Trader’s Narrative

David Rosenberg, strategist at Gluskin Sheff continues to be staunchly bearish. He digs into his trench even further it seems with each point the S&P 500 climbs. Today he lists the contrasts between now and 1982 to argue why this is not a secular bull market:

• P/E Multiples were 8x, not 26x.
• Dividend yields were 6%, not sub-2%.
• The stock market was trading at a discount to book, not a 2x premium.
• Monetary policy was aimed at reducing money growth and inflation rates, not
  creating both as is the case now.
• Fiscal policy was aimed at reducing nondefense spending, not accelerating it.
• Deficits were peaking and coming down, not surging to 10%+ relative to GDP.
• Global trade barriers were being torn down; not erected.
• Deregulation back then was in; today it is all about re-regulation and
  government ownership.
• Union membership was on the way down; today it is back on the rise.
• The dollar was entering a Plaza Accord bull market, not a mercantilist bear
  market.
• Credit, household balance sheets and participation rates were expanding, not
  contracting.
• Tax rates, income, capital gains and dividends, were declining then; rising now.

He also compares the batch of government bureaucrats and politicians now to back then:

In 1982, Ronald Reagan was President (two consecutive terms as Governor of
California), Don Regan was Treasury Secretary (35 years of financial sector experience), Martin Feldstein as the Chief Economic Advisor to President Reagan (the dean of business cycle determination), and Paul Volcker was Fed Chairman (9 years of prior financial sector experience). Compare and contrast to Barrack Obama (junior senator from Illinois for 3 years); Timothy Geithner (21 years experience in government, three years as a lobbyist); Larry Summers (no private sector experience; 27 years of academia and government) and Ben Bernanke (no private sector experience; 30 years of academia and government).

Which team do you think deserved the higher multiple — the one with actual experience in the real world or the one immersed in academia and government?

To play devil’s advocate, no two bull markets are equal in every way. It is a stretch to require a secular bull market to require experienced politicians for example. But cheap (or at least, reasonable) valuation is a condition that is difficult to explain away.

The debate that is continuing to rage is whether this is a bear market rally or a bull market. Although I find it interesting that the topic has somewhat shifted. Now it is whether this is a secular bull market or a cyclical. To throw a log on the fire, here is some interesting historical data.

If you were to take the relative distance of the Dow to its simple long term average and watched for when it fell at least 10% below it and then subsequently, rose 10% above it, you would have a very lazy but incredibly profitable way to time the market.

Eighteen of the last 21 times the Dow rallied from at least 10 percent below the 200-day level to 10 percent above, it posted gains during the next 12 months

Source: Bloomberg

We reviewed something close to this simple system recently. Instead of waiting for an index’s price to drop and then regain composure, we simply looked at the extremes. Or how far it would stretch below its long term trend in order to indicate to us a ripe time to go long the market.

While valid, the problem with the signal that I suggested back in March 2009 is that it is difficult to tell exactly when we’ve hit “extreme”. As with the recent behavior of the volatility index (VIX) it is clear that although an indicator can set a certain range for a long time, in the blink of an eye, you are presented with an outlier. In such a situation, what was once considered the shore becomes very deep water indeed.

Since I prefer the Standard’s & Poors 500 index, I decided to take a look at its historical performance using the same criteria from 1950 to today.

First, I recorded when the percentage distance from the simple 200 moving average fell under -10%. And then when it rose above +10%, I walked forward 3 time frames, 90 trading days, 180 trading days and 265 trading days to find out how the market performed. I realize that the above article from Bloomberg is probably using regular calendar days not trading days but I don’t think that is a material difference.

September 14 1953 -9.39%
April 8 1954 +10.19%
90 days later: +13.4% higher
180 days later: +29.07% higher
365 days later: +39.04% higher
Continue reading ‘S&P 500 Buy Signal That’s Worked Since 1950’s’

A big question on a lot of minds is whether what we are seeing is just the run-of-the-mill bear market reaction (a bear market rally or “dead cat bounce”) or whether perhaps this is the start of a brand new bull market.

While I do have some ideas, I’m not sure myself. Well, no one really knows. What I mean to say is that I don’t have a strong conviction one way or the other right now. But I’d like to change that. So this week I’m going to cover the 7 prerequisites for a new bull market as set out by Jim Stack, the writer of the InvesTech newsletter.

According to Stack, there are seven major conditions that have historically been present before we’ve launched into a secular bull market. Like most approaches to the market, these seven conditions simply allow for a list that we can check off. The more conditions are present, the better the chances that this rally is the real deal. But as always, never a guarantee in sight!

The first one I want to cover is consumer confidence, or more precisely, a plunge of at least 34 points in the Consumer Confidence Index:

Plunge in Consumer Confidence - Marked by a drop of 35 points or more. This index is reported monthly by The Conference Board and is based on a representative sampling of 5,000 US households. It’s calculated as a weighted average composed of 40% current and 60% future expectations and is commonly used to predict the future health of the US economy. For investors, it can also provide a valuable clue to identifying the “Best Buy” opportunities on Wall Street. Logically, such opportunities seldom occur in the late stages of a bull market when consumer optimism is already frolicking at lofty levels. Instead, the time to start shopping for stock market bargains is after confidence has plummeted and gloom is widespread. In each of the past 5 recessions, the Conference Board’s Consumer Confidence Index has tumbled over 34 points before a new bull market was born. Watch for a similar drop that might help to confirm the next true low-risk buying opportunity.

Here is a chart of this indicator showing a plunge of almost 50 points:

Incidentally, it is almost at the exact same level when the stock market reached its bottom in March 2003.

Here is the other widely followed consumer sentiment survey, Reuters/Michigan:

Its good to see these two surveys agree with each other so much. The Reuters/University of Michigan sentiment survey is even lower than where it was at the March 2003 market bottom. It is plumbing depths not seen since the early 1990’s and 1980’s. Curiously, back in the 1980’s, the unemployment rate was twice as high as it is now.

Anyone familiar with market history will recognize those time periods as excellent times to buy. If you’re not or if you would like a refresher, just pull up a really long term chart from your favorite charting platform.

So we can comfortably check off this condition as being met. The next one tomorrow.

Oh and in the meantime, I highly recommend you give InvesTech a look see - and no, I am not affiliated with it nor do I receive any compensation if you do.

In an attempt to thoroughly confuse my remaining few readers, here are two polar takes on the market:

Seasonality
The best time to be long the stock market has been from November to the end of April. The months from May to October, produce so little in returns - on average - that you would do better parking your money to earn income. This seasonal pattern is usually expressed with the rhyme: “Sell in May and go away”.

Now, this is just a historical pattern and it doesn’t perfectly play out each year. But over time this has been the average performance. So now we have seasonality working against us, rather than with us.

As well, Hulbert did a quick study showing that winter months that have produced negative returns go on to produce negative returns in the summer as well. But winter months that have produced positive returns buck the “sell in may” trend and continue the positive performance.

The only good news from the data mining is that the summer months following down winter months have much higher volatility. So for those who are equally comfortable going long and short, we may have perfect trading weather breaking on the horizon.

Oracle of Dow Theory
On the plus side, Richard Russell, is unapologetically super-bullish. Russell believes that the bull market never really left. Even the 2000-2002 bear market was just a “correction” within a continuing secular bull market that began in early 1980’s.

He bases this on two reasons: during the darkest days of the bear market in 2002, we never really got to a true bear market valuation. Two, from a technical point of view the market has been building a base.

Russell is worth listening to because he has seen decades of market history and he has studied it closely day after day. There was a time when he was a frequent writer for Barron’s. This was way back when Barron’s had a technical analysis bent, before it jumped the shark.

The early March preliminary Reuters/Michigan consumer sentiment survey results were bad enough, coming in at 70.5 and they got worse when they were finalized at 69.5 in late March.

“A recession has occurred whenever the Sentiment Index has declined as much as it has fallen during the past year, including the recessions occurring from the mid 1950’s to the early 2000’s,” according to Richard Curtin, the Director of the Reuters/University of Michigan Surveys of Consumers

The full press release is available on the Reuters/Michigan website and also in my box of free trading goodies (in the Articles & Reports folder, named “Michigan Consumer Survey March 2008″).

A recession you say? Well, I’ll be!

There are several measures that Reuters/Michigan tracks. One of them is the “expectations index” which looks ahead to quantify how consumers see their future. In March 2008, this index hit (47.9) the lowest it has been since the 1973 recession (45.2).

Yes, you read that right. Today… US consumers feel almost as hopeless about the future, as they did in the days of the oil shock, a brutal bear market, the rationing of gas (depending on your plate number), etc. Unbelievable!

Here’s a historical chart of the Reuters/Michigan survey going back to early 1970’s:

As you’ve probably surmised by now, each time that consumer sentiment has scraped the bottom of the graph, the stock market and the economy have stopped their decline.

Starting with 1975, this was the end of the brutal bear market. Although equities didn’t bounce back, they stopped declining and entered a period of consolidation.

The early 1980’s saw the break out from this consolidation and the launch of the great secular bull market.

In 1990, the consumer sentiment spiked lower and the stock market followed with another significant long term bottom. Subsequent shocks in 1992 and 1993 don’t show a concomitant reaction from the market.

The next time consumer confidence approached such levels was in early 2003, which was the bottom of the bear market that followed the bursting of the tech bubble.

And now we are once again approaching these same levels. Which makes me wonder why consumers don’t have a long term memory? Collectively we seem to react with the IQ and recall ability of a one cell amoeba.

Here are some more historical charts of consumer sentiment as measured by the Michigan University survey.