimism (short-term Neutral for stocks)
- The Zweig Bond Model: The Cyclical Trend for Bonds has turned Bearish
Click here for the full piece.
Personal note
I’ve been working on two new white papers that we hope to publish shortly. One is on Diversification and Correlations and the second discusses how to pull it all together and create a “Total Portfolio Solution” that targets a certain return and controlled risk objective. It has been a great deal of work and, frankly, a lot of fun. I know…Susan tells me I need to get a life.
Daughter Brie is back home for the weekend having just returned from her final spring break trip. Real life for her is set to start in May. I remember my dad pulling me aside, with my graduation hat in hand, telling me it’s all downhill from here. I’d have to say it really hasn’t turned out to be that way. The ride has been pretty great – for which I’m grateful. A big dinner is planned for tonight and I’m showing up hungry. I hope you have something fun on the weekend schedule. Wishing you the very best.
Have a wonderful weekend!
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
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