John Serrapere has a new post up at IndexUniverse called Knowing Your Portfolio's Limits that is a good read.Of most interest to me was the discussion of comparing related items to look for a stealth change in market direction.
The broadest based one of these I know about and have touched on before is small cap versus large cap. Small cap does better at the start of a bull market so small cap outperforming is an indicator worth following--of course no guarantee.
Serrapere highlights a few others that make sense. Junk bonds versus corporates and either one versus treasuries can be useful, this is usually done by observing spreads but that can be difficult to do in terms of accessing the information but comparing ETFs like HYG to LQD (as Serrapere does) captures essentially the same thing. When something like LQD lags riskier parts of the bond market then things could be turning up and conversely leadership from the safer bonds indicates something bad coming.
Serrapere also like to compare the Nasdaq 100 to the iShares Consumer Goods ETF (IYK) which is a proxy for staples and which I own for some clients. Tech is obviously more aggressive while staples are defensive. I imagine this could be done with other sectors too like maybe healthcare.
A question I have is if going narrow for this sort of information creates noise that leads to the wrong conclusion. For example utilities are defensive but are vulnerable to rising interest rates. Of course since he doesn't mention utilities, maybe I have answered my own question; potentially noisy sectors are not used in this sort of study.
I am obviously a big believer in messages of the market hence my having written about the 200 DMA and inverted yield curve hundreds of times. The ratio work that Serrapere writes about is important because turns happen before people start to talk about them (sort of a by definition point) but it is in these sorts of stealth indicators where the best information can be found. For example the 200 DMA was breached for good in November 2000 and December 2007 (it was tested a couple of times after Dec 07). While I am not sure about this bear market, things like the tick, breadth and various measures of divergence started warning of big problems in 1999.
The market gives signals like this, they guarantee nothing but I believe they are worth learning about and heeding.
14 comments:
Two guarantees in life. Death and taxes. Taxes will go up big time. Plan your portfolio moves accordingly. Adios.
Roger- what do you think of the Gilead acquisition?
RE your comment about utilities. My utility stock is down of late (yours probably is, too); cause, I believe, is Obama's cap and trade (more properly called, carbon tax) proposal in the 2010 federal budget. Cap and trade, if it becomes law as written, will add over $100 per month to the average utility bill.
Market signals, absolutely yes, but better as an aggregate rule of thumb than as isolated indicators; that is, the more at one time the merrier because while one or two might lead you astray seeing several at once serve the same function as breadth, true range and sentiment in judging price momentum. Does wonders for confidence in position sizing and willingness to accept volatility.
Even very long-term buy-and-holders need to understand they are dealing in prices and dividend streams as determined by market and economic conditions together; they are not buying a 'share' of a company, they are buying a share of its future profitability (AKA cash flows).
OT: Setting aside the shear ignorance and silliness of the proposition (see http://tinyurl.com/b6wd22), does anyone wonder if those who are currently blaming Obama for a drop in their stock prices also blamed Bush for the Tech debacle of 2000-3? No? Does anyone think these market seers will follow the same logic and give Obama credit when the market recovers? No? Me neither.
I wonder if you have any interest in fleshing out your repeated statements that the inverted yield curve clued you in to the coming mess with finacials. I have never heard anyone (and am not sure you have either) say that the mess has been casued by the yield curve. I understand how the inverted yield curve hurts banks earnings and can signal a slow down coming in teh economy but isn't the finacial mess about nonpeforming loans - subprime or otherwise and not an inverted yield curve?
roger,
allow me to respond to anon 8:25 on the yield curve.
roger points out several "indicators" in his post. as far as i am aware, the inverted yield curve does not itself create bad conditions, but most of the indicators give you clues to financial market sentiment. when short term rates exceed long term rates (the inverted yield curve), that indicator that the market itself gives suggests that conditions are overheating--the market's "infinite" wisdom indicates that people are willing to borrow currently at higher rates short term than at lower rates for longer periods. under those conditions, the short term demand for money is simply too high. either long term rates will need to rise (usually creating issues for things such as mortgage rates and long term bonds etc.--refinancings will become more expensive) or short term demand for credit will need to drop because the economy softens.
further, when you see an inverted yield curve at the same time as a minimal spread between high grade corporate bonds (use lqd as a proxy) and high yield or junk bond spreads (use hyg as a proxy), the market tells you that it has no fear of risk (with a small yield spread, the market only grants a minimal incremental return for the much higher risk of hyg vs lqd) and likely a high level of greed (all the bankers and private equity guys want to do deals and the greed of the market fuels the fire with dicier and dicier deals). in early to mid 2007, the yield curve inverted and the high grade to junk bond spreads virtually disappeared. the credit markets told you in no uncertain terms that the environment was dangerous and overheated.
you should also be aware that if greed infects the credit markets, it almost certainly infects the equity markets as well. the signals existed in late 2006 and mid 2007, but at the same time, the signals don't (at least to my knowledge) give you any sense of the depths of the problems (or how bad the economy will be, how deep the equity markets will go, how many firms will default on bonds etc.)
hopefully this makes sense--the inverted yield curve does not directly cause the problems, but it does signal the excess in the system and the overall affinity to greed and aversion to fear among market participants in aggregate.
--gjg49
Roger,
I found John's insight interesting and is somewhat similar to Hussman. Sesing the market late last week was much closer to the so called bottom, I am curious to hear if you were putting any dry powder back into equities and if not what your possible strategy is?
My Apologies for the following typos - "financials" and
"I have never heard anyone say(and am not sure you have said either) that the mess has been caused by the yield curve."
just walked in the door from HI, it will be a while before I can catch up here.
thanks GJG, i have written about the yield curve countless times. you can plug that term into the search box in the right sidebar and get some of the posts.
off to the races....
bought FAS at the close, roger - think the financials have room to run?
Anon 4:35,
Be careful with the FAS play. I bought Friday at $2.40 and IMO all the easy money has been made with this trade as the market was massively oversold. We hit the same level of divergence versus the 200 day moving average (even worse by a percent or two) as November 2008, which was a record - 37% then, I think north of 38% this time.
The market is elastic and eventually snaps back. Now we will enter the next phase of "its over" "the government has saved us" "the economic data is improving" and "we'll be out of this in 6 months."
If the market holds 741 the next resistance level is 780 at which time I will put on SRS and FAZ once again...
Best of luck!
Rob from WI
My timing model is starting to get some sentiment juice but I won't have time to quantify it until tommorrow morning.
Roger, sticking to your 200 dma timing methodology should prove a winner here. I'm not sure how long it will take to breach those levels, but you'r long term volatility has to be much lower than a B&H investor.
Apparently the world has 500-odd less billionaires than it did a year ago, with some losing more than 50% of their fortunes.
That makes me feel a bit better. I hope it doesn't mean I'm a bad person.
I have found the comparison of the Vanguard Dividend Apprec ETF (VIG) to the SP500 quite useful as an early warning for change in market direction (up or down).
CA
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