Trader’s Narrative

At the beginning of the year we looked at the long term trend of IPOs and how they track the speculative impulses that run through the stock market. If you missed it, check out the historical chart of IPOs.

Last year’s bear market completely shut down the initial public offerings and took the number of companies going public to lows that we hadn’t seen since 1978. Depending on what criteria you use, we had about last year we had between 20 and 43 IPOs. Although the year isn’t over, it looks like we are set for a quiet recovery. So far, about 67 companies have amended their existing filings or registered to go public. More than half of them coming after the March low in the stock market.

Here is a chart of the IPO market for the past 20 years:

Source: Bloomberg

There is no sign that we are about to revisit the speculative frenzy that we saw accompany IPOs in the last bull market. That kind of speculative sentiment takes time to generate and the current IPO market is merely returning to ‘normal’ after the shock of the financial crisis. If anything, the IPO landscape going forward will be more selective and opportunistic.

Secondary Market
While the primary market is returning to normal, the secondary issues market has roared to life as companies rush to recapitalize and heal their damaged balance sheets. Just this week more than 15 US companies announced plans to issue more shares for a total of $7 billion. The largest chunk of that comes from Barrick (ABX) who is removing their infamous short position against gold. The same is true around the world. Lenovo and Alibaba both will place shares in Hong Kong. As well Cemex, the Mexican cement giant, will issue $1.8 billion worth of shares.

IPO Pipeline
Here is a chart of the quarterly IPO pipeline for issues filed, priced, and withdrawn:

There is a limited history shown but you can see that the activity in the IPO market in the past few quarters has mirrored closely what we saw in the bear market that followed the tech bubble. Around the same time that the stock market stabilized in late 2002 and early 2003 and again in early 2009, the number of IPO withdrawals increased, filings and pricings dropped to a trickle.

Here you can read the recently released report on the third quarter IPO outlook from Renaissance Capital. If the link doesn’t work, you can also find it at the Free Trading Resource section of the blog (in the Reports folder).

It isn’t difficult to argue that demographics is one of the most powerful engines of destiny for society and in turn every important facet within it, including the economy and the stock market. Think about it. Demographics determines what the priorities of a society, their spending patterns, their saving patterns, and beyond.

We are all familiar with the power that the ‘baby boomers’ have held sway over the North American economy for these past 50 years. Everything from modern marketing to pharmaceutical research (Viagra) has been shaped by their needs and wants.

So not surprisingly, this topic has garnered a lot of attention from academics in the field of economy. There are many studies which look into the consequences of demographics and you can find one at the end of this article.

In fact, this area of study has come to be a well worn path for economist. So much so that there is a short hand to describe a most intriguing ratio: MY ratio which stands for the middle-aged to young ratio or simply Middle-Young.

This ratio is key because in these two different stages of life, people have very different priorities which, aggregated as a great galloping herd, has an inevitable effect on the pattern of savings, spending and investing that happens in a given society.

When you are young, typically, your income is very small to non-existent. You are interested in spending primarily. Both as a means of entertainment and as a way to gain education in order to achieve your full earning potential later in life. So at this stage, the average young person has much higher expenses than income - which results in debt.

On the other hand, in middle age, the average person has reached their peak income potential. They do have expenses obviously but they are also mindful of their impending retirement and as a result, saving a portion of their annual income and investing it. The majority of this investment flows to the equity markets because that is where the best risk adjusted returns are.

The idea is to watch for the relative size of the asset rich, middle-aged members of a society to their much younger and poorer counterparts. If we have a low ratio, this means that there are fewer middle-aged people and relatively more younger people. And when the ratio is higher, there is an abundance of the older generation and less youth.

So it would follow then that demographics and especially the MY ratio potentially not only describes the fluctuations in the stock market, it also may explain the expansion and contraction in the Price/Earnings ratio.

After all, when you have an abundance of middle-aged investors chasing after stocks, they will be ready to pay a higher and higher price for them. And inversely, when you have few middle-aged investors there will be few competitive bidders for equities, allowing stocks to become extremely ‘cheap’.

Here is a chart from The Cowles Foundation for Research in Economics (authored by John Geanakoplos, Michael Magill and Martine Quinzii) which shows a remarkable correlation between the P/E ratio and the MY Ratio:

Continue reading ‘Does Demographics Drive The Stock Market?’

Last week there was a lot of chatter about a technical formation called a ‘golden cross’ which is considered to have bullish implications. This is when a short term moving average (usually a simple 50 day MA) crosses from below to rise higher than the long term moving average (usually a simple 200 MA). Because moving average tend to move in lethargic arcs, these types of formations are easy to foresee.

In keeping with everyone’s watchful expectation, the S&P 500’s 50 day moving average closed at 900.54 on June 24th 2009, rising slightly higher than the 200 moving average (897.19).

Since we’ve compared the current market to the nascent 2003 bull market in many different ways: breadth, wedge formation, flag formation, Weinstein analysis, etc. It is only natural then to take a look at the golden cross that presaged the bull market in 2003:

In the charts, the blue line is the 50 day moving average and the red line is the 200 day moving average. Marked by the green arrow, the medium term moving average crossed higher than the longer term moving average in May 15th, 2003.

But does the golden cross really deserve its bullish moniker? Obviously we can’t base any conclusions on one single observation in 2003.

Vincent Delisle of Scotia Capital looked at 14 previous S&P 500 bull markets (lasting on average 49 months and rising 149%). From these only about 17% of the gains materialized before a golden cross signal was given. After 12 months of a signal the average gain was 23%, implying that a golden cross doesn’t arrive too late to provide forward returns. Delisle adds that a golden cross appears to have more validity when it occurs with a rising 200 day moving average - something we had in 2003 but do not have now.

By the way, a “death cross” is the opposite and can be seen on the above chart marked by a red down arrow.

According to Jason Goepfert of SentimenTrader, any edge offered by golden crosses is minimal. Identifying the same distinction as suggested by Delisle, he looked at only instances where the 200 day moving average is declining.

Goepfert concludes:

…the returns going forward, up to six months later, were little better than random and not statistically significant. In fact, in the shorter-term they were a little worse than random. Only when we look out a year do we see some out-performance.

But he does agree with Delisle that most ‘unsuccessful’ golden cross signals coincide with the early 1940’s and that more recent examples have had much more success. The S&P 500 was positive 11 out of 13 times since 1942 with an average annual return of 18%.

Finally, a reader was kind enough to forward a recent research report from Merrill Lynch on golden crosses. I’ve added it to the Free Trading Resource Section and you can download it from the Articles & Reports folder.

In the Merrill Lynch report prepared by Mary Ann Bartels, it continues to distinguish between golden crosses that happen with a downward long term moving average and those when the long term moving average is rising:

Of the 42 Golden Cross signals triggered since 1928, 20 have occurred with the 200-day moving average in a declining trend or lower than it was 30 trading sessions ago. These signals on average have generated 12-month returns of 13.3%.

The remaining 22 signals occurred when the 200-day moving average was rising or higher than it was 30 trading sessions ago. The returns for these signals were much lower and on average generated 12-month returns of 5.7%.

This is bullish for today’s market since the long term moving average of the S&P 500 is still falling. The report is full of insight backed by stats so I highly recommend you download it and take a look. Bartels also adds a new overlay by looking at golden crosses that happen during a recession (as defined by NBER). Signals that meet the condition of a declining 200 MA and a recession suddenly produce an average 12 months return of 23.3%.

Not surprisingly, her conclusion is that “the equity market remains in a base-building process that should lead to higher returns.”

Of course, that doesn’t mean that the market automatically heads higher and higher from here. Base building can be soul crushing. Ask any trader that lived through the 1970’s - no wonder everyone started wearing platform shoes