S&P 500 Index 1852
By Steve Blumenthal
April 9, 2014
I was pretty aggressive with my call to hedge in last week’s Trade Signals (What Was I Thinking). That view remains unchanged. While the equity markets cyclical trend remains bullish, the seasonal patterns are concerning and with sentiment back to Extreme Optimism (Bearish), I believe it is time to hedge long-term core equity exposure.
We all buy fire insurance and hope it is never needed. I’m suggesting the same today for your stock exposure.
Valuations are high, margin debt is surprisingly higher than it was in 2007, sentiment reflects too much optimism and the more challenging seasonal May to October period is approaching.
Included in this week’s update (the usual weekly charts):
- Sentiment Charts – Crowd Sentiment Poll: Extreme Optimism (Bearish)
- Sentiment Indicator Based on Forecasts Gathered From 130 Stock Market Newsletters
- Seasonal Tendencies: Challenging May to October Period
- Cyclical Equity Market Trend Charts: Bullish Market Trend Environment Remains
- Cyclical Bond Market Trend Charts: 10-year Treasury & 30-year Treasury: A Declining Interest Trend (note change)
Investment Sentiment charts 4-8-2014:
Sentiment Chart 1 – NDR Crowd Sentiment Poll: Extreme Optimism (Bearish)
The two sentiment charts that give me the most caution are the Crowd Sentiment Poll (my favorite) and the Investors Intelligence Survey of Advisory Services. In Chart 3 below you’ll see that the sentiment of 130 investment newsletter writers just peaked at the most optimistic level since 1987.
If you are a new reader, the gray area highlights the historical market performance when Investor Sentiment, as measured by Ned Davis Research, moves into the Extreme Optimism (Bearish) Zone (above the dotted black line or a reading of 66).
Sentiment Chart 2 – NDR Daily Trading Sentiment Composite – Neutral
Sentiment Chart 3 – Sentiment Indicator Based on Forecasts Gathered From 130 Stock Market Newsletters
The chart is centered on the concept that the stock market tends to be a manifestation of group psychology in motion, as highs coincide with extreme group enthusiasm and lows coincide with excessive crowd fear. This sentiment indicator uses forecasts gathered from 130 stock market newsletters. Such information can be useful at opinion extremes, because at those extremes the stock market majority is usually wrong. Almost by definition, a top in the market is the point of maximum optimism and a bottom is the point of maximum pessimism.
This is concerning from an extreme sentiment standpoint; however, I will really get concerned when either of the following cyclical trend charts turn bearish. For now, the major cyclical trend for equities remains higher and I continue to lean in that direction.
Seasonal Tendencies: The Challenging May to October Period
Following are two of my favorite cyclical market trend charts:
Cyclical Equity Market Trend Charts – Both Trend Charts Remain Supportive of Current Bullish Trend
Cyclical Trend Chart 1– 13/34-week EMA – The cyclical bull market’s uptrend remains in place. Note the blue 13-week EMA line remains above the red 34-week EMA line. Also note how well this simple, tactical trend indicator has historically captured the cyclical bull and bear market trends. Signals occur when the lines cross.
Cyclical Trend Chart 2– The Big Mo Multi-Cap Tape Composite continues to signal a bullish uptrend for the market. The last “B” buy signal was in 2011. Note the 88% Profitable Long Trades and the Gain/Annum when “Bullish” investing in the S&P 500 Index and the “Switch” to cash on Bearish readings (orange highlight).
Following is a quick look at the trend in interest rates.
Cyclical Bond Market Trend Charts: 10-year Treasury & 30-year Treasury:
The 30-year Treasury bond is now in a Declining Interest Rate Environment. The 10-year Treasury bond is nearing a change in trend.
The 13-week EMA (blue) line has just crossed below the 34-week EMA (red) line. This suggests long- term interest rates are declining – moving to a Cyclical Bull or declining interest rate trend environment.
As it relates to long-term focused core equity exposure, if you have yet to do so, I believe it is important to put a hedge in place by month end. Risk of a 5% to 20% correction is high. Be prepared to buy (and remove hedges) when sentiment moves back to Extreme Pessimism.
The longer-term cyclical bull trend remains in place (as measured by Big Mo), the Fed remains accommodative (Don’t Fight The Tape or The Fed); however, sentiment and seasonal patterns support a correction.
I received a number of requests to show the Zweig-NDR Bond Model on a consistent basis. We’re doing some deeper work on that right now and it is my intention to provide this in each week’s Trade Signals. If you missed it, here is the link to last week’s On My Radar where I first introduced it.
CMG Tactical Strategy Update
We continue to hold mostly long equity exposure in our CMG Opportunistic All Asset Strategies. Our CMG Tactical Rotation Strategy moved to a more defensive position for April: 50% TLT (iShares Treasury Bonds) and VNQ (Vanguard REIT). Both strategies are relative strength based trading strategies.
High yield bond prices appear to have bottomed and are moving higher. We traded back into high yield bonds at the beginning of April in our CMG Managed HY Bond Program. April is typically one of the best performing months for the high yield bond market. We hope this month proves true to form.
With kind regards,
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
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:
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