S&P 500 Index 2089
By Steve Blumenthal
August 19, 2015
I’m moving up the level of risk due to several factors: One is a change in signal on volume demand vs. volume supply. Selling pressure is dominating buying demand, which is a concern in a period of low liquidity. Valuations remain stretched and the cyclical bull market is aged.
Trend evidence is positive but deteriorating. Sentiment is in the Extreme Pessimism zone which is historically bullish for equities. I lean towards giving upside the benefit of the doubt; however, I recommend to stay hedged on your equity exposure and include a number of other risk streams (such as liquid alternatives – which I define as anything other than traditional stock and bond buy-and-hold) in your portfolio(s).
Remember that overcoming a 20% decline takes a gain of 25%. That is a lot easier to achieve than overcoming a 50% decline which will take a 100% subsequent gain to get back to even. The math of loss is painful. It is time to risk protect.
As a quick aside: 20% out-of-the-money put options on the S&P 500 Index would cost about 33 bps to hedge that equity exposure – using December 2015 SPY put options. This would limit your loss to approximately 20% below the current level.
Call us if you have any questions and we can discuss what you own and share with you a few suggestions.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend:
- NDR Big Mo: Bullish signal
- 3/34-Week EMA on the S&P 500 Index: Bullish Trend
- Volume Demand is greater than Volume Supply: Sell signal for Stocks
- Weekly Investor Sentiment Indicator:
- NDR Crowd Sentiment Poll: Extreme Pessimism (short-term Bullish for stocks)
- Daily Trading Sentiment Composite: Extreme Pessimism (short-term Bullish for stocks)
- Don’t Fight the Tape or the Fed: Neutral signal
- U.S. Recession Watch – My Favorite U.S. Recession Forecasting Chart: Signaling No Recession
- The Zweig Bond Model: The Cyclical Trend for Bonds is Bullish
Cyclical Equity Market Trend: The Primary Trend Remains Bullish for Stocks
The active signal is highlighted in yellow. The historical performance statistics are highlighted in orange. See important disclosures at the bottom of this report.
The red line in the middle section of the chart is the model equity line. Note that it is deteriorating. The text inside of the chart explain how buy and sell signals are generated.
Big Mo follows a weight of evidence approach to determine the market’s cyclical trend.
13/34–Week EMA Trend Chart: Cyclical Bullish Trend for Stocks
Following is a closer look at the S&P 500 via the investable/tradable ETF “SPY” 2006 to present. Note the test of the 200-day MA line. It held yesterday.
Click here to see “How I think about the 13/34-Week Exponential Moving Average”.
In summary, both price momentum indicators, Big Mo and the 13/34-Week EMA, remain on “buy” signals – signaling a cyclical bull market (up trending) state.
However, one of my favorite demand vs. supply indicators moved to a sell signal on June 30, 2015. Returns when “On Sell” are highlighted in yellow. The data dates back to1982.
Volume Demand Vs. Volume Supply – SELL signal
The yellow highlight in the upper left shows the S&P 500 Index % Gain/Annum when the model is on a buy signal. Also noted is the market’s % gain per annum when the model is on a sell signal and gain/annum with 89.5% profitable long trades (orange arrows).
Note the line in red. A drop below zero shows that there is more selling pressure (volume supply) than there is buying pressure (volume demand). More buyers than sellers drive prices higher and vice versa.
Buy signals are generated when the spread rises above -0.25 (the bottom dotted line) and sell signals are generated when the spread falls below 0.85. You’ll see that the red line is clearly below -0.25.
Why then is it on a buy signal? Confused – so was I.
Take a quick look at the chart and I’ll explain immediately below.
I spoke with NDR and here’s the answer: The indicator briefly rose up through -.25 on July 30, 2015 before falling back below -.25 on August 6, 2015 without first rising above .85. To create a sell signal, the indicator would have had to first cross above .85 and then back below it.
That is the logic programed into the model – let’s call it an unusual nuance. Seems to me that if selling volume is overpowering buying demand then risk remains greater and a sell should be maintained.
- Buy when the spread rises above -0.25
- Sell when the spread falls below 0.85
With that said, I’m not suggesting a change in what has been a very good model, but I am going to change my view on this indicator from Bullish to Neutral and only move back to a buy if it rises above -0.25 (the last reading was -0.427 yesterday).
While no single indicator will ever be perfect, the long-term historical buy and sell signals based on measuring volume demand minus volume supply has done a pretty good job at identifying market turning points.
Here is a bit of a different look at the same data – different trigger. This model is in a sell.
Given this rare nuance in the S&P 500 in the NDR Volume Demand/Supply Spread signal, I’m changing my view to a Sell Signal and will readjust if a new buy signal is triggered (-0.427 needs to rise above -0.25). Better to be cautious given the extreme valuations, length of current cyclical bull, etc.
Investor Sentiment 8-19-2015:
NDR Crowd Sentiment Poll: Extreme Pessimism from Below (Short-Term Bullish for Stocks)
Click here to see “How I Think About Investor Sentiment”.
Daily Trading Sentiment Composite: Neutral (short-term Bullish for stocks)
Don’t Fight the Tape or the Fed
The indicators that comprise this next chart are a combination of NDR’s Big Mo and the 10-year Treasury yield. I did a piece recently titled “Watch Out For Minus Two”. Look at the historical returns when trend turns negative along with an up move in interest rates. I’ll continue to post this chart each week as we are near a minus number 2 (orange arrow points to -1).
U.S. Recession Watch – My Favorite U.S. Recession Forecasting Chart: Signaling No Recession
Because the largest equity market declines occur during periods of recession, it is important to monitor for the probability of recession. Wall Street economists have a very poor track record in correctly timing recession. The next chart is my favorite recession watch chart. It is systematic (rules based) and looks to the stock market as its leading indicator. 79% of its signals, dating back to 1948, have been correct. Here is how it works:
Note the up and down arrows in this next chart.
- The down arrows occur when the S&P 500 index falls below its 5-month smoothed moving average line by 3.6% or more.
- The up arrows occur when the S&P 500 index rises above its 5-month smoothed moving average line by 4.8% or more.
- The idea here is that the stock market is a good leading indicator of future economic activity.
- You can also see +1, -5, -1, etc. above several of the down arrows. For example, a +1 means that the recession signal occurred 1 month after the actual recession started. Note that recessions are only known in hindsight. A -5 means that the recession signal was 5 months early.
- All in all I think it has a pretty good historical track record in predicting recession. Let’s keep an eye on this chart as the stock market tends to decline 30% to 40% or more during recessions.
What you can do is reduce your equity exposure on sell signals. There are also a number of ways you can hedge your downside risk exposure. Remember that it requires a 100% return to overcome a 50% loss. The largest losses tend to come during times of recession.
Finally, as we do each week, let’s take a look at the bond market. Following is my favorite process to identify when to shorten high quality bond maturities and when to lengthen maturities. ETFs can be used to position into short-term exposure (examples like “BIL”) or long-term bond market exposure (examples like “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.
The Zweig Bond Model: “BUY” – Signaling a Switch to Long-Term Bond Exposure: The Model is Bullish on Bonds
Click here to see how you read the above chart.
Click here for notes on “How To Track The Zweig Bond Model” on your own.
Thank you for your interest in this weekly post. It is appreciated! This is a process that has helped me over the years to better stay in line with the market’s primary trend(s). It helps me avoid the many daily distractions (commentator, analyst, CNBC, etc.) and stay disciplined in my investment process. I hope you find it helpful in your investment and advisory work with your clients.
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With kind regards,
Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
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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:
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.
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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.
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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).