A "Sheer Misery" Market Defined
During a recent meeting, I was asked for my take on the current environment for "tactical" investment strategies. It was noted that most tactical managers had a rough go last year and wondered if the environment had changed with the calendar. My response was brief and to the point, "It's been 'sheer misery' in the tactical space since the beginning of 2014... and no, nothing has changed."
Not surprisingly, I was asked to put "some color" behind my view and to extrapolate on why the environment has been tough on folks trying to employ a tactical approach to investing (which according to Investopedia is defined as: "An active management portfolio strategy that rebalances the percentage of assets held in various categories in order to take advantage of market pricing anomalies or strong market sectors.")
I tried to respond as succinctly as possible and when I was done, I realized that others might find my explanation of the current environment worthwhile.
So, here was my response and some thoughts on what investors/advisors should be doing now...
Since the beginning of 2014, stocks have working higher in a very choppy, sometimes violent fashion. Intraday volatility has increased dramatically as high-speed trend-following has become increasingly prevalent. For example, the S&P regularly moves plus or minus 0.5% within a matter of minutes these days - and without any news.
The next point is that each new high in the indices (and there have been more than a few over the last 15 months) has been met with selling. This price action has been affectionately referred to as the dreaded "breakout fakeout." The problem is that "breakouts" tend to be considered a good thing by most trend or momentum-based market indicators. So, in short, this means that the indicators most tactical managers employ have been consistently "fooled" each time a "fakeout" occurs.
Given that this trend has quickly became quite obvious to most traders, a great many of these "breakout fakeouts" quickly evolved into pullbacks as the "fast money" types sold short with glee each time a breakout failed.
However, after pulling back a handful of percentage points, each and every one of these declines (which are traditionally a friend to tactical managers) was quickly reversed as the next round of QE/monetary stimulus/friendly Fedspeak arrived from the likes of Mr. Bullard (see the October decline bottom), the ECB, China, Japan, etc.
In addition, the market has been a bit of a bucking bronco of late as we’ve seen no fewer than 10 changes in direction since December alone – and 7 already this year!
Perhaps the best statistic I’ve seen that describes the environment is this... From 1955 through 2012 the S&P experienced a "V-Bottom" every 1.6 years on average. However, since the beginning of 2013, the market has experienced a "V-Bottom" every 1.5 months on average.
Then there is the "fund flow" issue, that is likely responsible for the V-Bottoms. By now, most folks know about the money that has been flowing steadily into the U.S. market. But let's spend a moment to review the cause and effect here.
With the U.S. Fed and the Bank of Japan printing trillions in fresh cash via their QE programs last year, the bottom line is that money had to go somewhere. And what we saw is that an awful lot of it wound up in the U.S. stock and bond markets (remember, money goes where it is treated best).
And while the U.S. has stopped its QE program, the ECB has now stepped in to pick up the slack to the tune of €60 billion a month for a total of 19 months. As such, there is underlying support for the stock market whenever a "dip" takes place.
So, with the "fast money" selling all new highs and the fresh new QE money buying the declines, you wind up with a choppy, mean-reverting environment that has eventually managed to move steadily higher.
In sum, the fast-paced changes in direction have been tough as tactical managers have had a very difficult time dealing with this up-one-minute and then down-the-next market.
So, what is working, you ask? In essence, this continues to be a time to be more "strategic" in your approach to the markets. Or another way to put it is that your risk management techniques have needed to be longer-term in nature in order to succeed.
But perhaps the best answer is that investors, advisors, and clients alike have to learn to diversify their portfolios properly. And no, I'm not talking about that ancient MPT stuff.
What I'm talking about is diversifying your portfolio by strategy, by manager, and by methodology. In other words, don't put all of your eggs in one basket. The bottom line is that ALL (yes, ALL!) investment managers/strategies experience periods of underperformance from time to time. So, don't freak out when it happens to you or a money manager near you employ.
In 2013 it was asset allocation that was made to look silly as the term "diworsification" made a comeback. But since then, allocating across asset classes has worked just fine. Then since the beginning of 2014, tactical strategies have clearly been picked on by Ms. Market.
So, is it time to give up on all those folks trying to manage risk or stay on the right side of the market? In a word, no.
While no one knows how long the current environment - the same environment that is causing tactical managers to struggle - will last, there is one thing we do know for certain about the stock market. And that is right about the time you've got the answer, the game changes.
So, instead of dumping those underperforming tactical managers, a true contrarian might be licking their chops at what will likely amount to an opportunity when the environment changes. And it will change, you can count on it.
Turning to This Morning...
At long last, there is some data for traders to chew on this morning. Overnight in China, the news was disappointing as the HSBC Flash Manufacturing PMI fell back into the contraction zone. Across the pond, the news was surprisingly good since both the Manufacturing and Services PMI's were above expectations for the Eurozone and Germany. And with Greece scrambling to try and deliver reforms in order to receive the cash it desperately needs, European bourses are a bit higher this morning. Here in the U.S., the CPI sported a gain for the first time in four months and stock futures are pointing to a modestly higher open on Wall Street.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: -0.39%
Crude Oil Futures: +$0.16 to $47.61
Gold: +$4.90 at $1192.60
Dollar: higher against the yen and pound, lower vs. euro
10-Year Bond Yield: Currently trading at 1.902%
Stock Indices in U.S. (relative to fair value):
S&P 500: +3.38
Dow Jones Industrial Average: +35
NASDAQ Composite: +9.51
Thought For The Day:
One loyal friend is worth a thousand relatives. -Euripides
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 Fed/ECB Policy
2. The State of the U.S. Economy
3. The State of the U.S. Dollar
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Positive
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 2 years)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Key Near-Term Support Zone(s) for S&P 500: 2080
- Key Near-Term Resistance Zone(s): 2120
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator (Short-Term): Positive
- Price Thrust Indicator: Positive
- Volume Thrust Indicator: Neutral
- Breadth Thrust Indicator: Neutral
- Bull/Bear Volume Relationship: Positive
- Technical Health of 100+ Industry Groups: Moderately Positive
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- S&P 500 Overbought/Oversold Conditions:
- Short-Term: Overbought
- Intermediate-Term: Neutral
- Market Sentiment: Our primary sentiment model is Neutral .
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.
- Weekly Market Environment Model Reading: Moderately Positive
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research
Trend and Breadth Confirmation Indicator (Short-Term) Explained: History shows the most reliable market moves tend to occur when the breadth indices are in gear with the major market averages. When the breadth measures diverge, investors should take note that a trend reversal may be at hand. This indicator incorporates an All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 5-day smoothing and the All-Cap Equal Weighted Equity Series is above its 25-day smoothing, the equity index has gained at a rate of +32.5% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +13.3% per year. And when both are below, the equity index has lost +23.6% per year.
Price Thrust Indicator Explained: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average. When the Value Line's 3-day rate of change have moved above 0.5 standard deviation of the 30-day average ROC, a "thrust" occurs and since 2000, the Value Line Composite has gained ground at a rate of +20.6% per year. When the indicator is below 0.5 standard deviation of the 30-day, the Value Line has lost ground at a rate of -10.0% per year. And when neutral, the Value Line has gained at a rate of +5.9% per year.
Volume Thrust Indicator Explained: This indicator uses NASDAQ volume data to indicate bullish and bearish conditions for the NASDAQ Composite Index. The indicator plots the ratio of the 10-day total of NASDAQ daily advancing volume (i.e., the total volume traded in stocks which rose in price each day) to the 10-day total of daily declining volume (volume traded in stocks which fell each day). This ratio indicates when advancing stocks are attracting the majority of the volume (readings above 1.0) and when declining stocks are seeing the heaviest trading (readings below 1.0). This indicator thus supports the case that a rising market supported by heavier volume in the advancing issues tends to be the most bullish condition, while a declining market with downside volume dominating confirms bearish conditions. When in a positive mode, the NASDAQ Composite has gained at a rate of +38.3% per year, When neutral, the NASDAQ has gained at a rate of +13.3% per year. And when negative, the NASDAQ has lost at a rate of -8.5% per year.
Breadth Thrust Indicator Explained: This indicator uses the number of NASDAQ-listed stocks advancing and declining to indicate bullish or bearish breadth conditions for the NASDAQ Composite. The indicator plots the ratio of the 10-day total of the number of stocks rising on the NASDAQ each day to the 10-day total of the number of stocks declining each day. Using 10-day totals smooths the random daily fluctuations and gives indications on an intermediate-term basis. As expected, the NASDAQ Composite performs much better when the 10-day A/D ratio is high (strong breadth) and worse when the indicator is in its lower mode (weak breadth). The most bullish conditions for the NASDAQ when the 10-day A/D indicator is not only high, but has recently posted an extreme high reading and thus indicated a thrust of upside momentum. Bearish conditions are confirmed when the indicator is low and has recently signaled a downside breadth thrust. In positive mode, the NASDAQ has gained at a rate of +22.1% per year since 1981. In a neutral mode, the NASDAQ has gained at a rate of +14.5% per year. And when in a negative mode, the NASDAQ has lost at a rate of -6.4% per year.
Bull/Bear Volume Relationship Explained: This indicator plots both "supply" and "demand" volume lines. When the Demand Volume line is above the Supply Volume line, the indicator is bullish. From 1981, the stock market has gained at an average annual rate of +11.7% per year when in a bullish mode. When the Demand Volume line is below the Supply Volume line, the indicator is bearish. When the indicator has been bearish, the market has lost ground at a rate of -6.1% per year.
Technical Health of 100 Industry Groups Explained: Designed to provide a reading on the technical health of the overall market, this indicator takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.
Weekly State of the Market Model Reading Explained:Different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Market Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.
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 nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program.
Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.
The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
David D. Moenning, an advisor representative of CONCERT Wealth Management Inc. (CONCERT), is founder of Heritage Capital Advisors LLC, a legal business entity doing business as Heritage Capital Research (Heritage). Advisory services are offered through CONCERT Wealth Management, Inc., a registered investment advisor. For a complete description of investment risks, fees and services review the CONCERT firm brochure (ADV Part 2) which is available from your Investment Representative or by contacting Heritage or CONCERT.
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