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Why Tactical Strategies Aren't Working Very Well - Part I image

With traders waiting to hear what Mario Draghi has to say this morning, I'd like spend a few minutes on the idea that the character of the market has changed rather dramatically during the current bull run.

Cutting to the chase, there can be little argument that a great many tactical managers/strategies have struggled (sometimes mightily) since the credit crisis ended in 2009. Disciplined investing strategies designed to make hay while the sun shines AND when the market declines, which were all the rage after the S&P 500 was nearly cut in half for the second time in 9 years, have failed to impress since. Tried and true indicators possessing strong returns for decades have suddenly stopped working. The question, of course, is why?

For example, one of my favorite short-term indicators is called a trend-and-breadth confirmation model. The idea is very simple. If the price trend of the market is up and the trend of the advance/decline line (a stock-only A/D line is preferred here for obvious reasons) is up, logic - and history - suggests that the stock market is in good shape and that the odds of the continued gains are high.

More specifically, this simple indicator uses a 25-day simple moving average of a multi-cap stock universe and a 5-day MA of the universe's advance/decline line. According to the computers at Ned Davis Research, this indicator would have been VERY useful since 1980. In fact, when both price and breadth were above their respective moving averages (which occurs about 41% of the time), the market has gained ground at an annualized rate of 30.4%.

Conversely, when both price and breadth were below their respective MAs, stocks have declined at an annualized rate of -22.4% per year.

And when one is above the MA and one is below, the annualized return of the stock market index used has been a respectable 12.7% per year.

From my seat, this rather simple indicator is incredibly intuitive. If the market is "in gear" and the indicator is positive, stocks tend to go up. When the indicator is negative, stocks go down. And when the indicator is neutral, stocks tend to do okay because, well, stocks have an upward bias the vast majority of the time. It is for this reason that versions of this indicator have been in my toolbox since the early 1990's. After all, what's not to like about such a simple indicator that has proved successful over a very long period of time.

Here's the Rub

The great thing about using a price-oriented indicator is that unlike so many other models designed to help one figure out what is likely to happen next in the stock market, price cannot deviate from itself. In other words, an indicator based on price isn't going to suggest one thing while price does the other. It is what it is.

But here's the problem - and the primary reason I have made a fairly dramatic shift in my thinking about how to analyze the markets in recent years. My trend-and-breadth confirmation model has stopped working.

If you look at this indicator since 2007, the results are very, very different. Instead of seeing annualized gains in the 30% range when the indicator is positive, the annualized return in the "current era" of the stock market are... wait for it... negative.

That's right. Since 2007, the very same indicator that sports a gain of 30.4% over a 36 year period now produces an annualized LOSS of -12.5% when positive. Wait, what?

If you think the upside-down results might be due to the fact that I started the clock before the big smack-down in stocks, give yourself a gold star as this certainly makes sense. But, wait, there's more.

Since 2007, when the indicator is negative, stocks have actually gained ground at an annualized rate of 10.6% per year.

And here's the best part. When the indicator is neutral, meaning that either price or breadth is below the MA and one is above, stocks have soared at an annualized rate of +32.5% per year.

The Takeaway

So, let's think about this for a second. When both trend and breadth are positive, stocks go down. When both are negative, stocks go up. And when they are conflicted, stocks rocket higher. Which leads me to ask, what the heck is going on here?

Since Super Mario is on deck and my time allotted to "pen" my morning missive is quickly evaporating, I'll leave it here this morning and pick this discussion back up tomorrow. But the key takeaway is that if anyone using tried and true, successful indicators to guide their "timing" in the market, they may want to do some digging in order to see if what they are using still works today.

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).

      1. The State of Global Central Bank Policies
      2. The State of U.S. Economic Growth
      3. The State of the U.S. Dollar

Thought For The Day:

Make the present good, and the past will take care of itself. -Knute Rockne

 

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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Disclosures

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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