S&P 500 Index 1985
By Steve Blumenthal
October 29, 2014
Technical trend evidence remains positive and investor sentiment evidence continues to support a short-term recovery uptrend. The market remains expensively priced, the cyclical bull is aged – risk is high.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains Bullish (as measured by NDR’s Big Momentum indicator and separately by the 13/34-Week EMA S&P 500 Index Trend Chart)
- Weekly Investor Sentiment Indicator – NDR Crowd Sentiment Poll: Extreme Pessimism (Bullish for the Market)
- Daily Trading Sentiment Composite: Extreme Pessimism (ST Bullish for the Market)
- The Zweig Bond Model: Cyclical Bull Trend for Bonds (supporting longer-term treasury and Corporate bond exposure)
- Demand/Supply Chart – Quickly Back to a “BUY” Signal
Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains
Big Mo follows a weight of evidence approach to determine the market’s cyclical trend and measures a number of market internals to determine trend.
Click here to see “How I Think About Big Mo”.
13/34-Week EMA Trend Chart: Cyclical Bullish Trend for Stocks Remains
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.
In summary, Big Mo and the 13/34-Week EMA suggest that the market remains in a cyclical bull market (uptrending) state. Sentiment (as seen in the next few charts) remains pessimistic (which is bullish) and recent technical support held.
As long as Big Mo and the 13/34-Week EMA remain bullish, buy the dips and own equities (but hedged).
This cyclical bull move is aged.
Investor Sentiment 10-28-2014:
NDR Crowd Sentiment Poll: Extreme Pessimism (Bullish)
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).
The weekly NDR Crowd Sentiment Poll (one of my favorite sentiment indicators) is in the Pessimism zone – bullish for stocks. Note the red arrow and the poor historical equity market performance when the majority of investors are bullish.
“The secret to my success is that I buy when everyone else is selling and I sell when everyone else is buying. Sounds easy to do yet it will be one of the hardest things for an investor to master.” Sir John Templeton, the Union League, Philadelphia 1985
Note that the average value of the indicator at Extreme Optimism (1995 to present) is 68.2. The idea here is that one wants to be a buyer when everyone else is selling (Extreme Pessimism) and a seller or equity hedger when everyone is extremely optimistic.
Daily Trading Sentiment Composite: Extreme Pessimism (ST Bullish for the Market)
Of the above two sentiment indicators, the Daily Trading Sentiment has been the better performing indicator over the last 18 months.
The Zweig Bond Model: “BUY” Signal – Cyclical Bull Trend for Bonds
Historical performance is summarized in the table on the bottom right. The yellow highlight shows the current buy signal for the strategy and historical performance on signal (the model was established in the 1980s – the data is hypothetical). The blue line shows the growth of $100 since April 1, 1967 in comparison to the black line which is the Barclays Aggregate Total Return index. The table at the bottom left compares the two.
Click here for notes on “How To Track The Zweig Bond Model” on your own.
Given the historically low yield on bonds, it is important to understand what happens to bonds when interest rates rise. However, for now, the weight of evidence continues to support being positioned in longer-term bonds, bond fund ETFs and/or bond mutual funds.
Interest Rate Gain/Loss Per Every 1% Interest Rate Move
*Think about the above chart as it relates to trading bond fund ETFs tied to the Zweig Bond Model signals as well as the current high risk environment tied to ultra low interest rates.
Demand/Supply Chart – More (Buying) Demand than (Selling) Supply
This too is bullish.
Here the spread between advancing volume and declining volume is bracketed to show how market turning points might be found. When weakening demand relative to supply falls to the upper bracket, a sell signal is generated. As the trend reverses, demand overcoming supply, a buy signal is generated; this happens when the spread rises above the lower bracket.
Where I think John Bogle is correct is that it is very difficult for most individuals to successfully manage their money. Lacking time and, in many cases, investment knowledge, investors adopt a buy and hold forever mindset. Evidence shows few have his conviction (and few have his net worth).
Trade Signals is about identifying valuation and risk regimes. I believe that risk can be identified and managed and that minimizing the impact of large crisis corrections (that do and will continue to happen) is important. Some form of hedging is worth the small expense when valuations are high, forward return potential is low and the cyclical trend aged. That is where we find ourselves today.
Risk management is important for one reason – it enables the power of compounding to work over time. Overcoming a 20% decline requires a 25% return to get back to even. Overcoming a 50% decline requires a 100% return. The deeper the loss, the harder it is and the longer it takes to recover. Sadly, most people don’t know this simple fact.
The timing of the next major correction may be unrecoverable for the oldest of baby boomers nearest retirement. I believe a disciplined approach towards risk should be adopted as the ability to stay the course is enhanced.
Valuation measures can give us a good sense of probable future returns. When stock market valuations are high, hedge your equity exposure. When valuations are low, don’t hedge. Today, valuations are high. Hedge and overweight to more tactical and flexible investment strategies. Find strategies that seek growth but can quickly get defensive. Post the next crisis, tilt back to overweight equities. Until then, focus on your defense.
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.
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