This blog is intended to keep clients and friends current on my investment management activities. In no way is this intended to be investment advice that anyone reading this blog should act upon in their personal investment accounts. There are other significant factors involved in my investment management activities that may not be written about in this blog that are equally as important as the things that are written about that materially impact investment results. Neither is this blog to be construed in any way to be an offer to buy or sell securities. To be notified via e-mail when new posts are made, click on the subscribe button below. To view previous investment strategies, click strategy downloads.
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Here Is What The Indicators Say

April 1st, 2019

2019-03-31

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The graph above shows the percentage performance of the S&P 500 over the past year.   If you were someone that did not panic in the November/
December sell-off, and held onto your investments, you are up about 8% over the past 12 months.

However, I like to analyze various factors that go into the markets movements to give me a feel for where we are going and what the investment strategy should be to best address where it is going.  So, I thought I would share with you some of those factors and what they are telling me:

 Momentum

  • 7-Day Relative Strength Index (70/30): nearing over-bought levels and rising (67.92)
  • 14-Day Relative Strength Index (80/20): rising (63.95)
  • Volume-Weighted Relative Strength Index (80/20) – shown as MFI below: rising (65.63)

2018-03-31 2

Breadth

  • McClellan Oscillator (50/-50): rising out of negative territory (7.92)
  • McClellan Summation Index (500/-500): weakening but still overbought (874.59)

2018-03-31 3

Note:  The top green and red graph is the Summation Index

Investor Sentiment

  • VIX Volatility Index (12/22): low volatility (13.74) equating to investor over-confidence

2018-03-31 4

Trends

  • Moving Average Convergence/Divergence: positive trend but weakening, with black indicator line below red trend line
  • Price/Momentum Oscillator: positive trend but weakening, with black indicator line below red trend line

2018-03-31 5

Participation

  • Percentage of S&P 500 Stocks Above 50-Day Moving Average (70/30): over-bought (71.80)
  • Percentage of S&P 500 Stocks Above 200-Day Moving Average (70/30): Positive (58.60)

2018-03-31 6

Based upon the indicators above, I expect that we are nearing a top in the market and should be rolling over.  We may have some continued upside as the computerized trading systems try to break through the all-time high, but the resistance is strong overhead and the indicators are mostly pointing to a weakening market.  Figuring out the indicators is never just a black and white decision, there are always nuances to it, plus they are just indicators and not commandments.  However, by and large they provide information that is critical to staying on the profitable side of the stock market.

As a result, we have been raising cash and will likely continue to do so as the market rallies toward the all-time high (if it does).  Risk Management is a key part of active investment management, and right now the risk is to the downside.

–Mark

Signs Of A Slowing Economy

March 22nd, 2019

Sentiment

Graph above courtesy of sentiment.com

Double Click on Any Image for a Full Size View

 

I wanted to share with you the current investment strategy activity as its been presented to our board of directors.  It includes some strategic changes based upon the technical indicators we follow and changing fundamentals of the economy.  The graph above shows you how investor sentiment has moved into the zone where we normally see stock prices pull back.

‘With the stock market approaching its all-time high, and the various technical indicators we follow telling us that the market is over-valued, breadth is weakening, momentum is waning, sentiment has gotten complacent, and the near-term trend appears to be rolling over to the downside, we have begun to book profits in positions that have moved above their calculated Intrinsic Value and/or positions that have significant gains since the January lows.  We have moved client portfolios up to maximum cash levels as outlined by their individual investment policies.  This is consistent with our view that the economy has begun to slow over the past three months and that corporate earnings growth has slowed significantly now that the impact of lower taxes is built into quarter-over-year-ago-quarter estimates.

 

With the Federal Reserve on hold with further interest rate increases questionable, plus the flattening of the yield curve with the spread between 2’s and 10’s at just 14bps, we have lengthened durations in bond portfolios and moved client portfolios up to maximum fixed income allocation as outlined by their individual investment policies. We have closed our positions in adjustable rate and floating rate government bonds, reduced our allocation to short-term fixed income corporate and government bonds, and increased our intermediate term holdings.  Additionally, we have moved a small percentage of the bond portfolio to long-term treasury holdings as a hedge against the downside risk in the stock market.  In accounts that allow both mutual fund and individual securities, we re converting mutual funds to individual bonds to lock in current rates for income clients.  This is consistent with our view that the economy has begun to slow over the past three months and that we risk an inversion of the yield curve that often presages a recession.”

10-2

The graph above shows the spread between the 2 year treasury yield and the 10-year treasury yield.   It has moved below the 14 basis points discussed above down to 13 basis points.  That means if you are a treasury investor, you are only paid 13/100’s of one percent more to tie up your money for 10 years than 2 years.  Because the yields are being crushed at the longer end of the maturity offerings, you are paid virtually the same amount of money on either maturity.

When the longer term maturities really fall like we have seen with the 10 year treasury yield, that is indicative of a slowing economy where investors a driving the yield down with demand for that maturity in spite of the shorter term paying the same return.  They are willing to do that because of the safety factor of being in a US Treasury Note and the opportunity to make capital gains on the principal because they believe yields will continue to fall (as yields fall, other investors are willing to pay you more than you paid for your note thereby providing you with capital gain income if you sell to them, which is a strategy the big bond investors like mutual funds and pensions use to enhance their returns).

Now is a time for caution, and we are positioning client portfolios accordingly so that when we get a correction we have cash on-hand to reinvest at lower prices.

–Mark

4th Quarter Strategy Implementation & 2019 Forecast

January 7th, 2019

2018-12-31

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Stock prices were pummeled in December – the worst December ever recorded for stock price performance.

Stock markets dropped last month based upon the ongoing tariffs, weak Chinese economic data caused at least in part by the tariffs, the Federal Reserve rate hike and announcement of three additional rate increase projected for 2019.

Despite these market moving items, other economic reports for the month were positive.  The manufacturing and services sectors of the economy both continued to growth. Retail sales were higher. Housing starts and existing home sales were both positive in November. Inflation was steady with the rate remaining at 2.2%.

With the broad market decline, the standard playbook for a distressed market kicked in:  large cap and higher quality stocks had relatively lesser declines on average than other types of stocks. Besides company quality and capitalization, price gain (i.e., momentum) and higher dividends yields were also favored by investors and performed better on average.

The worst performing companies had high betas (i.e., more historic volatility than the market) or were value stocks with factors such as price/sales, price/earnings and price/cash flow (i.e., value and momentum are typically opposite investing strategies).

No industry group had positive average price gains for December.  Driven by declining oil prices, most of the worst performing groups were in the oil and gas sector. Drug manufacturers and drug stores – typically a defensive area for investors to be when the market is in turmoil – also acted badly in December.

To recap our investment strategy implementation during the quarter, we began to raise cash in client accounts in August as the market was flirting with all-time highs.  We sold all companies whose current prices were above their intrinsic values as determined by a discounted cash flow analysis.  We also sold companies that had higher debt burdens or lower cash levels than industry standards.  This raised cash in client accounts that we could use for buying power if/when prices headed lower.

October 3rd was a seminal day in the markets as the Federal Reserve stated firmly that it planned on raising interest rates at least four more times.   This shook investors and they began to take profits and the stock market decline began in earnest.

As stocks that we liked fell in price, we would add shares, as is standard practice in order to lower our cost basis.

As the market decline continued, we used this opportunity to buy higher quality and larger capitalization stocks since, from a historical perspective, they perform better during turbulent markets.

We also added to health care companies – particularly those in cancer research that have products in the FDA approval process showing successful trials – given the historically defensive position healthcare companies have been treated by investors.

As the market continued down, we opportunistically started positions in certain high growth tech companies that have secular tailwinds but whose prices were down significantly from their highs several weeks prior.

For our Dividend Income clients, we followed a similar path, weeding out higher beta and lower quality companies with prices above intrinsic value and added to large cap companies with strong balance sheets and safe dividends.

As we got closer to year-end, and the negative impact of December was realized, we made tax loss sales in order to offset the gains we posted raising cash in August and September.  Many of the stocks we sold are on our re-purchase list because they are companies we want to own.   However, based upon tax law, we cannot repurchase them until after a month has passed.

As we enter 2019, we anticipate a rally in the first few weeks, but a potential lower low (i.e., a low in the market below that we saw in December) in March.  However, the news last week from the Federal Reserve that the 2019 rate increases are not a certainty may have made the December low the bottom for this correction.  We will just have to see what happens with the economy and corporate earnings announcements in coming weeks before we will know for sure.  If we do experience a lower low in March, then I’d expect a rally into the Summer.

There are a number of people forecasting a recession in the second half of this year.  I think it is too early to have a strong opinion one way or the other based upon the change in the Fed’s interest rate increase stance.   We do know that they have drained a significant amount of liquidity from the economy (see the chart of the Monetary Base – courtesy of Dennis Gartman and Doug Kass – at the top of this blog post ) but we do not know if it is enough to cause the economy to go into recession.

We also do not know the extent of the negative impact of higher interest rates on corporate earnings.  When 4th quarter 2018 earnings are announced beginning next week, we will have a better idea on this, but if significant, could drop GDP growth from the 3%+ level to 2% or below.  This could then be the beginning of a trend toward negative GDP growth that would define a recession.

One thing we do know is that the large GDP growth percentage in the prior quarter came from companies building inventories and not from increasing sales.  Typically, if inventories are building from sales that did not grow at an anticipated rate, this will also lead to a decline in GDP in subsequent quarters.

Longer term, the large debt levels for the State and Federal Governments, corporations, and individuals will be a big problem, negatively impacting the economy for a generation.  When you add in the off-balance sheet future liabilities for governments and corporations you are flirting with disaster – particularly with the next big issue likely to negatively impact the economy and markets, severely underfunded pensions at both the government and, to a lesser extent, corporate levels.  The demographics of our country, with the ratio of people receiving benefits to those providing funding to pay the benefits in a continual decline, will be very difficult for state governments to address without negative implications for their citizens.

It is easy to freeze up when stocks are going down in price – we don’t stop managing portfolios just because the market is turbulent.  We continue to watch the data and implement an investment strategy that will be defensive when needed and opportunistic when available.

Volatility Roils The Stock Market

November 13th, 2018
spx 2018-11-13
S&P 500 Index Annotated
Double click on any image for a full sized view
 
It has been a couple of weeks since I posted something on the blog related to the direction the stock market was headed. If you recall, on that last post I noted that we were due for a bounce higher off the October lows – which we got – and a potential retest of those lows before heading higher – which we may be in the process of achieving right now. After a retest, I noted there was the potential for a move back higher going into year-end.
 
The graph above is a version of one that I have had on the blog previously during times of higher volatility. I thought it would be interesting to look at it again when I was reading Lance Roberts blog and he showed his version of it. Lance goes into additional detail on small caps and mid caps, while I am going to stick with the large cap S&P 500 Index. Lance also uses fewer indicators than I do, but its remarkably similar.
 
Before I get into the nitty gritty of the chart above, here is a little background:
>This is a 20 year monthly chart of the index with four indicators and a trendline;
>The green circles represent times when the index moved above or below the 10-month trendline (called a trend change), but only three of the indicators confirmed a change in trend;
> The pink circles are times where there was a trend change and all four indicators confirmed it; and
> The red squares are times when there was a trend change but only two indicators confirmed it plus there are red arrows showing the indicators that contradict it.
 
For an indicator to confirm the trend change, it must cross either the limit line (as with the Williams % Index, the McClellan Summation Index, and the Rate of Change of the VIX) or cross an indicator trend line (as is the case with the MACD). In my system, the greater the number of confirming indicators, the more intense the move up or down in the market will be upon change of trend.
 
The trend change with the green circles is easy to see and can reliably tell you that you need to either get more aggressive in your investing because the market has changed to an intermediate trend higher or more conservative because the market has changed to an intermediate trend lower.
 
You will notice the two green arrow on the lower left. The one furthest left shows a move of the indicator above the upper blue limit line, but a move below it prior to the other indicators showing that there is trouble brewing and forecast a downturn in the trend. The second green arrow shows you that when the other indicators confirm the trend change, this one had already moved below the limit line.
 
That downturn ended up being the NASDAQ dot-com crash and the 911 market crash – if you had followed what the indicators were telling you, then you would have gotten conservative by raising cash so that you had liquidity available to buy quality companies (hint: NOT pets.com which is one of the more famous dot.coms to go bust).
 
PetsIndicators are not perfect. The dot-com crash was indicated by the change in trend, but the 911 terrorist attacks happened without warning and there was no possible way for the indicator to show that dire of a situation was at hand. This should have been a situation where we used a pink circle, and if it was some other economic event that had some warning we likely would have seen it in the indicator.
 
The pink circles show you when the trend change was confirmed by all four indicators – and when that happens – a fairly infrequent occurrence – you should be prepared for a potentially major move that takes the trend materially higher or lower. We discussed the dot-com/911 crash above that should have been circled in pink, but you also see the subprime mortgage crash of 2008 circled in pink along with the subsequent recovery that has led to a nine-year bull market with minor corrections along the way.
 
The red boxes denote trend changes with only two confirming indicators. These tend to be less severe than either those with three or four confirming indicator. I’ve added red arrows to show the non-confirming indicators to show that they did not cross their limit lines when the trend change happened. You might be able to discern that the trend changes are short-lived and shallow in these cases compared to the pink and green sets which have larger and longer moves.
 
So, what does this tell us about right now? On the far right of the chart I’ve used red boxes to show where we are now (in retrospect, I should have used another color or shape to separate them from the two sets of red boxes to their left). You can see that we had a trend change on the price graph, with the black index line crossing downward over the red trend line. We also had a confirming signal in the upper-most panel showing the Williams % Index crossing below the upper limit line and the MACD crossing below its red trend line. However, the Summation Index (the red and black area graph) has moved back into positive territory (just barely) and the Rate of Change on the VIX never was able to cross above the blue limit line.
 
[If you want additional information on these indicators, you can find it below the video below]
 
Based upon the readings as they stand right now, it looks like the current correction should begin to head higher again after a potential retest of the lows from October. The key index price to watch is 2603.54, which was the low in the month of October. If we can close out November without breaching that low, then we have made the first monthly “higher low” and that could lead to a rally into year-end. If we breach the October low in the next two weeks, then we are likely headed back to the February lows of 2532.69 on the index. If that doesn’t hold, then we are looking at 2380 as the next support level on this index which would put us squarely in bear market territory. If we do rally into year-end, we have several layers of resistance at 2751.71, 2761.98, 2822.44, 2899.89, and 2939.86.
 
If you listen to the investment gurus that appear on TV, most are predicting a year-end rally. I don’t know exactly what they base that on – they don’t ever disclose the indicators they follow nor how those indicators have acted over the years – but let’s hope they are correct and we are on the road to higher stock prices. Investor sentiment is negative at the moment, but until we get three or four of the indicators to confirm the trend change, it appears to be a normal pull-back at the present time. If we see further confirmation of a correction, I will let you know here on the blog.



–Mark
 
Indicators:
 
Williams % Index: a momentum indicator that tells us whether investor buying is increasing or decreasing. When investors are committing money to the market, that is the time to get more aggressive as they are likely to be driving prices higher.
 
MACD: A momentum indicator based upon two trend lines, when momentum is slowing the trend is weakening and visa versa. This is a very traditional indicator that is widely used and consistently helpful in providing a buy V sell signal.
 
Summation Index: a breadth indicator that shows the cumulative difference between stocks going up V stocks going down in price. In a downtrend, if the cumulative difference turns positive, that means in spite of what is happening in the index, individual companies are starting to come out of the correction and the index should follow suite soon. The opposite is true in an uptrend when the cumulative difference turns negative.
 
50-Day Rate of Change of the VIX: the VIX is a volatility indicator based upon the buying and selling of options. I use the derivative Rate of Change to smooth out the daily gyrations and to show the velocity of the volatility in terms of whether it is increasing or decreasing. The limit line is subjective but over the years I have grown comfortable with the level I use to tell me whether to get more conservative or more aggressive.

Rising Yields Take Toll On Stocks

October 11th, 2018

S&PDouble click on any image for a full size view

As always happens, rising yields have finally started to matter to the stock market.

What I wanted to discuss in this blog post is to what extent damage has been done, is there more to come, and what are we doing based upon the analysis.

If you look at the S&P 500 graph above, you will see that I have annotated it.  It is those annotations that I want to focus our analysis on so that we can develop a thesis for action.

Let’s start with the blue arrows on the price graph.  The lines around the price graph are trend lines based upon the 50 (solid green), 200 (solid purple), and 250 (solid red) day moving averages.  The dashed lines represent a band of +/- 10% around each of those trend lines.  The S&P 500 tends to move between the bands around the 250 day moving average.  These act as significant support and resistance levels to prices on the index.    You can see that I have a blue arrow pointing to the price line where it bounced off the dashed red line at the top when the market peaked in Jan/Feb this year and fell back to support at the purple 200 day moving average line.

The other moving average lines also act as support and resistance to prices on the on the index – I’ve marked several other blue arrows to show you how it happens.

What I want to focus you on is the last arrow on the right.  That is where we are today and you can see that the price has bounced off the 200 day moving average – and so far the 200 is holding.  I don’t have an arrow pointing to the peak price on the graph on September 20th, but you can see that prices never moved up to the top of the red dashed line – meaning they were never as extended as they were in Jan/Feb.  Part of that is the slope of the move up to both peaks – in the Jan/Feb peak, you can see prices moved up faster and the line is much steeper than the move to the recent peak.  From a technical perspective, that is a healthier move higher and more sustainable than the steeper/faster move in prices.

However, on the downside, I want you to look at the green 50 day moving average line and you can see that for three days, it held the price decline, but when it broke, you see the big move down yesterday (the long red thick straight line next to today’s much smaller/thinner red line).  The long red line represents a big move in prices yesterday (down 3.4%) and the thickness represents huge volume (the highest of the year).

What we want to focus on is whether the purple 200 day moving average line can hold and the market can stabilize, or will it break and we are left with the 250 day moving average as our last resistance before a significant correction ensues.

In writing this blog over the years, I’ve written about my Trendline Rule of Three.  When a support or resistance trend line is broken for less than three days, then you can consider that it held.  But if that line is broken for more than three days or three percent, then you must begin to look at the next trendline for your support or resistance.  In our discussion of the green 50 day moving average above, after three days, it was broken for greater than 3% meaning it is no longer in play and our hopes rest on the purple 200 day moving average holding and stabilizing the market.

But, since hope is not an investment strategy, we must look at supporting evidence to draw a conclusion.  Things like:

> price oscillators to gauge whether we are over-bought or over-sold,

> monthly price levels to confirm changes in trend,

> investor cash flow coming into or out of the market,

> volatility readings, and

> the health of the financial markets overall.

Price Oscillators

Lets focus on the two green boxes.  The uppermost one shows the relative strength index and the significant move below the 30 indicator line tells us that we are severely over-sold at the current time.  The lower one shows a similar reading below the 20 and 15 indicator lines.

Both of these price oscillators are short term indicators, but they are saying that we will be having a near-term bounce higher in prices soon.

Neither of these indicates how high the market will go back up on that bounce.  Just remember, 3.5% above current levels is the green 50 day moving average line that will act as resistance to any move higher.  So you have to assume that any move higher will be limited to 3.5% or less on the first attempt to move back above the 50 day moving average.  Does it have to be limited?  No, but the odds are greater that it will be since the resistance is there.  In most cases, to break above a resistance trend line, it takes a few attempts and even a retrace back to the lower support level (currently our purple 200 day moving average line).

Our conclusion is that we are due for a short-term bounce higher in stock prices in the near future.  It may be limited to 3% or so and it may retest resistance of the 200 day moving average line.

Monthly Price Levels

We look at monthly price levels to confirm either a continuation of a trend or a change in trend.

Last month we had a high on the index of 2940.91, and we closed positive for the month.  This month, we have broken beneath last month’s low 2864.12. We now need to close beneath 2864.12 on the last trading day of this month to imp give us a reversal of the bull market uptrend.

Our conclusion is that since we are trading below 2864.12 now, this indicates we need to be cautious with our investment activity, but not take any action to prematurely sell significant amounts of our stock holdings.

Investor Cash Flow

Let’s look at the Red box on the money flow indicator.  You can see that in Jan/Feb, cash flow into the market reach unsustainable readings, indicating that investor enthusiasm and euphoria got too high which always precedes a drop in stock prices.  The pink arrow to its right shows you that there was never the excess cash flow indicative of investor euphoria.  That supports our analysis above when examining the price line that we had never gotten as extended on prices as we did in Jan/Feb.

I also want you to see that we do not have a reading below the 20 indicator line telling us that lack of cash flow has reached unsustainable levels, meaning this intermediate term indicator says it is not yet time to be a buyer.   A reading below the 20 line (and particular the 10 line which isn’t labeled) is one of those situations where, if you are an investor that wants to use margin, you would have a fairly low risk entry point to buy stock on margin.  Clearly we are not there yet, so going all in on the market and using margin to buy stocks in the current sell-off is a dangerous prospect.

Our conclusion here is that from an intermediate term perspective it is not time to be either a buyer or a seller.

Volatility Readings

The black line superimposed over the green area graph is the VIX Volatility Index.  It represents investors buying options to protect against a significant correction in the market.  You can see the purple and pink arrow pointing to the black line graph.  Back in Jan/Feb, this line went from under 10 to above 35.  Under 10 is an indication that the market has too much enthusiasm and that raising some cash is warranted – over 35 is an indication that there is too much pessimism and that a buying opportunity should come soon.

The pink arrow shows you where we are today.  The steep increase of the past two days coincides naturally with the sell-off.  However, you can see that we have not risen above the level of the sell-off last April where the 200 day moving average resistance line held at a higher low than the Jan/Feb correction.  We can also see that the line never got below 10 after the Jan/Feb correction, never indicating a significant correction was coming.

Our conclusion here is that volatility has returned, but the VIX is not currently telling us that the sell-off is likely to turn into a full blown correction.  That can change in an instant, but right now the odds are against it.

Financial Market Health

The green area graph in the bottom panel represents the TED Spread.  The ted spread is the difference between interest paid on dollar denominated bank deposits in Europe versus the USA.  The concept is that the difference widens during times of financial market stress and narrows during times of relative calm in the markets.

I’ve drawn a purple downward sloping arrow from the peak of the green area graph  in April to today’s level.  Back in April, we were all concerned about the health of some of the European banks who were under-capitalized but had loan losses that would cause the banks to go under.  Due to the interconnected nature of the financial system, a major European bank failing would have world-wide repercussions on the financial system, and potentially could take down other banks, including those in the USA.

That peak on the graph coincided with the April sell-off in the market, but as Germany stepped in an recapitalized the failing banks, the crisis was averted and the financial system stress abated.  You can see that I have circled in purple the today’s level, which has been holding steady at a low level during this sell-off.

Our conclusion here is that the Ted Spread is indicating that at the current time there is not some macro economic issue that would impact the global financial system causing the stock market to drop significantly.

Conclusion and Strategy

Based upon our reading of the trend lines, price levels, and indicators, the current sell-off should be contained to either the 200 day moving average or the 250 day moving average.  We will likely see a move higher to the 50 day moving average and a retest of the 200 day moving average while the market consolidates this move lower and looks for a reason to either break above the 50 or below the 200 – and since we are entering earnings season, the results being better or worse than expected will probably be the determining factor in this movement.

From the conclusion above, our strategy is to be cautious but not panic and sell prematurely in this sharp sell-off.  We want to wait to see if the 200 day moving average holds as resistance, and if not, whether the 250 day moving average holds as resistance. We also want to end the month above 2864.12 on the S&P 500 Index, which is between the 50 and 200 day moving averages.

We are, however, selling some shares of companies whose price is currently greater than their fair value.  This will give us some cash to reinvest in companies that are both undervalued and that have sold off greater than the broader market.  We have been making those sales, and when we determine if the 200 holds, that will be our indicator to begin buying.

In an uptrending market, we would hold onto those shares and not sell them as the earnings growth anticipates higher fair market values ahead.  However, given uncertainty, we must stick to our discipline and act prudently for clients.  The companies will move into the bull pen of companies we have owned in the past that we want to own in the future based upon valuation and earnings growth.

Reading the market is never easy and it is always a best guess proposition based upon your reading of the price action and the indicators you trust.  I have been at this for 35+ years, and by writing this blog, I am hoping to share some of the knowledge I have accumulated and inform you of what we are doing with client money and why based upon our analysis and strategy.

As things change, I will be back here on the blog with updates for you – let’s just keep a positive outlook that it will be because of higher prices.

–Mark

Yields Are Rising

July 12th, 2018

Treasury 2 yr

Double Click on Image for Full-Sized View

The graph above is of the 2-year treasury note yield. At 2.58%, it is at a 10-year high – and looks like it could continue to rise.

The stock market has had a rocky start to 2018. One of the big reasons is rising interest rates. There is a trade-off between stocks and bonds – as bond yields fall, stocks become more attractive to investors. This is based upon a couple of reasons: (1) lower interest rates mean that corporations borrow at lower rates, and the difference between the higher and the lower rates equates to increased net income for shareholders, which makes stock prices rise (all else being equal) – so rising rates mean just the opposite, lower earnings and lower stock prices; and (2) when valuing stocks, you are really looking at a discount of a company’s future earnings – those earnings are discounted using current short term treasury rates, so falling rates will yield a lower discount and produce a higher valuation – while rising rates yield a higher discount and produce a lower valuation.

As an investment manager, we watch treasury yields very carefully. Rising yields means rising risk – the risk that your investment portfolio will go down in value. Above, we discussed how rising yields impact stock prices, but they also negatively impact bond prices.

As yields rise, the value of bonds goes down. Think of it like this: you bought a 2-year treasury last year at a yield of 1.35%, but today you could buy one yielding 2.58%. The yield has almost doubled over the course of a year, so if you want to sell that bond to someone else, your bond yielding 1.35% with a remaining life of 12-months provides less return than the current bond yielding 2.58% with 24-months remaining life. You would have to sell your bond at a discount so that the yield moves from 1.35% to the current yield on a similar new bond with 12-months remaining life. Today, a 1-year treasury note yields 2.36%, or a full 1% above your bond. That is a big discount, or loss in value from its face value, that you would have to take to sell the bond today.

Rising interest rates are bad for both stocks and bonds as shown above. So what does an investor do? Sell everything and move to cash?

No, part of managing investments for clients means that you have to work hard to make money even at times when extraneous forces are presenting headwinds to stocks and bonds.

As far as stocks go, you have to find ways to deal with the two issues discussed above: earnings and valuation.

To deal with the earnings issue, you need to focus on: (1) companies that have no debt (not always possible) or at least companies that have a lower level of debt than their industry average; and (2) industries that do not need to borrow as much as other industries to operate their businesses. Reviewing ratios of debt to equity for individual companies, and comparing them to other companies in their industry, will help with the first issue above. Over-weighting your industry allocations to industries with little borrowing needs, like biotech and technology, while under-weighting industries with heavy borrowing needs, like manufacturers, help with the second issue.

As far as bonds go, you need to focus on building a ladder of individual short-term bonds and CD’s (say one to three years in duration), short-duration mortgage bonds that repay principal along with their interest payments, and adjustable rate bonds (we focus on mutual funds for these last two) all are good hedges against rising rates. The short-term ladder allows you to hold your bonds to maturity (since selling early can cause losses due to the discount to face value as shown in the discussion above) and then reinvest your proceeds in higher yields. The mutual funds are defensive by the nature of their investment portfolios – you just need to be very careful when looking at a mortgage bond mutual fund to make sure the average duration is short. Additionally, if rising inflation is the proximate cause of the rise in yields, mutual funds that focus on TIPS (treasury inflation protection securities) can be a successful investment as well.

For the classic rock fans out there, here is a classic: the Animals playing House Of The Rising Sun

For those who are fans of today’s music, here is a cut from Jurassic World: Rise by Skillet

–Mark

 

What’s Up With The market?

June 11th, 2018

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A couple of weeks ago, I wrote that the market had a 60% chance of moving higher based upon the fact that it had cleared the blue downward sloping trend line and had broken above the May R1 resistance level. I noted that we could likely retest that downward sloping trend line and that if we then successfully moved back above the May R1 resistance level, we would likely see our next major stop at a bit above the 2800 level on the S&P 500 Index.
 
Above, I have updated the original graph to extend the two blue trend lines with orange lines and added an orange arrow at the point where the market did in fact retest the trend before a sustained move higher. I have also circled the area where we have broken above the June R1 resistance level. My Rule of Three states that now that we have broken above June’s R1, we need to stay above it for three days or three percentage points. Once that happens, the June R1 becomes a support level, just as the May R1 is now a support level since we have sustained a move above it for at least three days.
 
So, what’s next?
 
1. Let’s start at the bottom of the image in the panel that represents our Trend Analysis. As I noted in our previous blog post, we want to see the blue 50-day moving average move above the pink 100-day moving average. You can see that the blue line has curled upward and could move above the pink line in coming days. When that happens, you have a very strong up-trend in place with the 50-day above the 100-day above the 200-day above the 250-day moving average.
 
That stacking of the trend lines in order from short-term to long-term means that in all of the short-term to long-term time frames, the market is trending higher. Once a trend is in place, the market tends to follow that trend as the various trend following investment strategies add more money to be invested. It also means that investors that are on the sidelines jump in and add money to the market as it appears to be investor friendly.
 
2. Now, let’s move up one panel on the image to review our Sentiment Analysis. As I noted in our previous blog post, we see positive sentiment with (a) Cash Flow being consistently positive and rising and (b) Momentum moving into positive territory and rising. Since then, cash flow has continued to be strong (the orange area graph) showing money moving into the market, and momentum has gotten stronger (the black and red line graph) with both lines in positive territory and rising, and the black line consistently above the red line.
 
3. Finally, in the very top panel we have our Short-Term Relative Strength Analysis. This is the only worrisome item on the image. You can see that the line have moved above the upper threshold reading, which typically means that in the near-term, the price action has gotten ahead of itself and we are due for either a couple of down days or a couple of choppy sideways days until the price action gets less giddy.
 
So, when we combine the price movement of the primary graph and its need to stay above the June R1 resistance level with the relative strength line showing a need for the market to cool down a bit, my best guess is that we do not get our our three day rule confirmed and we drop back below the June R1 resistance level.
 
However, given the strong Trend and Sentiment that are in place, this will be a buying opportunity for those that have cash to invest, and they will add it to the market and push us back above the June R1 resistance.
 
So, lets give this a 65/35 chance of seeing ultimately higher prices where we hit 2,825 on the S&P 500 Index before we see another retest of the blue/orange downward sloping trendline.
 
Will we make it all the way to 2,875-ish all-time high? Stay tuned to the blog and I will keep you updated on the progress the market is making.

—Mark

 

Where Do We Go From Here?

May 21st, 2018

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I thought it was a good time to have a discussion about what is happening in the market and where we are going from here.
 
In the graph above, the large image in the middle with the two blue lines is the price graph of the S&P 500 Index (my proxy for the entire stock market). If you look at the blue arrow I’ve drawn, you can see that we had a breakout above the downtrend line that traded above the R1 resistance line for a couple of days, then fell to retest the downtrend line (you can barely see the red tail thave came down to the downtrend.
 
After a bit of back and forth over a few days, we have closed slightly above R1 resistance again. IF we are able to stay above this resistance for three days, then in my investment world we have broken out and should move up to R2 resistance, and then if we successfully hold that level, make an assault on the all time high we saw back in January.
 
You will note that there are lots of “ifs” in that paragraph. The reality is that no one knows exactly what the stock market will do – the various support and resistance level, trend lines, moving averages, and other indicators all play a role in helping us to make some educated assumptions. But there is never any certainty in the market.
 
Over the next couple of trading days, we need to have the S&P 500 index close above 2725.76 for there to be a chance for a move higher. If we don’t, then watch for another test of the downtrend line, around 2675. However, the market has some things in its favor:
 
1. Look at the Orange Arrow. It is point to the Money Flow indicator – which shows the indicator in positive territory and moving higher (albeit slowly). This is a good thing, when this indicator is in positive territory that mean investors are committing money to the stock market and that is supportive of higher prices.
 
2. Look at the Purple Arrow. It is pointing to the Price Momentum indicator. The black line is above the red line, both are pointed upward, the black line is pointing further upward than the red line, and both are above the 0.0 indicator line. This tells us that prices are once again in a rising trend and that they are gaining in velocity in their move upward.
 
3. Look at the Red Arrow. It is pointing to a Line Graph with various moving averages that give you an idea of the Trend. One of the simplest things to know about the stock market is when it is moving higher, it tends to continue to move higher – and visa versa. This is a pretty graph if you are an investor, one you would grade as a “B” maybe. Ideally, for an “A” rated graph, you would have the black price line above all of the moving averages, with the moving averages all in order: 50-day, 100-day, 200-day, and 250-day. You will see that the blue 50-day moving average is below the 100-day moving average – its not ideal, but it is far from a deal killer. You can see that the black price line is in a nice trend above the 100-day moving average – but the blue 50-day line is still pointed downward. What you want to watch for is the blue line starting to turn upward – that will give you some confidence that we have a chance to retake the old highs made in January.
 
So, where do we go from here? I’d say that based upon the positive readings from our indicators and the positive reading from our trend graph, I’d say the odds favor us continuing to move higher over near-term to test out the R2 resistance at 2803, or a roughly 2.5% move higher. Then we need to check our indicators and trend again.
 
1. Lets give this scenario of a move to 2803 a 60% chance of happening and a move back to the downtrend line at 2675 a 40% chance.
 
2. I’ll feel better in a couple of days if we can hold above the R1 resistance level. If we do, then I’d move our odds up to 75% of reaching 2803 and 25% of dropping to 2675.
 
3. If the 50-day moving average crosses above the 100-day moving average, I’ll move our odd up to 85/15.
 
4. If the price line remains above the 50-day and above the 100-day, then I’d move the odds to 95/5.
 
As usual, anything can happen in the stock market – we are always one tweet away from a 3% drop in the market as investors get spooked by something that may or may not come to pass. If that happens, then we have to check our indicators and trend to see what sort of damage was done and come back with a new look at where do we go from here.
 

Or for you closet Buffy fans…

–Mark

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