Sunday, November 17, 2013

11/17/2013 Market is almost average!!!

Sector Model
Large Portfolio
(Since 5/31/2011)
Sector Model
Large Portfolio

Rotation: selling BDX; buying JOY (in the Coal industry).

So, is this a bubble, or what?  Lately it seems that every other article is a prediction that we are overbought.  PE is too high, trends are over-extended, and the Wilshire 5000 market cap is higher than the United States GDP.

Hussman came up with his own Sornette “Log Periodic Bubble with Finite-Time Singularity” crash prediction.

Egads!  It’s a Sornette Singularity!

(Careful eyes will note that Hussman cheated a bit on this graph by using a linear axis instead of a logarithmic one.  If you want to convince folks of a bubble, you do that sleight of hand trick and it scares the pants off of them every time).

Now let’s come back to earth… where normal folk call this pattern a “wedge.”

Okay – so what the heck does it mean when the market is getting a wedgie?

Let’s bypass the math.  This one is simpler just drawing some lines on a chart:

DON’T BOTHER trying to keep track of which line is which.  The point is that basically any kind of trend line you draw will converge at the same spot: 2050 on the S&P around the end of 2014.

But if you MUST know which is which…

The top line is the long term linear regression on the S&P, extended forward.

The second line is the top trend from 2008 to present, extended forward.

The third line is the October 2008 to present linear regression, extended forward.

The bottom line is the bottom trend from 2008 to present, extended forward.

My scale, in contrast to Hussman’s, is logarithmic.

I did this a few months ago and came up with the same value:

That was back in June.  Remember folks screaming about a bubble in June?  I don’t either.  NOTHING HAS CHANGED.  It’s the same stupid wedge formation, pointing to the same stupid price target, and hitting it at the same stupid time.

The long term traders, the short term traders, the optimists, and the pessimists, have all been trading with that same target in the back of their minds.

My point back in June is the same one I need to make now – this graph doesn’t show what the market WILL do, only what everyone seems to THINK it will do.  And even if the market were to hit EXACTLY 2050 by the end of 2014, we still wouldn’t know what it was going to do NEXT.

MOST rising wedges resolve bearishly, but that’s just because the rising bottom line has a more extreme angle than the rising top one.  It’s harder to sustain something that’s more extreme, but it’s not impossible.  SOMETIMES a rising wedge resolves upwards – about a third of the time.  And a small fraction of the time the trend hits that singularity and just keeps right on in the same direction, neither breaking out nor breaking down… just… continuing as if nothing happened.

These patterns are illusions.  But short term action is mostly illusion too, so let’s explore this illusion together.

March 2009, the market hits 666 and everyone thinks it is the apocalypse.  Everyone but godless heathens or people in comas are safely out of the market.  Then it turns.  Everyone who was going to sell, sold.  If you were a buyer, you had no one left to buy from… at those low prices.

So the prices begin to rise – furiously.

Still, the volatility offers plenty of opportunity for astute market timers – and I mean sophisticated models.  There’s money to be made in the swings.

But then as the wedge continues to narrow, those timing opportunities happen closer together in both time and price extremes, until there just isn’t enough room between the top and bottom of the price extremes to make any more money.

Two things happen then:

First, folks give up short term timing and ride the trend.

Second, folks start listening to smaller and smaller signals to predict larger and larger breakouts, until the tiniest yap of a cocker spaniel spooks the entire flock of sheep over the cliff.

Volatility is range bound.  The lowest record on the VIX is a bit above 9 and the highest just under 90.  The average is a little above 20.  The longer it stays below 20, the more extreme the breakout will ultimately be.  The longer the market goes without a correction, the greater that correction will be.

But without an extremely sophisticated model and a good bit of luck, you’ll never be able to manage it.

That leaves three solutions most folks face:

First solution: time.

Second solution: hedge. 

Third solution: use fundamental value to create a margin of safety. 

I do the third solution here, with a little technical kick added to the fundamentals to optimize the industries and sectors I’ll target.

Just to put this into perspective, if you had a crystal ball and could predict with 100% accuracy whether the S&P would be up or down each month, you could time your way to a 30% return.

I already get a 30% return, without timing.  I’m a huge fan of timers who can actually DO it, but I know my own limitations, and I can’t time my way out of a paper bag.  Wedge formations and Sornette Singularities don’t DO anything for me, so I let them pass.  The good news is that my model outperforms over 10% in a bull, but over 20% in a bear.  And, while I don’t enjoy the pullbacks, they just put me that much more ahead of the rest of the market than I would have been with an uninterrupted bull.

If you trade on your own – find a source of sanity that works and stick with it.  Crashes will come.  What’s your strategy?  Write it down now, before the next crash… whenever that may be.

The ultimate solution to the next crash isn’t knowing WHEN it will come, but knowing WHAT you will do when it does.

But back to the chart and the news.  Is this a wildly overbought market?  Or is this, instead, just a boring reversion to the mean.

I go with boring.

But “Market is almost average!!!!” doesn’t make for a good headline.


PS – those following the blog will have seen more whipsaws in the sector model this week.  To make it easier to follow, I’ve added a widget that allows folks to sign up for email alerts when I do my 3:45pm sector update.

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