Tuesday, January 29, 2013

Risk/Reward in $SPX Based on Citi Economic Surprise Index


According to JPM, the last 7 times that the Citigroup Economic Surprise Index (CESI) went negative, over the next 3 months, the $SPX had average upside of just 1% versus an average downside of 8%. In other words, based on that indicator alone, your risk/reward here is 8:1 down. Note that CESI went negative last week (January 25). 


Monday, January 28, 2013

1 Year Forward PE Ratio, 2003-Present

Since 2005, the $SPX has "comfortably" traded between a 12 month forward PE of 12-15 times. Below 12 has been an extreme reached in early 2009, mid-2010 and October 2011. Above 15 times marked the top in 2007 and April 2010. Over the last 10 years, the average has been 14.2.

Keep an eye on this. At SPX 1500 and assuming consensus $112 in FY13 EPS, the $SPX is trading at 13.3 times.

Saturday, January 26, 2013

Weekly Market Summary

Our overall market view remains positive. Trend and breadth remain solid - this is the key. For the 9th week out of the last 10, a majority of indices/sectors closed >13ema. This week: all 4 indices and 8 of 9 sectors. Notably <13ema are technology and $EEM, which is now negative for 2013.

Sentiment, downgraded last week, and macro expectations (defined by the Citigroup Economic Surprise Index (CESI), which turned negative this week, are the main headwinds going forward.

VIX during 2004-2007

While a $VIX under is associated with excellent returns in $SPX, it is not accurate to say that intermediate periods of time will not see solid sell-offs. 

For example, $VIX was sub-20 from 2004-07. 2004 was a dog year for $SPX, the other years were very good. Note, however, that $VIX would occasionally 'burp' 50-80% higher during that period, and $SPX would decline more 4-7% for 1-4 months. The notion that this was a period of consistent low volatility is wrong

CSFB "Fear Barometer" Hits a Peak

CSFB "Fear Barometer" hit a peak this week. In the past, this has been a good indicator of potential small percentage pullback in equity markets. Whether markets shrug this off and push remains to be seen.

This chart is via the excellent site, SentimenTrader. I recommend bookmarking it.

Friday, January 25, 2013

Winning Streak Hits 8 Days - A Higher High Ahead

$SPX has just completed an 8 day streak of up days. This is a considerable sign of strength and demand. After a pause, empirically, the market should continue to make new highs. In other words, winning streaks do not end with a notable top.

Friday, January 18, 2013

Weekly Market Summary

Our overall view remains positive. There is no apparent weakness in either trend or breadth, and we are still in a seasonally bullish time period. For the 8th week out of the last 9, a majority of indices/sectors closed >13ema. This week: all 4 indices and 9 of 9 sectors

Sentiment changed this week, from neutral to negative; fund manager cash balances are at the low end of the range and equity weightings are high. Other sentiment readings are not extreme, however

Thursday, January 17, 2013

Wall Street Sell Side Indicator is Mega Bullish

BAML's survey of Wall Street consensus equity allocations indicates significant bearishness. This is a contrarian indicator, and the current low levels suggests equities will rise 26% in the next 12 months.  The indicator is 47; when its below 50, returns the next year have been positive 100% of the time since 1985.

Tuesday, January 15, 2013

Fund Managers' Current Asset Allocation - January

There was a notable increase in bullish fund manager behavior over the past month. The highlights from the January BAML fund manager survey are as follows:
  1. Cash balances have dipped to a very low 3.8% (4.1% in December 2012), lowest since February 2011. The typical range is 3.5-5%.
  2. Equity allocations: a net 51% of fund managers are overweight equities (highest since February 2011). Just 35% overweight in December

Friday, January 11, 2013

Summation Index Climbs Higher


One of the main reasons to remain optimistic on the market is that breadth continues to expand.  Today, $NYSI (the McClellan Summation Index) closed above 700. As the chart below shows, when summation becomes oversold (below -500) and then climbs back above 500, market indices usually continue to climb higher. That is the current situation.

Investors Intelligence: Not Yet Hot

Investor Intelligence survey for this week shows increasing bullishness. The bulls minus bears (lower panel) is approaching 30, an area of two prior peaks in $SPX. Over 35 would be a cause for increased concern. Not yet.

Weekly Market Summary

This is the first post of a new weekly market summary.

Our overall view remains positive. Trend and breadth, the two most important factors, remain bullish. For the 7th week out of the last 8, a majority of indices and sectors closed week >13ema. This week: all 4 indices and 9 of 9 sectors as well $EEM, Euro 350, All World ex-US. Conversely, $TLT <13ema the last 7 weeks.

The main concern is sentiment; it's not hot, but getting warm.

Saturday, January 5, 2013

When Is Fund Manager Equity Exposure Extreme?

This is a follow on to the prior post on fund manager cash balance data from the monthly BAML report. This time, we are looking at equity exposure. The charts are from the same article by Short Side of Long found here.

Like cash balance, there is a good signal when investors feel panic near market bottoms. Below 10-15% equity weighting and I will be looking long. Even in early 2008, there was a sizable bounce before heading lower. There were other reasons to ignore this signal later that year.

When Is Fund Manager Cash Balance Extreme?

BAML publishes a monthly report on fund managers' cash balances. On the Weekly Market Summary, you will see that we look for extremes above 5% (bullish) and below 3.5% (bearish). 

Below are two charts from 2001-2012 from Short Side of Long. This excellent article on this subject is here

In the first, the lines are for cash above 5%. The most recent signal was at the June 2012 low. Even in 2008-09, this turned out to be a very useful indicator of extreme panic. A Fat Pitch.

Friday, January 4, 2013

Buy When the VIX is High (Above 40)

Having just shown that the best risk/reward is when the VIX is below 20, you'll find a surprisingly good bounce in $SPX when VIX spikes above 40. In the chart below, from 1996 to 2012, there were 5 great buying opportunities when VIX over 40. Unfortunately, buyers using this strategy were destroyed  in 2008. So there you go: it works 83% of the time.

A great chart from Short Side of Long below:

Thursday, January 3, 2013

Best $SPX Risk/Reward When VIX is Under 20

The best risk/reward in $SPX occurs when VIX is under 20. Average monthly returns (1.5%) and the maximum downside (-4.4%) occur during these periods. On average, monthly returns are positive 77% of the time. 

For comparison, when VIX is 25-30, average monthly returns drop (0.2%), maximum downside doubles (-9.1%) and the monthly returns are positive only 52% of the time. 

It gets worse the higher the VIX. A nice report can be found here with a the summary table extracted below.

Wednesday, January 2, 2013

McClellan: 40 Year Cycle in DJIA

A chart from Tom McClellan showing the DJIA 40 year cycle. Each point on the chart is compared to the period 40 years prior. According to this cycle, a big bottom is coming up in 2014 following a big top this year.

Sentiment Expressed in the Press


Sentiment expressed in the press is always gloomy at market bottoms. Here are two examples. The first is from December 2011. "Our decade from hell will get worse in 2012." $SPX rose over 20% in the next 12 months.

Tuesday, January 1, 2013

Recommended Web Sites

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I recommend bookmarking and regularly visiting these sites:

What is the Fat Pitch?

In baseball, a fat pitch is a hittable ball. The odds are in your favor. You might miss, but it is a situation where you should take a swing of the bat. If you swing at good pitches and avoid the crappy ones, you improve your OBP. Once on base, it become a running game.

The stock market serves a lot of curve balls. Now and then comes a Fat Pitch, your odds-on opportunity to swing the bat. Get on base and then manage your base-runners.

Specifically, the Fat Pitch on this site refers to two situations.

Fat Pitch Market Summary: A Structured, Quantitative and Empirical Methodology

The objective of the Fat Pitch is to provide a structured, quantitative and empirical methodology for evaluating the state of the market. At any point in time, there are a variety of factors pulling on the market. We want to determine the relative importance of each factor in order to answer two questions:
  1. In which direction should we be investing in the market? 
  2. Are tailwinds behind this direction or are headwinds picking up?
Every Friday we publish a Weekly Market Summary with green, yellow and red lights on it. Green is good and red is bad. Everything on this site is in support of this market summary. The little tabs across the top of the site (trend, breadth, etc) mirror the different factors we follow to monitor the market. There is nothing here that doesn't fit with the methodology. Anytime you want to understand why a factor is red or green, click on the tab and read the accompanying analyses. To the fullest extent possible, we quantify and use empirics to determine the state of every factor.



Each factor discussed below.

Who is the author of this blog?

Everyone always wants to know how the story ends. So let's start there.

2014
If you would like to connect, please visit my LinkedIn profile.

2013
One of Business Insider's Top 100 People in Finance to Follow

Started this blog.

2010
Blocked by Zero Hedge.

2008
SPX at 1500. Said, "I will now spend more time trading." Learned many real time lessons on the way to 666.

1998
Moved back the US and founded consulting firm with two partners. Focus is on corporate and product strategy, especially for medical technology companies. Many large, listed companies are clients.

For Entertainment and Educational Purposes Only

Nothing here constitutes advice. All investment decisions you make are your own.