Archive for the ‘technical analysis’ Category

Breadth Character of the US Stock Market

Monday, March 27th, 2017
  • Major stocks indexes still in intermediate-term up trends
  • Breadth indicators suggest problems underneath with prospect of near-term corrective move
  • Maintain current reserves in anticipation of better entry point for broad index positions

WHAT ARE BREADTH INDICATORS?:

Stock market breath indicators  measure the degree to which the price of a market-cap weighted index, such as the S&P 500 index, and the broad equal weighted market are changing in harmony — looking for “confirmation” or “divergence”. With confirmation, expect more of the same. With divergence be prepared for the path of the index to bend toward the direction of the path of the breadth indicator.

It works in a way similar  to the physical world as described in Newton’s First Law of Motion, which says that an object in motion continues in motion with the same speed and direction unless acted upon by outside force. The object is the stock index price. The force is the breath indicator.

There are multiple forces acting upon the object (the stock index), and it is the sum of those forces  that determine the speed and direction of the  index. Breadth indicators are among the more  powerful forces, because they reflect the effect of other forces (such as earnings and growth prospects and microeconomic news) on each of the index constituents separately.

Breadth indicators tend to be more effective at signaling impending market tops than market bottoms.

As more and more of the broad market issues move in the opposite the direction of the market-cap weighted stock index, the greater is the probability of reversal in the direction of the stock index.  The breath indicator represents the equal weighted broad market, which normally peaks before the market-cap weighted indexes peak..

Additionally, when breath indicators reach extreme values in the same direction as a market-cap index,  the market-cap  index is thought to be overbought or oversold, and subject to moderation back toward the moving average.

Let’s look at a few breadth indicators that we follow weekly to see what they might be suggesting at this time about the Standard & Poor’s 500.

CURRENT S&P 500 INTERMEDIATE-TERM TREND CONDITION:

First, let us stipulate that the S&P 500 is in an uptrend. Actually most major indexes around the world are currently in up trends (see a recent post documenting trends around the world).

Figure 1 shows our 4-factor  monthly intermediate-term trend indicator in the top panel in black (100 = up trend, 0 = down trend, 50 = weak or transitioning trend).  (see video explaining methodology, uses, and performance in a tactical portfolio since 1901).

FIGURE 1:

(click images to enlarge)

2017-03-27_SPY trend

 

BREADTH INDICATORS CONDITION:

Percentage of S&P 1500 In Correction, Bear or Severe Bear

We  look for divergences between the direction of the combined constituents of the S&P 1500 broad market index with the direction of the S&P 500 index.

In Figure 2, we plot the percentages of constituents  in a 10%  Correction or worse;  in a 20% Bear or worse;  and in a 30% Severe Bear or worse versus the price of the S&P 500.

This measure’s how much bad stuff is happening in the broad market.  The weekly data is a bit noisy, so we also plot the 13 week ( 3 month) average shown as a dashed line over the weekly data.

Leading up to the 2015 correction, these indicators (particularly the 10% Correction or worse indicator) gave an early warning of developing risk of a market reversal.

After the 2015 correction, those indicators continued to deteriorate, event though the &P 500 recovered; once again giving a signal that not all was well, which led to the 2016 correction.

After the 2016 correction,  those indicators improved rapidly  until the period before the 2016 election where concerns were rising. After the election, the indicators once again improved very rapidly, but now those issues in Correction, Bear  or Severe Bear  are rising again, suggesting caution about the possibility of another market reversal.

(click images to enlarge)

FIGURE 2:

2017-03-26_CBSB

Percentage of S&P 1500 Stocks Within 2% of 12-Month High:

In Figure 3, we plot the percentage of S&P 1500  constituents within 2% of their 12 month high, versus the price of the S&P 500.   This measures how much good stuff is happening in the broad market.

That breadth indicator  began to decline months before the 2015 correction and continued to decline even as the market recovered from that correction, portending the early 2016 correction.

The 13 week average turned down before the larger part of the corrective move preceding the 2016 election and rose after the election, but now it is  rising again, suggesting the possibility for a corrective move in the near term.

FIGURE 3:2017-03-26_2pct

S&P 1500 Net Buying Pressure:

Figure 4 presents another breath indicator, which recall “Net Buying Pressure”.

It measures the flow of money into rising and falling prices of the constituents of the S&P 1500 for comparison with the  direction of movement of the S&P 500  index.

The chart below plots  the Net Buying Pressure for 3 months, 6 months, and 12 months.

We multiply the price change in Dollars of each of the 1500  constituents each day, and multiply that change by the volume of shares traded each day. We sum  the negative products, and sum the positive products.     We then divide the sum of the positive products by the sum of the positive and negative products combined. If the ratio is more 50%,  that means there is more positive product than negative product, which we called Net Buying Pressure.   If the ratio is less than 50%,  that means there is less positive product than negative product, which we call Net Selling Pressure.

You can see in the chart that Net Buying Pressure began to decline in advance of correction in 2015 and continued to decline even as the index recovered before going into a second correction 2016. Since then net buying pressure has risen until just recently, when it has begun to decline again. That suggests to us trend in the S& 500  is not well supported by the broad market, and may be ready for a corrective move.

FIGURE 4:

2017-03-26_NetPressure

 

Bottom line for us is the view that the broad market foundation of US stocks is materially weakening, making the major market-cap indexes (dominated by the largest stocks) increasingly, visibly vulnerable to a material corrective price move; which suggests a better time later to commit new capital than now.

 

 

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All Key Regional Stock Markets Are Now In Intermediate Up Trends

Wednesday, March 22nd, 2017

With Europe and China joining the other key regional markets, they are all now in intermediate up trends, as measured by our 4-Factor Monthly Trend Indicator.  This is not a prediction of the future, merely an observation of the current trend condition of the markets.

(see video description of the indicator methodology and uses; and performance of the US large-caps in tactical allocation since 1901; here).

Each market is plotted below using a proxy ETF, showing the trend indication month-by-month for the last 10 years (4+ years for China ETF).

The trend indicator is plotted in black in the top panel, showing 100, 50 or 0.  A 100 means up trend.  A 0 means down trend.  A 50 means a weak trend or transition between trends.

The 4 factors shown in the main panel are:

  • whether the leading edge of the 10-month moving average is pointing up or down (gold line)
  • whether position of the price is above or below the 10-month average (black vertical bars)
  • whether buying pressure is net positive or net negative (dashed green line, left scale)
  • whether the rate of price change in the direction of the trend is keeping up with a geometric pace  (red dots).

US STOCKS INTERMEDIATE-TERM TRENDS:

(click images to enlarge)

S&P 500 Large-Cap (SPY)

2017-03-21_SPY trend

S&P 100 Mega-Cap (OEF)

2017-03-22_OEF trend

S&P 400 Mid-Cap (MDY)

2017-03-22_MDY midcap

Russell 2000 Small-Cap (IWM)

2017-03-22_IWM Smallcap

Russell Micro-Cap

2017-03-22_IWC microcap

Russell 3000 “total market” (IWV)

2017-03-22_IWV R3000

 

INTERNATIONAL STOCKS INTERMEDIATE-TERM TRENDS:

Europe (VGK):

2017-03-22_VGKtrend

Japan (EWJ):

2017-03-22_EWJ trend

China (MCHI):

2017-03-22_MCHI trewnd

Global Emerging Markets (VWO):

2017-03-22_VWO Trend

Frontier Markets (FM):

2017-03-22_FM trend

 

 

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Equity Market Conditions Assessment & Portfolio Allocation Intentions 2017-03-17

Monday, March 13th, 2017

This note has three parts:

  1. Short summary of our current market view and portfolio allocation implications
  2. Bullet point outline of details behind our thinking in 5 segments (Trend, Valuation, Sentiment, Breadth, Forecasts)
  3. Supporting graphics for most of the bullet points provided in 24 charts and tables.

The short summary is of our market view and intended allocation actions for discretionary accounts, and recommended actions for coaching or “prior approval” accounts

For those of you who want a feel for why we have our market view and why we believe the allocation changes are appropriate; the bullet points will help.

If you want to see what data is behind most of the bullet points, you will want to look at the 24 supporting graphics.

There is an unfortunate need to use some jargon in the bullet points and graphics which may be unfamiliar to some of you, so please call or write in to have any of them explained; and to discuss their significance to portfolio decisions.

THE SHORT SUMMARY …………

Major world equity markets are in up trends — but there is mounting evidence that the US markets are over-extended and significantly vulnerable to a meaningful downward adjustment based on a combination of valuation, breadth, possible turmoil from key elections in Europe; and as Goldman Sachs puts it “rhetoric meets reality” in Washington.

Downside risk exists, but while the trend remains upward, we are remaining invested.  However, we are not committing additional assets from cash positions to US equity risk positions at this time (except for dollar-cost-averaging programs) due to the elevated vulnerability of the US stocks market.  We will be transferring some of the US equity risk assets in portfolios to some international markets that are in intermediate-term up trends that offer better valuation opportunities.

Portfolio changes or recommendations will be framed within the strategic allocation policy level of each client which varies based on individual needs, goals, stage of financial life, preferences, risk tolerance, and other limits or factors.

Based on valuation and long-term forecasted returns, US stocks exposures will transition from the higher end of individual portfolio policy allocations to the long-term strategic objective levels, or a bit below.  We are currently underweighted non-US developed markets and emerging markets allocations, which we will gradually raise to the long-term strategic allocations levels of each individual portfolio’s allocation policy.

Emerging markets have a more attractive valuation level than other non-US international stock markets (although they pose significantly more volatility), and allocation to them may be raised somewhat above strategic target levels within individual permitted allocation ranges.

For determination of intermediate trend status, we relay on our monthly 4-factor indicator. For more information about our trend following indicator and its performance implications, click here to see our descriptive video.

THE BULLET POINTS …………

  • TREND (see Figures 1-6): The intermediate-term stock trends are:
    • United States – UP
    • Non-US Developed Markets – UP
    • Emerging Markets – UP
  • VALUATION (see figures 7-12): Based on history:
    • United States – Expensive on Price-to-Book and Price-to-10yrAvEarnings and not expensive when earnings yield is compared to Treasury yields.  However, when rates rise the comparison will worsen, making stocks more expensive.
    • Non-US Developed Markets – Moderately expensive on Price-to-Book and moderately inexpensive on Price-to-10yrAvEarnings
    • Emerging Markets – Significantly Inexpensive on Price-to-Book and Price-to-10yrAvEarnings
  • SENTIMENT (see Figures 13-17): for US stocks are:
    • Institutional Investors – are reducing equity allocations (a Bearish indication)
    • Investment Newsletter Writers – Bullish at record high levels (a Bearish contra indication)
    • Individual Retail Investors – strongly Bearish this week but neutral last week
    • Options Market – complacent to mixed (jargon terms defined below):
      • Volatility Index – below 200-day and long-term average (complacent, expects smooth ride next 30 days)
      • Skew Index – above 200 day average and long-term trend line (nervous about possible large downside move, next 30 days)
      • Individual Equities PUT/CALL ratio – is 9% above its 200-day and its 10-year average (more cautious that institutional investors)
      • Index PUT/CALL ratio – is 7 % above 200-day average and 4% below its 10-year average (cautious but mixed signal)
  • BREADTH (see Figures 18-21) the trends are:
    • Percent of S&P 1500 stocks in Correction, Bear or Severe Bear have decidedly turned up (Bearish)
    • Percent of S&P 1500 stocks within 2% of their 12-month highs have decidedly turned down (Bearish)
    • The net flow of money is into S&P 1500 stocks over 3 month, 6 months and 1 years, but the leading edge of those flow has turned down
    • The net flow is explained by the net Buying Pressure declining substantially more than the Selling Pressure; and both measures are at levels below the 12-month average indicating reduced overall force driving the market
  • FORECASTS (see Figures 22-24):
    • “Street” consensus 2017 S&P 500 earnings growth 8.9% on revenue growth of 7.2%
    • “Street” consensus 2018 S&P 500 earnings growth of 12.0& on revenue growth of 5.1%
    • Consensus 3-5 year earnings growth for S&P 500 is 8.89%
    • Consensus 3-5 year earnings growth for MSCI non-US developed markets stocks index is 8.76%
    • Consensus 3-5 year earnings growth for MSCI emerging markets stocks index is 10.37%
    • Consensus 3-5 year earnings growth for MSCI core Europe stocks is 8.11%
    • Consensus 3-5 year earnings growth for MSCI Japan stocks is 9.43%
    • Consensus 3-5 year earnings growth for MSCI China stocks is 7.13%
    • Bank of America/Merrill Lynch just raised its 2017 S&P 500 price target from 2300 to 2450
    • Research Affiliates (leading factor based investor) forecasts 10-year real (after inflation) returns:
      • US large-cap stocks 0.7% (with 14.4% volatility)
      • US small-cap stocks 0.5% (with 19.6% volatility)
      • Non-US Developed Markets stocks 5.4% (with 17.0% volatility)
      • Emerging Markets stocks 7.0% (with 23.3% volatility)
    • GMO Bearish Mgr (lowest min fund investment $10 million available) forecasts 7-year real returns
      • US large-cap stocks – negative 3.4%
      • US small-cap stocks – negative 2.7%
      • Large International stocks – positive 0.2%
      • Emerging Market stocks – positive 4.1%
    • BlackRock (fund manager in the world) forecasts 5-year nominal returns
      • Large US stocks 4.1% (with 15.5% volatility)
      • Small US stocks 4.1% (with 18.7% volatility)
      • Large International stocks 5.5% (with 18.5% volatility)
      • Emerging Markets stocks 5.5% (with 23.3% volatility)

Options Jargon Description:

VIX: VIX is the options pricing implied volatility of the S&P 500 index over the next 30 days, based on at-the-money options

SKEW: SKEW measures the relative options “implied volatility” (essentially price) of S&P 500 out-of-the-money PUTs versus out-of-the-money CALLs with strike prices the same distance from the market price – essentially measuring the perceived “left tail risk” (tail risk is the probability of prices going below the level that is predicted by a normal probability Bell curve).

Portfolio managers are predisposed to buy PUTs for protection and sell CALLs for yield, which tends to increase out-of-the-money PUT premiums and depress out-of-the-money CALL premiums.

SKEW of 100 means the market expects equal implied volatility (essentially prices) for out-of-the money PUTs and CALLS.  SKEW greater than 100 means the market expects higher implied volatility (prices) for PUTs relative to CALLS – more perceived large downside risk.

The record low SKEW was 101.9 on March 21, 1991. The long-term average SKEW is around 115, and the high is around 150. The current 200-day average SKEW is about 130, and the current level is about 140. That means there is a heightened concern about a greater than typical risk of a large downside move in US stocks.

INDIVIDUAL EQUITIES PUT/CALL RATIO: The Equities PUT/CALL ratio is the PUTs volume divided by the CALLs volume on individual stocks. This tends to be reflection of actions by retail investors; and is often a contrary indicator.

INDEX PUT/CALL RATIO: The Index PUT/CALL ratio is also the ratio of the volume of PUTS and CALLS, but tends to be a reflection of the actions of institutional investors; and is not considered a contrary indicator.

THE SUPPORTING GRAPHICS …………

(click images to enlarge)

TREND

FIGURE 1: 
Over the past year, US stocks (VOO), non-US Developed Markets (VEA) and Emerging Markets (VWO) are generally in an up trend, although the US is way out front.

2017-03-13_00
FIGURE 2:
Over 3 years, the three regions are up, but the US is way ahead, and did not have as severe down moves as the other two regions.

As you will see the outperformance by the US is related to its current overvaluation, and the weaker performance of the other markets, is related to their more attractive valuation.
2017-03-13_01
FIGURE 3:
Our 4 factor monthly trend indicators ranks each of the three regions as in an up trend.
2017-03-13_02
FIGURE 4:
This time series of our trend indicator for the US shows the up trend established since March 2016.
2017-03-13_03
FIGURE 5:
The up trend in non-US Developed Markets was established in November 2016.
2017-03-13_04
FIGURE 6:
The up trend in Emerging Markets was established at the end of December 2016.
2017-03-13_05

VALUATION

FIGURE 7:
On price-to-book basis the US is very expensive (at the top of its 10-year range). Non-US Developed Markets are “normally” valued (at just above their median level). Emerging markets are inexpensive (price significantly below their median level).
2017-03-13_06
FIGURE 8:
In terms of the Shiller CAPE Ratio (price vs 10-year inflation adjusted average earnings), the US is very expensive relative to is long-term history. Developed Markets are inexpensive, and Emerging Markets are significantly inexpensive.
2017-03-13_07
FIGURE 9:
Based on a variety of valuation metrics the US is expensive. The Developed and Emerging Markets inexpensive by comparison.  Emerging Market have more attractive valuations than the Developed Markets.

In terms of profitability, the US is tops, which partly explains the higher valuation. Developed Markets are less profitable than Emerging Markets.

Emerging markets have competitive dividend yields and the lowest payout ratios.

Emerging markets seem to be a bit less leveraged than US stocks, and the Developed Markets are the most levered.
2017-03-13_08
VALUATION of US ALONE ….

In addition to the price-to-book and Shiller P/E to their respective histories, several other valuation metrics for the US should be considered; almost all of which suggest the market is very expensive

The “equity risk premium” [(stock earnings / price) – (10-yr Treasury yield)] is the only key valuation metric that suggest that stocks may not be overvalued; and that argument depends of the current historically low Treasury yields.

FIGURE 10:

Current equity risk premium for the 10-year inflation adjusted earnings-to-S&P 500 price is 0.90%. Since 1881, the equity risk premium for the S&P 500 and its large-cap precursors was higher 68% of the time.  That suggest modest overvaluation.

However, since the risk premium first went negative in 1964 (except for 4 months in 1929), the equity risk premium was only higher than now 30% of the time — a Bullish suggestion.

The question is whether the 135 history, or the 52 year history is the more important to consider. If the long history is more important, then the S&P 500 is somewhat expensive relative to the yield on 10-year Treasuries; but if the shorter history is more important, then the S&P 500 is inexpensive relative to Treasury yields.  However, Treasury yields are suppressed, and if they normalize to something in the 3% to 4% range before profits increase a lot, then stocks are expensive.
2017-03-13_09
FIGURE 11:
Current equity risk premium for the 12-month trailing earnings-to-S&P 500 price is 1.17%. Since 1881, the equity risk premium for the S&P 500 and its large-cap precursors was higher 68% of the time.  This also suggests moderate overvaluation.

However, since that risk premium first went negative in 1967 (except for 1 month in 1921), the equity risk premium was only higher than now 29% of the time — a Bullish indication.

The question is whether the 135 history, or the 49 year history is the more important to consider. The same logic applies as it does for the equity risk premium based on the 10-year inflation adjusted earnings yield.
2017-03-13_10
FIGURE 12:

S&P 500 GAAP earnings are not much higher than they were 4 years ago, yet the price of the index is a lot higher. That means much of the rise in the price of the index is merely paying more the what you get, not getting proportionately more for paying more.

10-year Treasury rates in 2013 more than doubled from less than 1.5% to more than 3%, yet the S&P 500 continued to rise in price faster than earnings.

Once again 10-year Treasuries have risen in 2016 from less than 1.5% to more than 2.5% and the price of the S&P 500 has continued to rise, even in the face of flat earnings, with falling earnings close behind in the rear view mirror.

If interest rates should make it to 3% in the near-term (not an unthinkable event), the equity risk premium on trailing 12-month earnings would drop from 1.17% to about 0.75%. Since 1881, the risk premium has been higher than 0.75% more than 70% of the time; and since 1967 it has been higher 64% of the time.  That would be Bearish.

This suggests valuation vulnerability in the face of probable moderate interest rate increases.

2017-03-13_11
SENTIMENT

FIGURE 13
The State Street Investors Confidence index is a behaviorally measured sentiment index — a measure of increases or decreases in public equity allocation in actual institutionally managed portfolios, a real measure of market sentiment by large institutions.

The rate of increase in their public equity risk allocations began a decline in around 2 years ago.  They began actually decreasing their public equity allocations in 2016 and continue to do so.

This is not an endorsement of current stocks markets.
2017-03-13_12
FIGURE 14:
Investors Intelligence monitors 100 leading investment newsletters to gauge the Bullish or Bearish sentiment of those writers. Extreme peaks in sentiment tend to be contrary indicators (not perfectly, of course), but when “everybody” is Bullish or Bearish, a trend is often about to be exhausted; because there are few additional people to join the point of view and bring move more money in the direction of the trend.

The current Bull-Bear spread is among the most extreme Bullishness of the last 10 years.  This suggests that a corrective action is likely nearby.

2017-03-13_13
FIGURE 15:
The American Association of Individual Investors conducts a continuous online survey of it members — essentially the retail investor.  Last week when this chart was created, the Bull-Bear spread was 2.29%, barely on the Bullish side of neutral.  In the subsequent week it turned on a dime dropping to negative 16.5%; strongly Bearish.

The chart suggests that this data is more a coincident indicators than a forward indicator, so the drop in sentiment parallels the recent weakness in the up trend.
2017-03-13_14
FIGURE 16:
TD Ameritrade publishes the Investor Movement Index.  It is Bullish at this time.  Here is what they do to make their index.

Each month Ameritrade calculates a short-term Beta (volatility relative to a benchmark such as the S&P 500) for each security.
Then it takes a sample of hundreds of thousands of customer accounts with at least $2,000 in their account and in which at least 1 trade was done the month, from its approximate 6 million customers.
It measures the total equity allocation and the aggregate short-term Beta (volatility relative to volatility of the S&P 500) of the equities in each portfolio (and other undisclosed factors) to develop the risk level of each portfolio.
Then equal weighting each account without regard to size or number of trades, it finds the median equity risk exposure, and puts that on its index scale (scale parameters not disclosed), and plots that versus the S&P 500.
The level and direction of the index is an indication of actual retail investor behavior instead of what they might say about their sentiment.

2017-03-13_15
FIGURE 17:
The options market reveals the actual risk taking behavior of investors in terms of the pursuit of gain (buying CALLs) or seeking protections (buying PUTs).  Here are 4 measures of options market behavior.

VIX measures the expected volatility of the S&P 500 over the next 30 days.  At under 12, the VIX is well below the 10 year average of about 20, and among the lowest levels of the past 10 years.  This is complacency.  Complacency is probably like everybody being on the same side of a boat, which makes the boat prone to tip over.  Volatility is a mean reverting measure, which suggest more volatility in the relatively near future than in the relatively near past.

The SKEW Index (defined above in the jargon section) is a measure of the concern over the size and probability of an unusually large downside move.  That measure is elevated, which gives reason for caution.

The Equity PUT/CALL index (defined above in the jargon section) is a measure of the relative “protection seeking/opportunity seeking” behavior of mostly retail investors.  That ratio is slightly elevated versus average levels, indicating a mildly increased relative pursuit of protection.

The Index PUT/CALL index (defined above in the jargon section) is a measure of the of the relative “protection seeking/opportunity seeking” behavior of mostly institutional investors.  That ratio is slightly lower than average, indicating a mildly lower than average relative pursuit of protection.
2017-03-13_16
BREADTH
This is one of our favorite measures, and one that we directly measure weekly since the beginning of 2014.  Breadth measures the condition or behavior of the overall membership of the broad S&P 1500 index and compares it to the price level of the market-cap weighted S&P 500 index — in other words, it checks to see if the rank and file members of the market are going in the same direction as the mega-cap leaders of the market.

For example, the price movement of Apple and Exxon have a lot more impact of the price of the S&P 500 or the S&P 1500 than 100’s of smaller members of the S&P 500 and S&P 1500.  If the rank and file are going in the same direction as the leadership, that is Bullish breadth.  If they are going in the opposite direction, that is Bearish breadth.  The leaders can only go so far for so long without the rank and file coming along.

FIGURE 18:
The percentage of S&P 1500 index constituents in a Correction or worse (grey line — down 10% or more from their 12-month high) rose dramatically before the November presidential election, then dropped off just as steeply to among the lowest levels in the past 3 years.  Just recently, however, the percentage in Correction or worse sharply turned up — still in “normal” range, but the direction change is a negative for the current stocks rally.

The same is true, but to a lesser extent for the percentage of S&P 1500 stocks in a Bear or worse (blue line — down 20% or more), or in a severe Bear or worse (red line — down 30% or more).
2017-03-13_17
FIGURE 19:
The percentage of S&P 1500 stocks within 2% of their 12-month high was declining prior to the election, turned up sharply to reach the highest level in the past 3 years immediately after the election, but has since declined to the “normal” range with a current downward direction.  The provides a note of caution about the current rally.
2017-03-13_18
FIGURE 20:
The Net Buying Pressure (Buying Pressure / Sum (Buying Pressure + Selling Pressure), which has been net positive since the bottom of the early 2016 Correction, began to decline before the election; resumed growing strength after the election; but has recently been losing steam.  This is not supportive of the current rally.
2017-03-13_19

BuyingPressureMethod
FIGURE 21:

The separate Buying Pressure and Selling Pressure components of the S&P 1500 stocks Net Buying Pressure in the figure above are shown here.

The rising S&P 500 price in 2016 was not matched by rising Buying or Selling Pressure, showing waning enthusiasm for equities.  After the election both Buying and Selling Pressure rose, but Buying Pressure rose more than Selling Pressure.  Recently however, the decline in Net Buying Pressure noted above, is the result of Buying Pressure declining substantially, while Selling Pressure has declined far less.

These data also suggest the fuel of the rally may be running low.
2017-03-13_20

PressureCompnentsMethod
FORECASTS
Looking way down the road with 5-10 year forecasts, and supporting our view that a shift in allocation more toward international equities, and less in US equities is appropriate, are forecasts by Research Affiliates (a noted factor-based asset manager), by GMO ( a Bearish asset manager for the very wealthy — $10 million and up to invest in their funds); and by BlackRock (the largest fund manager in the world).
FIGURE 22:
Research affiliates studies factors with focus on the current Shiller CAPE Ratio (Price divided by the inflation adjusted 10-year average Earnings) relative to its historical median, and historical highs and lows.  They find that to be a good long-term indicator of opportunity.  They view the CAPE Ratio as mean reverting over the long-term.

Based on CAPE and other factors, this chart shows how they see the real (nominal less inflation) return and the volatility of US, non-US Developed Markets (“EAFE”) and Emerging Markets (“EM”) working out over the next 10 years on an annualized basis.  They definitely see international equities as the place to be — but with more volatility.

2017-03-13_21
FIGURE 23:
GMO does not disclose their forecasting methodology, but they are among the most Bearish institutional manager, so worth noting for that.  Over the next 7 years, they see the real return on US large-cap stocks as negative 3+%; the real return on large international stocks as barely positive; and the real return on Emerging Market as positive 4+%.  They also see negative real returns on US and Dollar hedged international bonds, but positive 1+% real returns on Emerging Markets debt.

2017-03-13_22
FIGURE 24:
Over the next 5 years, BlackRock sees nominal return on US stocks as very low, and much lower than international stocks.  They see non-US Developed Markets stocks as generating nominal return  at about the same level as Emerging Markets, but with volatility similar to that of US small-cap stocks; whereas they see much higher volatility for Emerging Market stocks.
2017-03-13_23

 

 

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Intermediate Trend Status of All Stocks, ETFs and Mutual Funds (Feb.’17)

Wednesday, March 1st, 2017

Warren Buffet wisely said,

“Be fearful when others are greedy, and be greedy when others are fearful.”

Clearly, you should only be greedy for fundamentally “good” assets, which requires fundamental analysis as the first level of decision-making.

However, determining “when others are greedy” and “when others are fearful” is a matter of technical analysis, which is a good companion to fundamental asset selection and allocation.

Investors as a whole are most greedy at the top of an up trend, and most fearful at the bottom of a down trend.

To follow Buffet’s advice, you must choose between predicting the tops and bottoms of cycles (market timing), or measuring that a top or bottom has just occurred (trend following).

Trend following is the rational choice in our view.

  • Market Timing is based on unspecified or variable information and opinion inputs – it cannot be defined, automated and back-tested.
  • Trend Following is based only on price and volume behavior – it can be defined, automated and back-tested.
  • Market Timing is opinion; subjectively derived about what someone thinks the market ought to do next.
  • Trend Following is factual; objectively derived by observing what the market price and volume have done.

Diagram Mkt Timing versus Trend Following

The “QVM 4-Factor Trend Indicator” is an intermediate trend following method. It is meant to be a technical companion to fundamental asset selection and allocation.

A video explanation of the indicator methodology, including back-testing results with the S&P 500 and precursors from 1904  follows in this video.

It is reasonable to be in or overweight those securities in confirmed up trends; and to be out of or underweight those in confirmed down trends.

If you are considering certain securities for entry, it is reasonable to enter only in a confirmed up trend.

Why enter during a down trend, since you don’t know where the bottom is.  If those securities you intend to own are currently in a down trend, it is reasonable to wait for that down trend to change to a confirmed up trend before committing capital.

The principle value of trend following in practice is not outperforming in up markets, but rather outperforming in down markets (“winning by not losing”) — having a low capture ratio in down markets and a reasonable capture ratio in up markets.

Each month, we measure the intermediate trend status of thousands of listed stocks and ETFs, and over 1400 retail level mutual funds.

For February 2017, we measured the trend status for 8,020 securities.

  • 74% of both the S&P 100 and S&P 1500 stocks were in demonstrated up trends
  • 61% of the 6,578 listed securities were in demonstrated up trends.
  • 78% of the 1,442 mutual funds were in demonstrated up trends.

While this is a monthly subscription data service, the February data package is available to anyone without charge.  Download the full 2017-02-26 trend data spreadsheet here.

REPORT FORMAT AND CONTENT

This article will show you the current trend status of key securities, but first, here is the structure of  what is in the data package.

Full Spreadsheet ColumnsView Annotated

Each tab in the spreadsheet has:

  • the overall trend determination, and the status of the 4 components of the measurement
  • a strength measure for the trend
  • the position of the price versus its trailing high and its trailing range
  • an Overbought and Oversold indicator
  • the price change over the past 3 months and 12 months
  • the average Dollars traded per minute for the security (except for mutual funds which have no volume data)
  • and links per security to multiple third-party information sources (Morningstar, Seeking Alpha, Yahoo, StockCharts, & BarChart)

This is what the trend data looks like:
info1

This is what the other data looks like:info2This is what the third-party information links look like:

info3

If you would like to inspect your portfolio holdings in terms of their intermediate-term trend condition, download the February data package.  The tab for the 1,442 mutual funds most likely has any fund you may own.  The tab for all listed securities with sufficient data (about 28 months of existence) will most likely have the vast majority of the listed securities you own.

CAUTION: Bond funds are included in the study, but the trend determinations may be less clear for them, as bonds do not tend to change direction as often or as dramatically as equities — and this methodology has not yet been back-tested for bonds.  Bond funds are included for completeness, but may not all be appropriate for such analysis.  Long-term and low quality bond funds are probably more appropriate for this method of analysis than short-term and high quality bonds funds.

FEBRUARY TREND MEASUREMENT RESULTS

Here are some of the data points that may be of general interest about the state of the markets:

TARGET DATE FUNDS

All of the members of this group from Vanguard (the largest purveyor of target date funds) for retirement years 2015 – 2055 are in demonstrated up trends.

tgt date

Vanguard target date funds are composed of 5 funds in different allocations along a glide path — one fund each for:

  • US stocks,
  • International stocks,
  • Aggregate US bonds,
  • Short-term US Treasury inflation protected bonds,
  • Aggregate Dollar hedged international investment grade bonds

US ETFs BY STYLES, SECTORS, FACTORS & DIVIDENDS

These and most US asset categories are in up trends.  Some are in or near overbought condition as the “Buying Pressure Level” column shows.

styles and sectors

NON-US COUNTRY ETFs

More are in up trends than down trends. This list is of the country funds in up trends. Interesting to see that Argentina is in the second strongest trend, as measured by Buying Pressure Level.

countries up

This is the list of country funds in down trends.  Mexico is in that group, which may be partially a Trump effect.

Countries down

The other country funds are rated 50 either because they have weak trends, or because they are in transition from one direction to the other.

S&P 100 STOCKS IN UP TRENDS

74% of S&P 100 stocks are in up trends.  Here are the 25 of those in the strongest up trends.  They are mostly all in or near overbought condition.

SP100up

S&P 100 STOCKS IN DOWN TRENDS

SP100 down

LIQUID ETFs IN DOWN TRENDS

Most liquid ETFs (defined here as trading at least $15,000 per minute) are in up trends or rated 50 for a weak or transitional trend, but here is the complete list of those non-bond, non-levered, liquid ETFs that are in down trends.

LquidETFS down

COMMON PORTFOLIO ASSET CATEGORIES

The ETFs in this list represent commonly held asset categories in portfolios:

  • total US stocks
  • large-cap developed markets ex US stocks
  • large-cap emerging market stocks
  • US REITs
  • intermediate-term US Treasuries
  • short-term US Treasury inflation protected securities
  • US aggregate bonds
  • Dollar hedged investment grade international bonds
  • Dollar denominated sovereign emerging market bonds
  • gold bullion.

The David Swensen Portfolio components were referenced in his 2005 book, “Unconventional Success –  a Fundamental Approach to Personal Investment”.  The allocation he used (as updated in 2015 to 5% more emerging markets and 5% less REITs), was 30% US stocks 15% developed markets ex US stocks, 10% emerging markets stocks, 15% US REITs, 15% intermediate-term US Treasuries, and 15% US Treasury inflation protected securities.

He termed it a “reference portfolio” because it is merely a starting point for personalization based on goals, needs, circumstances, and the ability to stick with the portfolio over time.

Swensen is the long-time CIO of the Yale endowment.

2 simple portfolios

We hope you found this helpful and would be pleased to discuss with you how this methodology could be overlayed on your portfolio.  The monthly data subscription is $299 per year.

 

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Intermediate-Term Technical Condition of Domestic & Int’l Stocks and Bonds

Tuesday, November 29th, 2016

There is more to consider than technical condition of markets and securities, but combining technical condition information with fundamental and macro-economic information makes for better decisions.

Let’s look at the intermediate technical condition of US large-cap stocks; EAFE (DM ex US large-cap stocks) and EM stocks; as well as Aggregate US bonds, DM Dollar hedged investment grade bonds, and EM Dollar denominated sovereign bonds.

We used SPY, VEA, VWO, BND, BNDX and VWOB to represent those major categories in Figure 1.

FIGURE 1:

2016-11-29_a1

The red/yellow/green color coded scales in Figure 1 rate each category as trending UP or DOWN or in Transition.  If the category is in Transition, a horizontal arrow shows the direction of the Transition from Up to Down, or from Down to Up.  If the price has crossed the primary trend line in a direction opposite of the trend direction, the rating is noted with an “X”.

Figure 2 presents the 4 essentially non-overlapping monthly factors in the QVM trend indicator, along with how they are scored and summed to an overall rating. The indicator is a price-only indicator, which does not consider distributions, which are part of total return.

FIGURE 2:

(click images to enlarge)

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There are 9 possible configurations of the 2-month leading edge of the Major Trend.  Figure 3 presents those 9 configurations graphically and how each is scored by the indicator.

FIGURE 3:

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We use a custom built program to plot a running rating for each security, which is shown in black in the top panel of Figure 4.

The middle panel in blue is ancillary information showing the distance of the price from the 12-month trailing high.

The main panel contains the 4 factors:  Major Trend in gold; Price in black, Buying Pressure in green; and Parabolic Pace in dotted red.

FIGURE 4:

 

2016-11-29_d

In a more compact way, and for easier comparison between charts, we also look at charts from StockCharts.com that contain essentially the same, but not exactly the same data (see Figure 5) — the difference being that dividend adjustments made by StockCharts sometimes cause ratings to differ somewhat when the technical condition is close to a change.  Most of the time, for practical purposes, the StockCharts plots are sufficient.  The StockCharts plots, however, cannot calculate or display the actual rating.

FIGURE 5:

2016-11-29_e

Figure 6 shows the tabular output of our software showing how each of the 4 factors is rated, along with the overall trend rating, with some additional information (Buying Pressure level, distance of the price from the 12-month trailing high, and the position of the price within the 1-year high-low range).

FIGURE 6:

2016-11-29_e2

It is important to note that value and technical condition are not always aligned.

Figure 7 shows the Shiller price to 10-year average inflation adjusted GAAP earnings (“CAPE” for cyclically adjusted P/E), as it relates to the long-term median of that valuation multiple; and the expected 10-year return based on a potential decade-long mean reversion.

Bottom line, US large-cap stocks are in the best current trend condition, and are the most expensive, with the lowest return if valuation revert to the mean over the next 10 years.  Non-US DM stocks and EM stocks are in poor trend condition, and are significantly less expensive, with substantially higher next decade returns in the event of valuation mean reversion (see Figure 7).

Note that US large-cap stocks and DM stocks have similar expected volatility, whereas EM stocks have much higher expected volatility.

FIGURE 7:

2016-11-29_f

A more graphical way to look at the relative valuation of US large-cap stocks versus DM and EM stocks is in Figure 8, which shows the extremes of CAPE valuation, the range where the valuation is most of the time (in green), and the current valuation (black dot).  US large-caps are very expensive by this measure, and DM and EM stocks are inexpensive.

FIGURE 8:

2016-11-29_g

Figure 9 calculates the percentage price change that would be required today for a full mean reversion.  It is unlikely to make such a sudden full jump, but the percentages are another good way to see the disparities in valuation; and the theoretical price gain potential (before consideration of various political, macroeconomic and other factors).  It also shows the Morningstar provided 3-5 year earnings growth expectations, and our calculation of the PEG ratios using Morningstar data.

FIGURE 9:

2016-11-29_h

Figure 10 provides the current QVM 4 factor trend ratings for the 10 sectors of the S&P 500.

Figure 10:

2016-11-29_j

 

These data suggest that for those with a patient, long-term view, a little less US stock and a little more DM and EM stock should prove beneficial; BUT that requires accumulating assets that are in price decline, or maintaining an above average cash position to wait for DM and/or EM stocks to change to an intermediate up trend.  Even then EM stocks will provide a bumpy ride.

The cash holding to wait for a turn in DM or EM stocks is reasonable, because there is a distinct possibility (not necessarily probability) that US stocks could be in decline as DM and EM stock are ascending, in which case emotions may prevent the reallocation, or the gains and losses could substantially cancel each other.

All that is really being suggested here is rebalancing within the investment policy allocation range for each key asset type;, or using cash as in intermediary step between decumulation of one asset and accumulation of another based on trend evaluation.

Those near or in retirement need to make sure that in addition to any such long-term positioning, they maintain sufficient safe, liquid assets to be able to make withdrawals for a few years out of assets that do not fluctuate much in price, in the event of an extended or major market decline. The most vulnerable years are the 5 years leading to and 5 years after beginning to rely on the portfolio to support lifestyle.

In terms of sectors, the trend condition reports the obvious, which is that REITs, Consumer Staples, and Utilities are struggling with pending interest rate increases — and therefore should probably be kept at the minimum of the investment policy range for each portfolio until the trends recover.

The securities used in these trend evaluations were:

  • SPY – US large-cap
  • VEA – DM non-US stocks
  • VWO – EM stocks
  • BND – US aggregate inv. grade bonds
  • BNDX – DM Dollar hedged inv. grade bonds
  • VWOB – EM Dollar denominated sovereign bonds
  • XLB – basic materials
  • XLE – energy
  • XLF – financials
  • VNQ – REITs
  • XLI – industrials
  • XLK – information technology
  • XLP – consumer staples
  • XLU – utilities
  • XLV – health care
  • XLY – consumer discretionary

We will publish a similar review of country ETFs in a future article.

 

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S&P 500: Where From Here? (2016-01-22)

Monday, January 25th, 2016

We have been getting calls, asking where the market is going. To be clear, nobody really knows. Markets can do anything – an they usually do. That said there are some technical tools to take reasonably educated guesses about what might happen in the short-term (excluding exogenous changes, such as central bank policy changes, or shocking macroeconomic statistic releases, or some terrible world event).

Fundamental projections are not any more useful in the short-term than technical indications. Fundamentals do determine where markets end up in the long-term, in the short-term emotions, funds flows and world events (and media hype) have a lot more to do with market behavior than fundamental valuation.

Adam Parker, founder of FundStrat, and former Chief Equity Strategist at Morgan Stanley recently had this to say about market price forecasting based on valuation.

“Trying to figure out where the market is going is like taking something we don’t know how to forecast (the price-to-earnings ratio for the market) and multiplying it by something we aren’t very good at forecasting (the earnings for the market). We have always written that we don’t think anyone can forecast the market level P/E ratio in time frames less than a few years.”

OUR SHORT-TERM VIEW SUMMARY:

  • The primary trend for US stocks and the S&P 500 in particular is down
  • The rally last week was contra trend, but was likely not a reversal of the downward primary trend
  • The current S&P 500 price is far enough below its trend that there is a statistical probability of a contra trend rally to perhaps 1935
  • There are numerous fundamental and macro issues that are applying negative force to continue the downward primary trend
  • Internal breadth of the S&P 500 (as well as other major indexes around the world) is decidedly negative
  • Historical volatility over 1 year, 6 months and 3 months suggest a reasonably likely index price range over the next 3 months between 2250 and 1775
  • The downward path of the primary trend suggest the lower half of the 2250-1775 range is more likely to be realized
  • Fibonacci, Price Channel and Pivot Point indicators suggest the index price may experience resistance in 1935 to 1950 range, 1970 to 1975 and the 2015-to 2025 range

INVESTMENT UTILITY OF SHORT-TERM VIEW

Investors in Accumulation Stage (averaging in): This short-term view of the primary trend is not relevant to most investors with a long time-horizon before retirement, who have chosen their appropriate risk profile, and who are continuing to add capital to their investment portfolio.  Those investors are probably best served by simply maintaining the allocation risk profile they have selected, and going about the business of earning money and saving as much as they can.

Since downturns don’t last forever, and periodic investments buy more shares during downtrend than in uptrends,  short-term trend information may be useful to those periodic investors who can squeeze their household budgets to increase periodic investments during downtrends.

Investors in Withdrawal Stage (averaging out): This short-term view of the primary trend is relevant for those who are in or near retirement who want to reduce the “risk of ruin” (outliving assets) due to  having to sell assets during a decline to fund withdrawals.  Note that retirement portfolios are depleted at an accelerated rate when selling assets during declines, increasing the risk of outliving assets.

For those investors in the withdrawal stage of their financial lives, a recent statement by Bill Gross (formerly CEO of PIMCO and noted bond manager) is relevant.  He said the current market is one for return OF capital more than one of return ON capital.

The risk of ruin is minimized for those investors in retirement who can live out of investment income without selling assets.  Dividend investors may have a lower risk of ruin if their dividend stocks have above inflation dividend growth rates, and thus they may have less interest in short-term trend changes.

Investors With a Desire or Need for a Tactical Overlay: Several sorts of investors occur to us to may find short-term trend information relevant:  (1) those withdrawal stage investors  relying on capital appreciation for a significant portion of their retirement income, (2) those accumulation stage investors who wish to increase periodic investments during downturns, (3) margin investors, (4) options investors, and (5) and other investors in any stage of their financial stage of life who prefer to engage in some form of tactical investing:

  1. Withdrawal stage investors who cannot live out of investment income alone (who must periodically sell assets to fund withdrawals) may wish to use trend information to modulate their debt / equity allocation between minimum and maximum investment policy levels to reduce risk of ruin
  2. Accumulation stage investors may wish to commit more money to regular periodic asset purchases when prices are declining than when rising to improve the average cost of their holdings.
  3. Long or short investors on margin, want to be in line with the short-term trend to avoid leveraged losses and margin calls
  4. Option investing/speculation is short-term in nature due to option expiration dates — they definitely need short-term trend information
  5. Some investors just have a desire to be tactical with a portion of their assets for one reason or the other; ranging from a gaming spirit to the need to sleep well at night.
If for any of these reasons, or mere curiosity, short-term stock market condition and direction is of interest to you, please read on.

FUNDAMENTAL VIEW

The most important fundamental factor for most companies most of the time is the level and direction of profits. That picture for the S&P 500 is not good in the short-term past, and analysts have negative short-term expectations (although they expect 2016 overall to be a positive profits growth year).

These four charts illustrate the negative S&P 500 profits growth picture and the index price together. Each chart shows the price in vertical black bars; the moving average primary trend in gold; the quarterly GAAP reported profits in red; the earnings yield (inverse of the P/E) in the lower panel in black; and the dividend yield in the lower panel in green.

The upper left chart is for year-to-date. The upper right chart is for 3 months daily. The lower left chart is for 1 year weekly. The lower right chart is for 3 years monthly.

The charts show the gold primary trend line in decline and the price below the primary trend line. The 3-year chart, in particular, shows the downward turn in profits in 2015, and the corresponding flattening then decline in the stock index price.

(click images to enlarge)

2016-01-22 article 1

Operating earnings (equal to or less than GAAP earnings depending on various charges in GAAP reporting) is expected to be down in 2016 Q1, but then rise during the balance of the year as this FACTSET chart of quarterly operating profits shows:

2016-01-22 article 2

Revenue declined in 2015, but analysts expect it to revive in 2016 and 2017 – presumably in great part due to revival of oil and gas company profits (a major wild card).

2016-01-22 article 3

Profit margins have been squeezed, but are projected by analysts to revive after 2016 Q1, as this FACTSET chart shows:

2016-01-22 article 4

If you believe the analysts (take note of Adam Parker’s quote in the intro to the letter – then not much to worry about. If you focus on what is known and factual at the moment – then the picture is not very good.

Let’s keep these additional facts in the background too:

  • Global growth forecasts being lowered (still positive but lowered)
  • Fear of something nasty happening in Chinese markets
  • Europe struggling socially and financially with the flood of refugees from ISIS
  • Highly deteriorated internal breadth within the US stock indexes (narrow leadership with bulk of stocks in tough shape)

TECHNICAL VIEW

Technical analysis is viewed by many as hocus-pocus nonsense, and that may be true in theory, but the fact is that many people use and rely on technical indicators to make decisions.

The use of technical indicators by a significant group of investors makes them a force in the market, and therefore somewhat meaningful and relevant for short-term price behavior.

Certainly, technical indicators are not perfect or even close, but they do cause a significant amount of money to move in the market in response to them. Even if technical indicators have no theoretical basis, they can become self-fulfilling prophecies if enough investment money is moved on the basis of them.

Technical indicators should probably be looked at in combination and with the assumption that they will often be wrong, but if well used may be right more often than they are wrong – or may be wrong as often as right, but able to stem losses and let profits run.

A significant portion of professional money managers use a combination of fundamental and technical (as well as thematic) approaches to make decisions. When the two approaches are used together, the fundamentals tend to be how securities are selected (what to buy or sell), and technical indicators tend to be used to make judgements about when to buy or sell.

Technical indicators range from tools that are fairly easy to understand and that seem on the surface to be reasonable and logical and are widely used; to other tools that are very complicated, hard to understand and not widely used.

Getting back to the client question, “where is this market going?” Let’s look at a few technical indicators that are comparatively simple.

There are three really basic judgements you must make in the following order to use technical indicators beneficially:

  • FIRST: judge the direction of the primary trend
  • SECOND: judge whether the recent price behavior is in the direction of the trend (“pro trend”) or in the opposite direction of the trend (“contra trend”)
  • THIRD: judge the probability that the price position (whether moving with or against the trend) is high or low.

With those three opinions in mind, technically based decisions can begin to make some sense and possibly work out beneficially.

DIRECTION OF THE PRIMARY TREND

  • 10-week exponential moving average (solid red) = DOWN
  • 40-week exponential moving average (solid gold) = DOWN
  • 120-week exponential moving average (solid blue) = UP
  • 3-month linear regression direction (dashed red) = DOWN
  • 1-year linear regression direction (dashed gold) = DOWN
  • 3-year linear regression direction (dashed blue) = UP

2016-01-22 article 5

One could use shorter-periods, in fact day-traders probably use ticks, and minutes and hours; but for our purposes, we think 10-week and 3-month views are short enough; and the 40-week (equal to the 200-day average) and 1-year views are most important. We put in the 120-week and 3-year views to show that the current price is even below those long-term trend indicators.

We like the 40-week (200-day) and 1-year time-frame best for primary trend.

Our judgement is that the primary trend is currently DOWN.

RECENT PRICE BEHAVIOR: PRO TREND or CONTRA TREND

  • The 63-day (3-month) moving average is below the 200-day moving average (primary trend indicator) – PRO TREND
  • The 21-day (1-month) moving average is below the 200-day moving average and the 63-day average – PRO TREND
  • The price is below the 21-day and 63-day moving averages – PRO TREND
  • The way the 63-day, 21-day and price are stacked reinforces the PRO TREND judgement

Remember, the primary trend is down, so pro trend is “pro down”.

2016-01-22 article 6

PRICE POSITION PROBABILITY VERSUS TREND

The upper panel of this chart plots price position measured in the number of standard deviations it is from the 200-day primary trend line. Zero, means the price is on the trend line. These are called “Z-scores” (see Z-Score graphic below the chart).

Z-Scores have these meanings:

  • Based on a normal distribution curve, the price has a 68% chance of being between -1 and +1 standard deviations (Z = -1 to +1), and only a 16% chance of being out side of that range on either side (about 6:1 odds that the price will revert back to within the 1 standard deviation range).
  • The price has only about a 2.5% chance of being outside of the +/- 2 standard deviation range (about 40:1 odds that it will revert back to within the 2 standard deviation range).
  • The price has only about 0.1% chance of being outside of the +/- 3 standard deviation range (about 1000:1 odds that it will revert back to the 3 standard deviation range)

In the upper Z-score panel in the chart below, the dashed red line is for Z=0 (price on the trend line). The two solid red lines are for the boundaries of the 2 standard deviation range (Z= +/-2). The solid black line is for the boundaries of the +/- 3 standard deviation range (the upper black line does not show because the price did not get to that level in the period studied).

The interpretation of this chart is that back in the August Correction, unless there was a material change in circumstances other than price, there was a statistical certainty of a rally.

The current price is 2.08 standard deviations below the primary trend line which suggests further rally is likely, BUT the primary trend is down. So while the rally would take the price higher it would be short-lived, because it is a Contra Trend move. The kinds of material changes in outside circumstances that could change the primary trend and take the rally to new heights might be something like Saudi Arabia reducing oil production or the Fed backing off of a March rate increase.

2016-01-22 article 7

2016-01-22 article 8

S&P 500 INTERNAL BREADTH

Major index internal breadth is badly deteriorated and getting worse, not just for US stocks, but also for foreign stocks. Let’s look as some S&P 500 internal breadth data for the S&P 500. After the wild up and down week last week, the needle did not move much on breadth.

  • Median S&P 500 stock off its trailing 1-year high by 20.68% (minimally improved) versus the S&P 500 index off by 10.76%
  • % of S&P 500 stocks in 10% Correction or worse 77.48% (versus 82.56% the prior week – some improvement, but 77% in Correction is not good)
  • % of S&P 500 stocks in 20% Bear or worse 51.12% ( versus 52.94% the prior week – minimally improved and not a good number)

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2016-01-22 article 10

 

2016-01-22 article 11

TECHNICAL INDICATORS FOR POSSIBLE PRICE TARGETS AND RESISTANCE LEVELS

OK, let’s see what other tools might suggest for price targets and support and resistance levels given our three judgements:

  • Primary trend is down
  • Current rally is contra trend
  • Current price position relative to primary trend line indicates a higher probability of more transient contra trend rally than more pro trend decline (absent material external change in circumstances)

So what do some quantitative technical tools say about short-term price targets – specifically 3 months out?

This chart plots linear regression trend lines based on 1 year, 6 months and 3 months of history; and with a 3-month extension. Those trend lines intersect the price scale at 1975, 1985 and 1760 respectively.

The chart also plots “price probabiltiy ranges” (“probability cones”) out three months based on 1 year, 6 months and 3 months of history using historical volatility and a 70% probability. 70% probability is very close to the +/-1 standard deviations range we looked at in the Normal Distribution Curve above.

At the end of 3 months volatility-based price range projections (at 70% probability) we see prices between 2225 and 1795 based on 1 year history; 2250 to 1775 based on 6 months history; and 2045 to 1780 based on 3 months history. (see more about Linear Regression)

2016-01-22 article 12

Note that the probability cones are agnostic as to direction, but if we mentally apply the primary trend judgement, it makes sense to expect more action in the lower half of the probability ranges than in the upper half over the short-term.

Well, what about price levels that might possibly create some resistance in a rally?

This chart uses Fibonacci intervals to suggest price level and time periods where resistance might be expected if stocks behave in accordance with the Fibonacci pattern that is so common in life, and perhaps in financial markets (see these links for more about Fibonacci Arcs and Fibonacci Retracement).

Fibonacci tools plot distance between peaks and troughs that are divided into Fibonacci intervals, and some technicians believe that those intervals more often than not represent points where investors hesitate and create resistance on the way up and support on the way down.

The Fibonacci ARCs (blue) divide the vertical distance between peak and trough into Fibonacci intervals and then use those distances and the radius of the Arcs to suggest both price and date for resistance.

The Fibonacci Retracements (dashed red) simply divide the distance from peak to trough, but do not include a time element. One might argue that where the two tools intersect is a likely resistance point on the way up and support on the way down.

For better or worse those points are 1935 (38.2% retracement), 1975 (50% retracement – not a Fibonacci number, but a Dow Theory number) and 2015 (61.8% retracement) .

The peak was 2134 back in June 2015, and the trough was 1812 in January 2016.

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Another simple quantitative measure uses Price Channels (boundaries based on trailing high and low prices see more about Price Channels). Using the 63-day (3-month) and 21-day (1-month) Price Channels; and assuming that the mid-point of those channels are decision points for investors to be more Bullish or to hesitate, we see possible resistance at 1948 and 1968.

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Last, we might look at what are called Pivot Points, that predict possible support levels and possible resistance levels. StockCharts.com explains the calculations nicely here:

  • First support level is 1800
  • Second support level is 1693
  • First resistance level is 2025
  • Second resistance level is 2145.

They call them Pivot Points, because those are possible prices where investors (or traders) collectively will likely turn on their heels and pivot to move back in the direction from which they came.

The resistance levels are labeled R1 and R2 on the chart; and the support levels are labeled S1 and S2 on the chart.

2016-01-22 article 15

SOME DIRECTLY RELATED S&P 500 FUNDS: SPY, IVV, VOO, VFINX, FUSVX

 

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