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

Sector Model	XLK	-0.06%
Large Portfolio	Date	Return	Days
ABX	4/11/2013	-25.14%	219
QCOM	9/3/2013	8.89%	74
NEM	9/30/2013	-0.68%	47
BCR	10/4/2013	21.20%	43
BAX	10/7/2013	5.61%	40
BDX	10/11/2013	7.87%	36
ED	10/18/2013	3.42%	29
ISRG	10/21/2013	4.76%	26
EW	10/28/2013	-15.66%	19
ARLP	11/11/2013	0.16%	5
(Since 5/31/2011)
S&P	Annualized	12.50%
Sector Model	Annualized	23.19%
Large Portfolio	Annualized	31.79%

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!

(source) http://www.hussman.com/wmc/wmc131111.htm

(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:

http://market-mousetrap.blogspot.com/2013/06/06162013-blindside.html

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.

Tim

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.

11/14/2013 Sector update

The sector model flipped from XLB to XLK.

I've sold yesterday's XLB position for a new position in XLK, pocketing the 0.99% favorable gap.

11/13/2013 Sector update

At 3:59 the sector model flipped back to XLB.

The process is to trade any favorable gap in the morning (i.e. XLK up and XLB down), and if there is no favorable gap, to reassess at 3:45pm.

11/12/2013 Sector update

End of day data shows a slight edge to XLK.

If XLB gaps above XLK in the morning, I'll make the trade.  Otherwise, I'll recalculate before the close.

11/09/2013 The Lady or the Tiger

Sector Model	XLB	1.87%
Large Portfolio	Date	Return	Days
ABX	4/11/2013	-24.52%	212
QCOM	9/3/2013	1.77%	67
NEM	9/30/2013	-1.47%	40
BCR	10/4/2013	19.95%	36
BAX	10/7/2013	0.18%	33
BDX	10/11/2013	6.47%	29
ED	10/18/2013	1.99%	22
ISRG	10/21/2013	3.54%	19
EW	10/28/2013	-16.61%	12
FFIV	11/4/2013	3.26%	5
(Since 5/31/2011)
S&P	Annualized	11.89%
Sector Model	Annualized	24.13%
Large Portfolio	Annualized	31.05%

 

Rotation: selling FFIV; buying ARLP (Alliance Resource).

As I mentioned last week, the selling parameters are a ratio of:

(fundamental potential) / (current return rate). 

The current return on FFIV is an annualized rate of 942.24%... something that the fundamentals cannot sustain.

Nothing wrong with FFIV at all.  But I’ll take a little pop when it’s offered to me.

The question is – what to buy?

Well, the Sector model is in XLB (basic materials).

The Style model is in Mid Blend (basically anything).

BOTH are showing an aggressively positive configuration for the market, with a consensus target on the S&P of 1930 over the course of the next year.

So, commodity related stocks are a buy (per sector model) and stocks are a buy (per style model).

What gives?  Aren’t we overbought?  Shouldn’t we have a pullback?

We might, but a pullback is not the same thing as a bear.

Let’s revisit a post from May:

http://market-mousetrap.blogspot.com/2013/05/05172013-quantifying-bernanke.html

In that post we measured the effect of QE on the market against the levels it would have hit on a demographic projection.  The take away for today is that those same demographics show a bull market STARTING in 2013 and ENDING in 2018.

If QE were to continue past 2013, we would not see a continuation of the present advance, but rather an acceleration of market returns beyond 2200 on the S&P.

I say, “beyond,” because it’s impossible to say without knowing how much longer QE will continue.  2200 by 2018 is my estimate based on the PRESENT treasury balance sheet.  Additional expansion would give a higher number and create that bubble everyone has been so afraid of.

My own suggestion in May was that the Fed STOP QE in 2013, maintain the balance sheet through the next decade, and then reduce the balance by about 1% per month from 2024-2034.

That’s the ONLY way to do it without creating either an inflationary bubble (the blue line on the graph below) or a deflationary implosion (the red line on that graph).

What’s important for us today, however, is to understand that the demographics support a bull market from 2013-2018, with a normal cyclical bear starting after that.

The continuation of QE since my last post on this subject has changed the graph, but only slightly:

For the past few years I’ve been calling this a “fake bull market.”

The choice for Bernanke was either a fake bull or a real bear.  He chose the fake bull.

Now, NOW, we either get a real bull or a bubble.  Which one we get will be up to Janet Yellen.

Tim

 

 

 

 

11/06/2013 Sector change

The sector model is (yet again) showing XLB in the lead.

I'm closing the XLK position and entering a new position in XLB.

11/03/2013 Calculating a Sell Point

Sector Model	XLK	0.00%
Large Portfolio	Date	Return	Days
ABX	4/11/2013	-25.39%	205
QCOM	9/3/2013	5.46%	60
NEM	9/30/2013	-7.15%	33
BCR	10/4/2013	18.87%	29
BAX	10/7/2013	1.14%	26
BDX	10/11/2013	3.96%	22
DECK	10/15/2013	11.46%	18
ED	10/18/2013	2.93%	15
ISRG	10/21/2013	-1.19%	12
EW	10/28/2013	-16.60%	5
(Since 5/31/2011)
S&P	Annualized	11.76%
Sector Model	Annualized	24.35%
Large Portfolio	Annualized	30.66%

 

Rotation: selling DECK; buying FFIV.

Question of the week: do you sell when a stock goes up or when it goes down?

If you trade fundamentals, you either hold when it goes down or buy more of it.

If you trade technically, you may have both a stop loss and a price target.

Statistically, you are better off cutting your losses and letting your winners run.  A lot of folks try to do this with trailing stops.  That is, your stop loss is always a certain amount below the highest price, or just below the most recent low.  I don’t use the static return in my consideration, but rather the annualized rate of return:

Since I use technical considerations on an industry level and fundamental considerations on an individual stock, I have both price targets and stop losses on the industry that will POTENTIALLY rotate an individual stock into the sell zone – but then I measure the fundamentals to see if I actually want to sell it.  Both EW and BCR are in the same industry, for instance – so they will enter the sell zone at the same time.  WHICH one I sell on a given week will depend on the relationship of individual fundamentals to rate of return.

The actual ratio I use is fundamental potential / realized return rate.  The realized return rate on DECK is over 800% annualized, but it does not have a fundamental potential to sustain that rate, so I’m rotating off of a lucky pop and looking for another bargain.  It could go up another 100% during the next year, but will not likely go up another 800%.

Sometimes the fundamental potential degrades faster than the realized return rate, and I’ll take a loss.  But I end up with more gains than losses this way.

The Sector model is another beast entirely.  Unlike the Full model it can whipsaw, as it has this week.  The average holding period is a month, but sometimes we can have a week like this one.  The intraday data even whipsaws after the close, causing me to hunt for favorable gaps the next day.

So then, the Sector model closed in XLB, but AFTER the close the data shows a slight lead for XLK… by less than one hundredth of one percent.

I’m looking forward to the next boring stretch…

The method is to rotate if XLK gaps below XLB, and if not I’ll recalculate toward the close.  I’ve been scalping about half of a percent on each favorable gap, but I much prefer the boring stretches where I can let it ride.

Tim