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Why Tactical Isn't Working - Part III (Everybody's Doin' It) image

The key driver to the markets at the present time is the idea that the Global QE era is coming to a end. The question for such a massive, macro issue is, of course, what to do about it and when. So, with the market breathing a sigh of relief this morning in response to the Bank of England signaling that another rate cut is on the horizon and word out of Apple that they've sold out of the iPhone 7 inventories, I thought I would continue my little series on why so many tactical/technical trading strategies aren't working these days.

To review, I began this series last week by showing examples of technical stock market indicators that had proved invaluable for very long periods of time, but that over the last several years, well, not so much.

We looked at a trend-and-breadth confirm model, a couple momentum thrust indicators, and a sentiment model. All of these models/indicators, which were developed and maintained by Ned Davis Research (so the issue isn't the data or my spreadsheets!), have, in some cases, lost their effectiveness, and in others, stopped working altogether.

To be clear, these are merely examples of what has been happening in the technical/tactical world. To sum up the dilemma, the majority of the purely technical indicators/models I monitor on a daily basis are simply less effective today than they have been in the past.

And for the record, I'm not the only one holding this opinion. For example, in July of this year, Ned Davis himself told clients, "This is not the same market that I grew up with. Thus, I am skeptical of my own indicators..."

As I opined in the first two installments of this series, I'm of the mind that this helps explain why a great many tactical investing strategies (i.e. investing programs designed to "time the market") have basically stunk up the joint since 2013. I've talked to scores of financial advisors as well as fellow professional money managers on the subject and the sentiment is usually the same. Although I am indeed generalizing here, the common theme has been that tactical strategies have failed to deliver and/or seriously disappointed.

The Question is Why?

If you are a trader or an investment advisor utilizing tactical strategies for your clients, you know what I'm talking about. But the key question is, why are indicators/models/systems that had worked for literally decades suddenly out of favor - or worse?

Cutting to the chase, I believe there are three primary reasons that the tactical/technical approach has struggled. Here's the executive summary:

1. Everybody's Doin' It
2. Global QE
3. The Rise of the Machines

Let's spend a few minutes this morning exploring...

Everybody's Doin' it

When I began doing technical analysis in the early 1980's a 30-day moving average of a stock market index worked very well. As did a 50-day and the media's favorite indicator, the simple 200-day moving average. The reason this stuff worked was pretty simple - the indicators were hard to produce and only a small percentage of investors utilized the dark art of technical analysis.

Remember, this was before personal computers. Trendlines and support/resistance zones were drawn with a pencil (NOT a pen!) on your copy of the Wall Street Journal or what is now Investor's Business Daily. The calculation of moving averages involved a legal pad, a pen (not a pencil), and a calculator. Ah, good times.

The key here was that when the S&P 500 crossed it's moving average - or a band set a certain percentage above/below said moving average (which was considered highly sophisticated stuff at the time) - only a handful of folks knew about it. As such, the signal given didn't move the market - it allowed those following the signal to easily move in and out. Furthermore, there was no one there to front-run the signal.

At that time, fundamental analysis was all the rage and indicators using charts and math were viewed as witchcraft.

However, those practicing what was once called "market timing" (a term sullied by the mutual fund industry during the secular bull market of the 1990's) actually fared pretty well. You bought when the index moved above your moving average and you sold when it dropped below. And if memory serves, up until the turn of the century, such an approach worked pretty darn well!

In fact, using a technical approach would have kept investors out of harm's way during the fall of 1987. As such, I'm of the opinion that "The Crash of '87" was responsible for moving technical analysis out of the shadows and into the mainstream. And it was that monumental computer foul-up that helped launch my career.

Over time though, technical analysis became easier to do. The PC made it much, much easier/faster to calculate your moving averages. Next, the computer allowed you to place the indicator on a chart. Then that chart could be updated during the day - the advancement of technology in the early years of the PC was amazing!

As computers became a prominent part of our lives, technical analysis gained respect and more and more technical indicators were dreamed up.

Fast-forward to today. Now we have charts - with various moving averages and technical indicators - on our phones. Technical levels are talked about ALL day long on television. And everybody, everywhere knows then an important support zone is broken.

Why does this matter, you ask? The bottom line is, in the stock market, when something becomes too popular, it simply stops working. This is due to the fact that (a) everyone using a particular approach tries to make the same move at the same time and (b) folks try to front-run the move by making their trade before the signal is given.

Enter the "mean reversion" game. Nowadays, not only is everyone on the planet a market technician, there are also vast numbers of "fast money" types who prefer to "go the other way" whenever a trend is occurring. Doesn't everybody now know that the game is about buying when other people are selling and vice versa? Think about it. The media has probably convinced you that buying a "breakout" is a fool's game. Don't be a chump, we're told! No, the really SMART play is to buy on a dip, right?

As such, the preponderance of the fast money trader types - and especially the programming of this type of strategy into the computers responsible for the vast majority of trading today (more on that later) - have created an environment where "buying the dips and selling the rips" is the primary way the game is played on a daily basis.

And don't look now fans, but everybody's doin' it.

So, is it any wonder that "V-Bottoms" (which, in the past, were a rather rare occurrence), are now commonplace? Should we really be surprised that indicators focusing on trends in the market and/or momentum have been consistently fooled lately? And in turn, doesn't it make sense that old-school indicators don't seem to work very well anymore?

Remember, the stock market is a wonderful example of crowd behavior in action. And with everybody doin' the same thing - on SO many levels (institutions, hedge funds, central banks, etc.) these days - well, I'm just sayin...

Next time, we'll explore the role of the Global Central Banks. Then we'll get into the "rise of the machines." And finally, I'll offer up my view on some answers to this tactical/trading dilemma.

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      T1. The State of the Bond Market
      T1. The State of Global Central Bank Policies
      3. The State of U.S. Economic Growth
      4. The State of the U.S. Dollar

Thought For The Day:

Love,compassion and tolerance are necessities, not luxuries. Without them, humanity cannot survive. - Dalai Lama


Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

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