A Reversion to the Mean

Several weeks ago we saw our primary market risk indicator (among others) reverse down bringing the ‘defensive team’ onto the field; this meant that the risk in the market was elevated, and as I wrote earlier, we should be proceeding with caution. This did not mean that we needed to come to a screeching halt. It meant that we unload the dead weight in portfolios and trim positions which had appreciated nicely.
The past few weeks can best be described (thus far) as a reversion to the mean or put simply, an exhale for the equities market. In mid-October many investments were statistically overbought. So far this pullback, or correction, in the market has been very similar to that of June in a number of ways: it has coincided with a bounce in the US Dollar and it has (thus far) caused more (needed) pullbacks than it has outright collapses. Sure, there have been several earnings misses to the downside, but by and large many areas of the market are yet to show long-term weakness.
The international equity market continues to show positive signs from a long term relative strength perspective, so international equities, as an asset class, continue to be an emphasized asset class. The same holds true for the US, particularly small caps.

Securities and Investment Advisory services offered through NBC Securities, Inc., Member FINRA and SIPC. Investment products 1) are not FDIC insured, 2) not guaranteed by any bank and 3) may lose value including a possible loss of principal invested. NBC Securities does not provide legal or tax advice. Recipients should consult with their own legal or tax professional prior to making any decision with a legal or tax consequence.This is not an offer to sell or buy any securities products, nor should it be construed as investment advice or investment recommendations

Proceed with Caution

We have enjoyed a strong run while running offense since July 20th. Actually, we have been on offense for all but one month since March 12th. Since July 20th we have seen the S&P 500 Equal Weight Index (RSP) gain 16.1% and the S&P 500 Index (SPX) up 11.8% while 30 out of 40 economic sectors gained more than 10% with only one sector (Savings & Loans) falling. While the market’s move has been nothing short of impressive, a breather - of some sort - is not wholly unexpected, nor undesirable.
After Wednesdays (10/28/09) activity, the pendulum in the market has switched from demand being in control to supply being in control. With this shift to wealth preservation there are several things we can do: scale back current positions, set stop-loss points, and wait for pullbacks to initiate new positions. Remaining positive for the market is the fact that equities (US & international) are still strongly favored over cash and the overall trend of the major market indices remains positive.

It's not too surprising that after such a strong rally we see some sort of consolidation and pullback here. We will follow what the indicators are telling us and will not let recent markets unduly influence our decision making process. 2008 was bad for equities, we know that, but that has absolutely no bearing on 2009 or 2010. Right now, we know that this shift from demand to supply suggests that the risk in the market has heightened and we will be proceeding with caution.

Securities and Investment Advisory services offered through NBC Securities, Inc., Member FINRA and SIPC. Investment products 1) are not FDIC insured, 2) not guaranteed by any bank and 3) may lose value including a possible loss of principal invested. NBC Securities does not provide legal or tax advice. Recipients should consult with their own legal or tax professional prior to making any decision with a legal or tax consequence.This is not an offer to sell or buy any securities products, nor should it be construed as investment advice or investment recommendations.

WELCOME BACK TO 10,000! Well, sort of…

Headlines as the market closed on Wednesday October 14, 2009:
Dow Jones Marketwatch: “Dow Reclaims 10,000”
Wall Street Journal: “Dow Tops 10,000"
Reuters: “Dow hits 10,000 Mark on Earnings Optimism”
Unfortunately, or fortunately, it was the first time the Dow closed with five digits since last October. Big picture: the sobering reality for investors is that the Dow is right where it was 10 years ago; on October 15th, 1999 the Dow Industrials closed at 10,019.
We have had one heck of a run since March but according to published data, lots of investors have missed this up move; more on this below.

Markets fall when investor’s - rattled to the point of throwing in the proverbial towel - bail out (creating supply). At some point this ‘capitulation’ diminishes available supply and the market makes a bottom. (The flip side is that the ‘defensive’ cash becomes (potential) new demand for equities.) Consider this: a fully invested account represents no potential for net new demand to the market however, an account that is sitting in cash represents $$$ of potential demand for equities. In March of this year the equity markets reached such a tipping point; supply dried up and enough new demand re-entered the picture to produce a bottom and the subsequent rally. Several months later the media (sceptics the whole way up) are celebrating the Dow's return to 10,000.
According to published statistics, many investors have missed this rally. There are a lot of costs associated with this, if that is the case. Since March 9th, an investor in long-term US Government Bond Funds has lost approximately 7%, an investor in Money Market Funds has gained less than 1/10th of 1%, while the purchasing power of their Dollars declined 15% and the equity markets climbed more than 50%.
There are two facts that as investors we must realize; #1- bond funds attracted net deposits of $209.1 billion in the first eight months of 2009 while stock funds drew just $15.2 billion. Said another way, for every new dollar moving into equities, $14 were moving into bonds. What does this mean? Investors that were burned during the collapse of 2008 were busy flocking to the perceived safety of bonds right as the 2009 bottom was materializing. #2 - the continued decline of the US Dollar. The Dow has recaptured Dow 10,000 in terms of US Dollars. While this rally has taken the Dow back to even for the decade, ‘foreign’ investors have not yet been made whole for the decade. Due to the (continued/continuing) decline in the value of the US Dollar, the Dow would need an additional rally of 45% to get back to its October 1999 levels - in Euro currency, assuming the $ declines no further.
There is risk to investing in equities; domestic or international, but there is also risk in keeping assets in money market funds when rates are 0.25% and when the Dollar is trending lower. Investors have flocked to cash and bonds because they are perceived as ‘safe’.
I have advised clients on investments since 1983 and have learned that in this business it is the conventional wisdom that can be the most dangerous, and for this reason objective tools that are based upon supply and demand rather than fear and reticence can add tremendous value. That is what I use to guide your portfolio. My primary market indicator (the NYSE Bullish Percent - BPNYSE) has kept the offensive team on the field for all but a month since March 12th and remains on offense today. I am currently emphasizing two equity based asset classes; International Equities (emerging) and US Equities (small cap) along with some exposure to metals; industrial & precious - in the commodity area.

Consequences of a Falling Dollar

Not only have we experienced a terrific market rally since March, we have also experienced a falling US Dollar. A steady chorus of international voices making a strong case for a global reserve currency, helped to fuel the dollars decline. Unfortunately, one can also point to our domestic fiscal policy. The decline of the dollar has a number of consequences for cash assets held domestically; one being more expensive foreign goods (imports). The dollars decline has contributed to the bullish backdrop underlying many other asset classes - such as commodities and foreign securities. As it takes more dollars to buy the same amount of ‘stuff’, commodity consumers will often stock pile to avoid making future purchases with a weaker currency, while precious metals are often purchased as an inflation or purchasing power hedge.

One beneficiary of the falling dollar has been Gold, which has moved above $1,000/oz. to register new all-time highs; at least in US Dollar terms. Interestingly, in terms of the Euro, we find that Gold is still well below its highs from February of this year.
Gold, as an asset class, offers a strong outlook based upon its trend chart however, its outlook in terms of leadership within the commodity asset class and even the Precious Metals segment of the asset class, is much less attractive. The proxy for silver (DBS – PowerShares DB Silver Fund) gave a relative strength buy signal versus Gold earlier this year and continues to exhibit positive strength vs. gold.
Silver has outpaced Gold’s proxy (DGL – PowerShares DB Gold Fund) rather dramatically thus far in 2009: DBS +45% to DGL +14% and, for the reasons mentioned above Silver appears likely to continue doing so.
Where appropriate for accounts under my advisement, DBS is part of the commodity exposure - along with DBB (PowerShares DB Base Metals Fund). The commodity group as a whole typically benefits from a falling US Dollar however, some commodities will inevitably benefit more than others during any market cycle. Going back to 1990 the average annual differential between the best and worst performing commodity is 114%*. Tactical asset allocation allows me to ‘hand pick’ exposure to the stronger areas within commodities, providing us with the opportunity to do better than a non-tactical approach like ‘buy and hold’ the broad commodity asset class. For example, while the trend for the overall commodity asset class continued higher in September, the trend of Crude Oil was derailed in recent months; oil prices stalled in early August when a high was placed at $75 per barrel. This is a negative divergence from the other raw materials.
For now it appears that metals, as a sub-group within commodities, are best positioned to provide outperformance and, despite Gold’s recent highs, Silver is in a lead role for the time being.

*Dorsey Wright - October 7, 2009

Now what?

‘Summer’s over, kids are back to school, and the market tacked on another 11% while we were on vacation.’ ‘Is it too late to buy?’ ‘Should I sell?’ ‘Nothing good ever happens in the month of September, right?’ These are the types of questions that I have been fielding over the course of the past couple of weeks.

Let’s look at what is; During the past week the market averages pulled back and this has made people nervous. Of course we'd all like to see the market go straight up but, just like humans, the market inhales and exhales. During the exhales, it is important to determine if it is an exhale or more like a gasp for breath - like 2008's market.

Using geek speak and info I gleaned from stats 101 - The average S&P 500 component has contracted from 46% overbought on its distribution curve to roughly 20% overbought. What this tells me is that the market pullback was just an exhale. Should we start to see more exhaling we may want to take a more defensive approach but as it stands right now all of our risk indicators for the equity market remain positive, albeit at higher risk levels.

Therefore, while these questions make for good fodder with the media you may rest assured that I have tools to manage your account no matter what the market may throw our way.

Demand is Winning the Battle

There are many old sayings on Wall Street. One of my favorite is “let the trend be your friend”. What’s amazing is that these sayings have been around for many years because they have an uncanny knack for being true. Another favorite is “bulls make money, bears make money, while pigs get slaughtered”.
The rally in the market over the past five months has been much welcomed by many. To some though, it has been inexplicable, and to others it has been downright baffling. Judging by the talking heads, the fundamental analysis or economic outlook, for that matter, has simply offered no ‘logical’ explanation or ‘warning’ that investors would be in a buying mood. This is why I find tremendous value in following soulless indicators, like the NYSE Bullish Percent and relative strength, to guide my investment allocations.

I find these indicators to be useful. For example, the primary market indicator (NYSE Bullish Percent - BPNYSE) reversed into a column of X’s on March 12th of this year indicating that demand was taking charge, and despite a brief period in a column of O’s (supply) in June and July, the BPNYSE has been in a column of X’s (demand), suggesting an offensive posture for about 80% of the time since March. I don’t begin to profess to know why demand was winning the battle back in March, and we typically don’t find out for some time after the fact, but what I do know is that the irrefutable laws of supply and demand are in force on Wall Street the same way they affect produce in the supermarket. Further, we know that when there are more people willing to buy a stock than there are willing to sell, the price of the stock must go up. That being the case, it appears that there are many investors out there looking to get more invested, and even though our indicators are at high levels the offensive team remains on the field.

Securities and Investment Advisory services offered through NBC Securities, Inc., Member FINRA and SIPC. Investment products 1) are not FDIC insured, 2) not guaranteed by any bank and 3) may lose value including a possible loss of principal invested. NBC Securities does not provide legal or tax advice. Recipients should consult with their own legal or tax professional prior to making any decision with a legal or tax consequence.This is not an offer to sell or buy any securities products, nor should it be construed as investment advice or investment recommendations.

Similarities between the 80's recession and today-

Interestingly, history has shown that economic recessions are not necessarily bad for the market because the stock markets are always looking ahead, the recession of the early-1980s serves as a great reminder of this. In 1980 the US economy was dealing with rampant inflation and a burgeoning recession. Largely because of this, gold prices rose from a low of $104/ounce in 1976, reaching $850/ounce by January of 1980. To further confuse the issue, the Fed had the discount rate set at 12% and the country was entering an election year.
At the close of 1980 the US economy continued to struggle as the Fed discount rate reached 13% and the prime rate peaked at 21%! Ronald Reagan entered office in 1981 seeking aggressive reductions in domestic spending & tax cuts. Reagan succeeded in the latter largely due to his economic advisor, Arthur Laffer; know for the ‘Laffer curve’ which illustrated that government revenues would increase as tax rates fell. Naturally, these policies were greatly debated, not only for the principal of Laffer’s theory but also for the budget deficits they would produce in the near-term if inflation remained high. Complicating matters further, Reagan inherited a US Economy that was a mere few months from entering its longest economic contraction since the Depression (16 months). Fortunately, following that recession we experienced one of the longest sustained growth periods in this country's history - but at the time, comparisons to the 30’s were being made, just like our current recession.
Of particularly interest to me are the similarities between the 80’s and today:
By August of 1982 ‘talking heads’ were debating whether the market was reacting to the end of a deep recession, or simply experiencing a ‘bear market rally’. Similar to the most recent ten year period, investors had experienced a ‘lost decade’, as the Dow was down 17% for the 10 years leading into August 1982. Today, investors can look back 10 years and see that the DJIA has lost about 12%. Despite the current economic backdrop of budget deficits and a deep recession, we see the market indexes behaving in a way that is at least comparable to that of the 1982 bottom.
Despite the news in ‘82, the market had bottomed and the supply-demand relationship pointed to offense, but those who myopically stared at the economy for insight saw nothing but inflation, unemployment and deficits. The recession would ‘officially’ end in November of 1982, by that time the S&P 500 had rallied 33% from its lows. The recession of the 80’s actually ended with the stock market higher than it was when the recession began! The best returns were yet to come however, as the S&P 500 would rally for the next 5 years without a correction of 20%, or more.
Sentiment can change quickly, in either direction, and no apologies will be given afterward. This is yet another reason why I use soulless and unemotional indicators to keep me heading in the ‘right ‘direction. I have thrown out my (office) TV so the ‘talking heads’ will not influence my decision making. The supply-demand relationship indicated that demand was taking control in mid March (2009). The market rallied into mid-June and then took a breather to digest the move. Mid-July saw a resumption of the market’s upward move. I don’t know what the future holds, but I will continue to rely on the tools that have served me well thus far.
As an aside; a client called several months ago because they were alarmed that a TV commentator had said that the rally was not ‘good’. I have been in this business since 1983 and have come to appreciate all market rally’s….When I inquired why the media figure did not like the rally – the answer was that there was not much cash going into the market. Again, insight gained over 26+ years has shown me that I want to be invested before all the cash comes pouring in – not the other way around.
If you know anyone who you feel would benefit from a logical and organized approach to investing – feel free to pass along this link.

Securities and Investment Advisory services offered through NBC Securities, Inc., Member FINRA and SIPC. Investment products 1) are not FDIC insured, 2) not guaranteed by any bank and 3) may lose value including a possible loss of principal invested. NBC Securities does not provide legal or tax advice. Recipients should consult with their own legal or tax professional prior to making any decision with a legal or tax consequence.This is not an offer to sell or buy any securities products, nor should it be construed as investment advice or investment recommendations.