Category: Active Investing

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Weekly Stock Market Snapshot

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The above two dials provide a snapshot of our market view and attitude to risk.

Bull/Bear Market

The Bull/Bear Market indicator improved to 60% from 40% last week.

Heavy truck sales increased to 42,240 units in November, while October sales were revised up to 38,550 from the earlier reported 32,490.

Heavy Truck Sales

Just two of the five indicators now signal Risk-off:

Bull/Bear Market Indicator

Stock Pricing

The Stock Pricing indicator compares stock prices to long-term sales, earnings, and economic output to gauge market risk. We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile.

Stock pricing continues to rise, reaching the 97.95 percentile compared to 97.83 last Friday. This warns that stocks have the potential for large drawdowns.

Stock Market Value Indicator

Conclusion

The bane of forecasting is data revisions. The collection of data for October heavy truck sales may have been impacted by hurricanes in the Southeastern region of the US.

We are again at the border between a bull and bear market, with our bull/bear indicator increasing to 60%.

However, we do not plan to increase exposure to risk assets because stock pricing remains extreme, warning of the potential for large drawdowns.

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Weekly Stock Market Snapshot

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The above two dials provide a snapshot of our market view and attitude to risk.

Bull/Bear Market

The Bull/Bear Market indicator fell to 40% last Friday from 80% on November 9th.

The most recent bear signal is heavy truck sales, which plunged to a seasonally adjusted 32.5 thousand units in October 2024 from a peak of 46.1 thousand in May 2023.

Heavy Truck Sales

There are now three of five indicators signaling Risk-off:

Bull/Bear Market Indicator

Stock Pricing

The Stock Pricing indicator compares stock prices to long-term sales, earnings, and economic output to gauge market risk. We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile.

Stock pricing remains in the extreme range, at the 97.83 percentile compared to 97.67 last Friday, warning that stock prices have the potential for large drawdowns.

Stock Market Value Indicator

Conclusion

We are headed for a bear market, with our allocation to risk assets declining to 40%.

Stock pricing is also extreme, warning of the potential for large drawdowns.

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Weekly Market Snapshot – bear signal

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The above two dials provide a snapshot of our market view and attitude to risk.

Bull/Bear Market

The Bull/Bear Market indicator fell to 40% from 80% on Friday, November 9th.

The most recent bear signal is heavy truck sales, which plunged to a seasonally adjusted 32.5 thousand units in October 2024 from a peak of 46.1 thousand in May 2023.

Heavy Truck Sales

There are now three of five indicators signaling Risk-off:

Bull/Bear Market Indicator

Stock Pricing

The Stock Pricing indicator compares stock prices to long-term sales, earnings, and economic output to gauge market risk. We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile.

Stock pricing remains in the extreme range, at the 97.67 percentile compared to 97.59 last Friday, warning that stock prices have the potential for large drawdowns.

Stock Market Value Indicator

Conclusion

We are headed for a bear market, with our allocation to risk assets declining to 40%.

Stock pricing is also extreme, warning of the potential for large drawdowns.

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Bull/Bear Market Indicator

We aim to consolidate our economic and financial market analysis into a single quantifiable bull/bear market indicator.

Bull/Bear Market Indicator

We modified one of our five component market risk indicators to reduce whipsaws. Instead of the Fed Funds Rate confirmed by ISM Services Business Activity, we have created a composite indicator comprising:

  • the Fed Funds Rate;
  • the Coincident Economic Activity Index from the Philadelphia Fed;
  • the Chicago Fed National Financial Conditions Index; and
  • the S&P 500 with 30-week Twiggs Smoothed Momentum.

Three out of four components are required to confirm a bear market.

Our first signal was the Coincident Economic Activity Index which crossed below 2.5% annual growth for the 12 months to July, warning that the economy is slowing.

Coincident Economic Activity Index from the Philadelphia Fed

Last week, the Fed announced a 50 basis point rate cut, adding a second bear signal.

Fed Funds Target Rate (Average of High & Low)

However, the Chicago Fed National Financial Conditions Index below zero signals easy monetary conditions at a low -0.56.

Chicago Fed National Financial Conditions Index

30-Week Twiggs Smoothed Momentum also signals a healthy up-trend on the S&P 500 at 12.8%.

S&P 500 with 30-week Twiggs Smoothed Momentum

The signal, therefore, remains Risk-On.

Of our four remaining risk indicators, only one signals Risk-Off.

The spread between the 10-year Treasury yield and the 3-month T-bill discount rate has been negative for 22 months. While that is a record time, it does not negate its reliability in predicting a recession within 12 months after the inversion ends.

10-Year Treasury Yield - 3-Month T-bill Discount Rate

Our second risk signal would only be triggered when the yield curve inversion ends.

Employment in cyclical industries—manufacturing, construction, transport, and warehousing—accounts for most of the jobs lost during a typical recession. Cyclical employment grew by 17,900 in August, with no sign of a recession on the horizon.

Cyclical Employment

Heavy truck sales are another reliable leading indicator of recessions. Seasonally adjusted sales of more than 42,000 units in August continue to signal a robust economy.

Heavy Truck Sales

Conclusion

Four out of five risk indicators continue to signal a bull market.

Our strategy is to divide our investment portfolio into five equal-sized buckets of 20% each. For each indicator warning of a bear market, one bucket will be switched to alternative investments—such as A-grade bonds or gold.

At present, only the 10-year/3-month Treasury yield curve warns of a bear market, so we maintain 80% exposure to stocks.

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The Economics of Different | Eric Cinnamond

Eric Cinnamond on the trials and rewards of not following the herd:

I grew up in a small town outside of Louisville, Kentucky. I’m not even sure I’d call it a town – more like a zip code. We lived in a subdivision with five acre lots and gravel roads. Growing up on a gravel road had its challenges. Falling off your bike was painful! Walking or running on gravel can also be uncomfortable, with rocks often finding their way into your shoes. Dust is an issue too, along with bumpy rides and potholes. But there were some benefits.…. more

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The Myth Of The “Passive Indexing” Revolution | RIA

From Lance Roberts at RIA:

While the idea of passive indexing works while all prices are rising, the reverse is also true. The problem is that once prices begin to fall the previously “passive indexer” becomes an “active panic seller.” With the flood of money into “passive index” and “yield funds,” the tables are once again set for a dramatic and damaging ending.

Source: The Myth Of The “Passive Indexing” Revolution | RIA

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The dangers of passive investing

There is a lot to be said for passive investing.

Key Takeaways from Morningstar’s Active/Passive Barometer Report:

  • Actively managed funds have generally underperformed their passive counterparts, especially over longer time horizons.
  • Failure tended to be positively correlated with fees.
  • Fees matter. They are one of the only reliable predictors of success.

Prof. Burton Malkiel, author of A Random Walk Dow Wall Street, writes in the WSJ:

During 2016, two-thirds of active managers of large-capitalization U.S. stocks underperformed the S&P 500 large-capital index. When S&P measured performance over a longer period, the results got worse. More than 90% of active manager underperformed their benchmark indexes of a 15-year period.

…..In 2016 investors pulled $340 billion out of actively managed funds and invested more than $500 billion in index funds. The same trends continued in 2017, and index funds now account for about 35% of total equity fund investments.

Volatility is also near record lows as the market grows less reactive to short-term events.

CBOE Volatility Index (VIX)

Lower fees and lower volatility should both improve investment performance, so what could possibly go wrong?

Investors could stop thinking.

If passive funds are the investment of choice, then new money will unquestioningly flow to these funds. In turn the funds will purchase more of the stocks that make up the index.

Prices of investment-grade stocks that make up the major indices are being driven higher, without consideration as to whether earnings are growing apace.

And the higher index values climb, the more investment flows they will attract. Driving prices even higher in relation to earnings.

More adventurous (some would say foolhardy) investors may even start using leverage to enhance their returns, reasoning that low volatility reduces their risk.

The danger is that this becomes a self-reinforcing cycle, with higher prices attracting more investment. When that happens the market is in trouble. Headed for a blow-off.

Investing in passive funds doesn’t mean you can stop thinking.

Don’t lose sight of earnings.

When prices run ahead of earnings, don’t let your profits blind you to the risks.

And start thinking more about protecting your capital.

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The Quants Run Wall Street Now | WSJ

From Gregory Zuckerman and Bradley Hope:

For decades, investors imagined a time when data-driven traders would dominate financial markets. That day has arrived.

…. quantitative hedge funds are now responsible for 27% of all U.S. stock trades by investors, up from 14% in 2013, according to the Tabb Group, a research and consulting firm in New York.

Quants now dominate the short-term trading market but active managers (homo sapiens) are still very dominant in the much larger long-term investment market. And this is unlikely to change any time soon.

Source: The Quants Run Wall Street Now – WSJ

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The Trouble With Chasing Hot Strategies | Josh Brown

This should be blindingly obvious, but amazing how often it is ignored. Great post from Josh Brown at Reformed Broker:

How do most investors (and many advisors) select funds or strategies to allocate to? They look at what’s been working, learn the story and get long…….
And then mean reversion shows up – outperforming managers subsequently underperform, hot themes become over-loved, winning strategies become too crowded to offer excess returns. “No problem,” says the advisor, I’ve got six new ideas to replace the six ideas that are no longer working!”

It’s sad to say, but this is exactly how it works. I’ve been watching this for almost 20 years…….

Research Affiliates has an interesting pair of charts demonstrating this phenomenon in a new note from Rob Arnott, Jason Hsu and Co. They illustrate that increasing fund flows are a decent predictor of subsequent underperformance and that performance-chasing is destructive to returns across all types of investment products:

Research Affiliates

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S&P 500 Prime Momentum 12 month performance

S&P 500 Prime Momentum

The S&P 500 Prime Momentum strategy has now been running for twelve months, since November 2013, and returned 17.46%* for the period compared to 17.27% for the S&P 500 Total Return Index. This is below the average return for the 1996 to 2013 research period and is attributable to the sell-off of momentum stocks in recent months. Macroeconomic and volatility filters continue to indicate low to moderate risk typical of a bull market and we expect stocks to recover in the months ahead.

* Results are unaudited and subject to revision.

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