Trade Signals – Sell/Hedge the Rallies, Investor Pessimism Remains Extreme

S&P 500 Index 1898

By Steve Blumenthal
January 27, 2015

Pessimism remains extreme with the Weekly Sentiment at the lowest (most bearish) reading since 2011.  That supports a short-term bullish move.  I remain in the “hedge or sell the rallies” camp.

Our Zweig Bond model moved to a sell signal, suggesting shorter-term Treasury securities over longer-term maturities.  High-yield model is back in a buy signal.

I’m writing from Florida this morning and will share with you my high-level notes from the Inside ETF.com conference in Friday’s OMR.

Included in this week’s Trade Signals:

Equity Trade Signals:

• CMG NDR Large Cap Momentum Index:  Sell Signal – Bearish for Equities
• Long-term Trend (13/34-Week EMA) on the S&P 500 Index:  Sell Signal — Bearish for Equities
• Volume Demand is greater than Volume Supply:  Sell Signal – Bearish for Equities
• NDR Big Mo: See note below (btw, this process triggered a sell signal last Friday).

Investor Sentiment Indicators:

• NDR Crowd Sentiment Poll:  Extreme Pessimism (short-term Bullish for Equities)
• Daily Trading Sentiment Composite:  Extreme Pessimism (short-term Bullish for Equities)

Fixed Income Trade Signals:

• The Zweig Bond Model:  Sell Signal
• High-Yield Model:  Buy Signal

Economic Indicators:

• Don’t Fight the Tape or the Fed: Indicator Reading = 0 (Neutral for Equities)
• Global Recession Watch Indicator – High Global Recession Risk
• U.S. Recession Watch Indicator – Low U.S. Recession Risk

Tactical All Asset Model:

• Relative Strength Leadership Trends: Utilities, Fixed Income, Muni Bonds, Gold and Cash are showing the strongest relative strength:

• Positions are unchanged since last week.
• 73% defensively positioned (short, intermediate and long-term high-quality bond exposure and utilities), 9% allocated to gold and 18% in equities.
• It is the first time in quite some time that gold has shown strong relative price leadership.
• Overall, we continue to see the strongest price leadership in the traditionally “safer” asset class categories.

Cyclical Equity Market Trend: The Primary Trend Is Bearish for Stocks

1. CMG NDR Large Cap Momentum Index – Sell Signal – The Momentum and Market Breadth Data is reading Bearish for U.S. Equities (last signal was on June 30, 2015 with the S&P 500 Index at 2063.11).  This is my favorite risk on/risk off equity market indicator.

• N = a sell signal or get neutral on your equity exposure.  B = a buy signal.
• The top section shows the model (hypothetical) performance of the model (moving to cash on N (neutral signals) and moving to the S&P 500 Index TR on B (buy) signals (blue line) vs. buying and holding the S&P 500 Index (red line).
• The middle section of the chart is the model line that tallies the momentum and breadth scores of the stocks in our 22 market sectors. (An up trending line reflects a healthier market environment.)
• Performance attributions are in the bottom of the chart (red arrows).
• Tested is the period from 1991 to present.
• See important disclosures below. CMG, NDR

How I use the CMG NDR Large Cap Momentum indicator:  We run several strategies here at CMG.  In one of our strategies, we invest in a low-fee large-cap S&P 500 Index ETF on “B” buy signals and we switch to BIL (a short-term Treasury Bill ETF) on “N” sell signals.  We also run a long/short strategy based on the same signal.  Further, when the indicator is in a sell signal, it helps us identify periods where we should be more mindful of hedging our long-term focused equity holdings.  Here out-of-the-money put options on an ETF, such as SPY, may be prudent.

Separately, we run several well-known ETF tactical strategies.  Our tactical equity strategies look at relative strength that compares stocks, bonds, sectors, cash, etc. and seek to position in the assets showing the strongest price leadership.  Such strategies tend to move away from areas of greater risk (like equities) to less risk areas (like bonds and cash) and do so based on the rules built within each strategy.  Sometimes, our CMG NDR indicator may be in a sell signal, yet our tactical equity strategy may still have an overweight exposure to equity-oriented funds or ETFs.

As markets don’t generally tsunami overnight (though it can happen), historically, they tend to peak and change trend over months, not days.  Most corrections are in the 5% to 10% range with the sizable corrections tending to occur during periods of recession.  So with this thinking, I believe that portfolios should be broadly diversified to include a number of potential return drivers (let’s call each one separately a risk).  Thus, in my view, portfolios are a collection of various different risks (otherwise known as “diversification”).

2. 13/34–Week EMA Trend Chart: Cyclical BEARISH Trend for Stocks

Note (in chart below – upper right-hand corner) that the 13-week MA (blue line) recently crossed below the 34-week MA trend (red line).  The Cyclical Trend for Stocks is bearish by this measure.  You can see that this trend process has done a pretty good job at identifying the major cyclical bull and bear market trends (note small red and blue arrows).  A good stop loss level may be at the point the 13-week drops below the 34-week.

Click here to see “How I think about the 13/34-Week Exponential Moving Average.”

SB Comments:  Further adding to confusion is the inclusion of the 13- over 34-week EMA chart.  I believe it has done a good job at historically capturing the markets primary cyclical trend.  However, I simply see it as a data point I like to review each week.  We do not use it in any way with the management of our strategies.

3. Volume Demand vs. Volume Supply – Remains on a Sell Signal

Volume Demand vs. Volume Supply remains in a “sell” signal.  The process looks at a smoothed total volume of declining issues vs. a smoothed total volume of advancing issues using a broad market equity index.  The performance below is when Vol Demand is above or below Vol Supply.  More buyers than sellers or more sellers than buyers.  It is a relatively slow moving indicator.  The last signal buy signal was in 2012.  The sell signal was in June 2015.

• S&P 500 Index Gain/Annum (12-31-1997 to present) when
  • NDR Vol Demand Above Vol Supply: 10.0% (64.8% of the time)
  • NDR Vol Demand Below Vol Supply: -6.8% (35.2% of the time)

Here is the data 1997 to present:

See important disclosure information below. NDR disclosure.

SB Comments:  Similar to the 13/34 week EMA trend chart, we don’t use Volume Demand vs. Volume Supply in any of our investment processes.  Personally, I like to note if there are more sellers than buyers or buyers than sellers, as it is ultimately supply and demand that moves prices in all things.  Looking at this measure gives me another data point to get a feel for the level of potential risk.  This is an indicator I have viewed each week for many years.

4. Big Mo Multi-Cap Tape Composite Model – We have decided to remove this chart. We believe our CMG Ned Davis Research Large Cap Momentum Index is a better process and we’d like to remove confusion.  However, if you would like a copy of the chart, please send me an email reminder each week and I’ll forward a copy to you. 

NDR disclosure information. See important disclosures below.  CMG disclosure information.

Investor Sentiment 1-26-2015:

NDR Crowd Sentiment Poll:  Extreme Pessimism (short-term Bullish for Equities).  Current reading highlighted in Green (below).

• The current weekly sentiment reading is 45.5. Last week’s reading was 45.3.  See following data for performance based on sentiment readings.  Source: NDR
• Gain/Annum for the S&P 500 Index (data from December 1, 1995 to present):
  • Composite score Above 66 or Excessive Optimism = -7.7% (21.3% of the time) (Bearish for Stocks)
  • Composite score between 57 – 66 from above 66 or Neutral Optimism = 1.7% (17.6% of the time)
  • Composite score between 57 – 66 from below 57 is bullish = 18.8% (19.8% of the time)
  • Composite score Below 57 or Excessive Pessimism = 9.3% (41.3% of the time) (Bullish for Stocks)

Source: NDR

SB Comments:  Long ago, famed investor Sir John Templeton said to me, “The secret of my success is that I buy when everyone is selling and I sell when everyone else is buying.”  Back then, there were few sources available that measured and reported investor sentiment.  Now there are many.  My favorite is NDR’s Crowd Sentiment Poll.  It updates weekly and is slower moving than the Daily Trading Sentiment Composite (below).  I use the information to measure if pessimism is extreme or if optimism is extreme.  It helps with the hedging we do with the put options in one of our equity strategies.  For example, if optimism is extremely high (which is bearish for equities) and other indicators are suggesting high market risk, we may put hedges in place to protect some of the downside.  If the market then declines and moves into a reading of extreme pessimism, we may reduce or remove the hedges and look to reset them when the market rallies back to extreme optimism.

You can see how the market performed when optimism was extreme (poor performance) and when pessimism was extreme (good performance).  We try to stay in line with this as best we can with our hedging.

Daily Trading Sentiment Composite:  Extreme Pessimism (short-term BULLISH for stocks).  Current reading highlighted in green (below).

• The current daily sentiment reading is 26.7. Last week’s reading was 18.9.  See below data for performance based on sentiment readings.
• Gain/Annum for the S&P 500 Index (data from December 30,1994 to present):
  • Composite score Above 62.5 or Excessive Optimism = -11% (28% of the time) (Bearish for Stocks)
  • Composite score between 41.5 – 62.5 or Neutral Optimism = 6.6% (45.1% of the time)
  • Composite score Below 41.5 or Excessive Pessimism = 30.1% (26.9% of time) (Bullish for Stocks)

1994 to Present:

2006 to Present:

Source: NDR

SB Comments:  See explanation immediately above under the Crowd Sentiment data.  While the Crowd Sentiment is my favorite, it is mainly because I have followed it for so long.  That doesn’t make it better or worse than the Daily data.  I like following both and note that they are generally more in sync than not, though daily tends to move more quickly.

Again, you can see how the market performed when optimism was extreme (poor performance) and when pessimism was extreme (good performance).  We try to stay in line with this as best we can with our hedging.

See important disclosure information below. NDR disclosure link.

Don’t Fight the Tape or the Fed – Indicator Reading = 0 (Neutral for Equities).  Current reading highlighted in orange (below).

The indicators that comprise this reading are a combination of NDR’s Big Mo and the 10-year Treasury yield.  It highlights just how important Fed activity is to market performance.  Readings range from +2 to -2.  The following is the model data from January 1998 through present:

• The current indicator is 0 (Neutral for Equities).
• Gain/Annum when the combined indicator reading (199 to present) is:
  • +2 = 25.7% Gain/Annum (6.2% of the time)
  • +1 = 15.4% Gain/Annum (23.6% of the time)
  • Neutral (0) = 4.0% Gain/Annum (39.8% of the time)
  • -1 = -3.3% Gain/Annum (23.7% of the time)
  • -2 = -44.5% Gain/Annum (6.7% of the time)

Source: NDR

SB Comments:  This data pretty clearly shows the historical risks and rewards that come with being in line with Fed activity and market trend.  I use it to help me assess the level of market risk (high low or neutral).  You can see what the returns were like, historically, based on the reading of the indicator. To learn more about this indicator, I wrote a piece entitled, “Watch Out For Minus Two.”

 The Zweig Bond Model:  “Sell” – Signaling Long-Term Bond Exposure: The model is currently Bearish on Bonds

The Zweig Bond signal is one of my favorite processes to identify when to shorten high-quality bond maturities and when to lengthen maturities.  ETFs can be used to position into short-term exposure (e.g. “BIL”) or long-term bond market exposure (e.g., “TLT”, “LQD” and “AGG”).

Please note that this is not a specific recommendation for you as I have no understanding of your personal financial situation.  See important disclosure information below.

Click here to see how to read the above chart.  Click here for notes on “How To Track The Zweig Bond Model” on your own.  See important disclosure information below. NDR disclosure.

Client talking points:

A diversified investment portfolio is designed to meet predefined investment goals.  It is often hard to stay the course when stress presents.  That is when many investors make mistakes.  Diversification means that not all investment risks perform at the same time.  For example, managed futures and long/short funds have underperformed the last several years.  Now many experienced managers are performing well.  We’d all like to be in the best performing areas all the time, but that is just not possible.

Major market events tend to present one or two times per decade.  It is for this reason that a longer-term view can provide a useful perspective.  We know that many investors incorrectly sold out of the markets during the tech bubble in 2000-2002 and again with record selling at the height of the 2008 great financial crisis.  No one knows exactly how the current distress will play out.

I’ve been signaling for some time the issues in the high-yield bond market, issues that can present post Fed QE and zero interest rate policy, issues with unmanageable debt in Europe, Japan and China and the issues a rising dollar may trigger as it relates to the $9 trillion in EM debt that was borrowed in dollars.  As much as I’d like to think I do, I don’t know for sure which or how and when any of the above risks present and the degree to which they might play out.

What we can do is build portfolios that are diversified across a number of risk factors and market environments.  We can identify periods in time to become more or less aggressively positioned (overweight when valuations are cheap and underweight when they are expensive).  We can manage risk not only by the collections of ETFs and funds selected but also how we combine them together.  Diversification brings meaningful improvement to portfolios designed to achieve a return objective over a long-term period to time.

Note on Investment Risk and NDR:

I see the world of investing through a lens of risk and reward.  Ultimately, it is far more important to minimize losses than to capture the best gains.  Find me someone or some way to always capture the best gains – impossible, doesn’t exist.  I’m friendly with some of the world’s greatest investors, and none of them see themselves as perfect.

Over time, it’s really about understanding the power of compound interest.  To this end, I wrote a paper entitled, The Merciless Math of Loss (here).

Thank you for your interest in this weekly post.  It is appreciated!  I hope you find it helpful in your investment and advisory work with your clients.

A quick note on NDR: For years I have subscribed to Ned Davis Research.  They are an independent research firm.  Their clients are institutional (professional) investor clients like CMG.  They are one of the most respected research firms in the business.

They offer several levels of subscription. You can contact them directly at Ned Davis Research at 617-279-4878 to learn more.  Please know that neither I nor CMG are compensated in any form.  I’m just a big fan of their research and their way of thinking.  As a side, Ned Davis authored one of my favorite books entitled, Being Right or Making Money.  A great book full of sound, practical advice. 

Thank you for your interest in this weekly post.  It is appreciated.

Click here for “The History Behind Trade Signals”

With kind regards,

Steve

Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax

Social Media Links:

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You can sign up for weekly updates to AdvisorCentral here.  If you’re looking for the CMG White Paper Understanding Tactical Investment Strategies you can find that here.

AdvisorCentral is being updated with new educational resources we look forward to sharing with you. You can always connect with CMG on Twitter at @askcmg and follow our LinkedIn Showcase page devoted to tactical investing.

A Note on Investment Process:

From an investment management perspective, I’ve followed, managed and written about trend following and investor sentiment for many years.  I find that reviewing various sentiment, trend and other historically valuable rules based indicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included within a broadly diversified total portfolio solution.

My objective is to position in line with the equity and fixed income market’s primary trends.  I believe risk management is paramount in a long-term investment process.  When to hedge, when to become more aggressive, etc.

Trade Signals History: Trade Signals started after a colleague asked me if I could share my thoughts (Trade Signals) with him.  A number of years ago, I found that putting pen to paper has really helped me in my investment management process and I hope that this research is of value to you in your investment process.

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

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. 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 Global Equity Fund^TM, CMG Tactical Bond Fund^TM , CMG Global Macro Fund^TM and the CMG Long Short Fund^TM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456 (1-866-264-9456).  Please read the prospectus carefully before investing.  The CMG Global Equity Fund^TM, CMG Tactical Bond Fund^TM , CMG Global Macro Fund^TM and CMG Long Short Fund^TM 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).