The weight of evidence is becoming increasingly bearish for the US stock market

 “The trend is your frienduntil the end when it bends.” 

Stock indexes making higher highs and higher lows is a good thing – until it isn’t.

I run a combination of systems. Most of them are trend following in nature, meaning the objective is to enter a trend early in its stage to capitalize on it until it changes.

But when trends reach an extreme it’s time to take note.

For me, what follows is what I consider market analysis, which doesn’t necessarily result in an specific trades, per se, but instead, it’s my intellectual exercise to understand what’s going on. And it’s nice to have an idea of when a trend may be ready to change.

In law, weight of evidence “refers to the measure of credible proof on one side of a dispute as compared with the credible proof on the other.

It is the probative evidence considered by a judge or jury during a trial.

In this case, the jury are active investors in the market.

Probative evidence is having the effect of proof, tending to prove, or actually proving. So, when a legal controversy goes to trial, the parties seek to prove their cases by the introduction of evidence. If so, the evidence is deemed probative.

Probative evidence establishes or contributes to proof.

The weight of evidence, then, is based on the believability or persuasiveness of evidence.

Since we never know the future in advance, when we engage in market analysis, we necessarily have to apply the weight of the evidence to establish the probability.

After monitoring price trends and a range of indicators intended to measure the strength of a trend for more than two decades, I’ve got a feel for the weight of the evidence. So, my confidence in these observations has increased over time, even as imperfect as it is.

Let’s see some evidence to weight.

By the first of June, 98% of the S&P 500 stocks were trending up, above their short term trend 50 day moving average. Since then, we’ve seen some divergence between the stocks in an uptrend and the stock index.

Image

It tells us fewer stocks are participating in the uptrend.

The advantage of monitoring breadth measures like % of stocks above a moving average or bullish percent is it’s a high level barometer that may highlight what is changing. Sometimes, it’s what is diverging.

In this case, the price trend of the stock index is diverging with the percent of stocks in a positive trend.

One of the warning signs in January and February was this same divergence between the uptrend in $SPY and the breadth of participation of the individual stocks in the index.

Image

When I see divergence, it reminds me to look inside to see what has changed.

It’s usually explained by sector rotation.

For example, over the past month, Technology and Communications have shown relative strength, but the momentum in Consumer Discretionary and Utilities are the laggards.

As a new trend gets underway, some of the component sectors within the S&P 500 diverge, so we also see it show up in the percent of stocks trending up vs. down.

After watching quantitive technical indicators like this since the 90s, I can also tell you we commonly see a breadth thrust in the early stages of a new uptrend. We did in January to February 2019 after the waterfall decline at the end of 2018.

A breadth thrust is bullish confirmation.

How long the trend may last, well, we’ve always preferred to see more stocks parts-cation in an uptrend than less. The theory is a broad uptrend that lifts all boats has more true momentum. An example of elevated breadth was 2017, when the stock index trended up with very little volatility or setbacks.

But if you look real close, that yellow highlight of 2017 also shows the percent of stocks above their 50 day moving average oscillated between the 50 and 95% zone throughout the year. It’s an oscillator, so it swings between 0% and 100%, but the fact it stayed above 50% in 2017 was a signal of internal strength. It often swings wider in a typical year, but 2017 was far from typical.

The bottom line is, what we have here, now, is fewer of the S&P 500 stocks trending up, which means more are crossing down below their intermediate trend trend line.

So, my interpretation is the trends are weakening, and it’s likely to be more reflected in the stock index eventually.

Investor sentiment is another essential measure.

Nothing drives investor sentiment like a price trend. As prices trend up, people get more bullish (or greedy) and as prices trend down, they feel more fear (of losing more money.)

The Fear & Greed Index tracks seven indicators of investor sentiment. It’s gradually dialing back up to Greed, but not yet Extreme Greed.

But when we take a look inside, and understand how it works, I see the main holdout is VIX . At around 22, the VIX still indicates a moderate level of FEAR, but we have to consider VIX is fading from its highest level, ever, so its absolute level may not be as indicative.

Image

On the other hand, the level of the Put/Call Ratio is among the lowest levels of put buying seen during the last two years, indicating EXTREME GREED on the part of investors.

Image

Junk Bond Demand has reached EXTREME GREED. Investors in junk bonds are accepting 2.05% in additional yield over safer investment grade bonds. This spread is much lower than what has been typical during the last two years and indicates that investors are pursuing higher risk strategies.

Image

The 3rd EXTREME GREED indicator is the S&P 500 is 15.28% above its 125-day average. This is further above the average than has been typical during the last two years and rapid increases like this often indicate extreme greed, according to the Fear & Greed Indicator.

Image

Aside from neutral $VIX, some other moderate hold outs of the 7 indicators include breadth. The Fear & Greed Indicator uses the McClellan Volume Summation Index, which measures advancing and declining volume on the NYSE. It has fallen from EXTREME GREED just over a week ago.

Image

Stock Price Strength is another moderate GREED level. It says the number of stocks hitting 52-week highs exceeds the number hitting lows and is at the upper end of its range, indicating greed.

Image

Safe Haven Demand is at a bullish investor sentiment level. Stocks have outperformed bonds by 6.87% during the last 20 trading days, close to the strongest performance for stocks/bonds in the past 2 years – investors are rotating into stocks from the relative safety of bonds.

Image

THE BOTTOM LINE IS: The seven indications of investor sentiment are dialing up to a very optimistic level, signaling investors are bullish on stocks.

Though some of it isn’t yet extreme, when we put it in context, anything can happen from here, but its now at a higher risk zone.

Image

Another measure of investor sentiment is put volume. Puts are listed options on stocks and indexes that may be used to hedge the downside. The CBOE Total Put Volume is at the lowest level this year, which suggests there isn’t a lot of hedging taking place.

The NAAIM Exposure Index represents the average exposure to US Equity markets reported by the members of the National Association of Active Investment Managers. They are fully invested for the first time since December. Their exposure to the stock market has followed the trend of the stock index.

Another sentiment poll is the Advisors Sentiment, which was devised by Abe Cohen of Chartcraft in 1963 and is still operated by Chartcraft, now under their brand name of Investors Intelligence. This survey has been widely adopted by the investment community as a contrarian indicator. They say since its inception in 1963, the indicator has a consistent record for predicting the major market turning points. It has reached that point.

Speaking of Abe Cohen, another indicator he developed in the mid 1950s is the Bullish Percent Index. He originally applied it to stocks listed on the NYSE, but we have been doing the same for other listed stocks and sectors since. The NYSE Bullish Percent is an example of another gauge of overall market risk. A common analogy applied to the NYSE Bullish Percent is that of a football game: level of the bullish % represents the current field position and the “end-zones” are above 70% and below 30%.

Currently, at 70%, it has entered the higher risk zone, suggesting it’s time to put the defensive team on the field.

Many of these indicators are measuring the same thing; investor sentiment.

After everyone has already gotten bullish and put their money to work in stocks, we have to wonder where future demand for shares will come from.

It’s been a nice run, but stars are aligning to look more and more bearish in my opinion. Uptrends are great, but all good things eventually come to an end.

If we want to protect our profits, it is probably time to reduce expose or hedge.

And that’s likely right about the time most people are excited about their stocks and wanting to buy more.

What could go wrong?

As of this writing, we have a CAT 4 hurricane just hours from hitting Texas and Louisiana, the Fed meeting tomorrow, and China firing missiles into disputed sea.

That’s the weight of the evidence as I see it.

You can be the judge if the evidence is believable and persuasiveness enough, but the final arbiter will be the price trend in the coming weeks.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

If we’re going to see a second leg down, this is where I think it will start.

“I still had much to learn, but I knew what to do. No more floundering, no more half-right methods. Tape reading was an important part of the game; so was beginning at the right time; so was sticking to your position. But my greatest discovery was that a man must study general conditions, to size them so as to be able to anticipate probabilities.” – Jesse Livermore, Reminiscences of a Stock Operator, by Edwin Lefèvre, first published in 1923.

The US stock market is now at risk of another decline

First, the relative strength of the S&P 500 has reached a level I consider overbought for the first time since the crash.

It’s a measure of too far, too fast.

The Relative Strength Index (RSI), developed by J. Welles Wilder. Born in Noris, Tennessee, Wilder was a mechanical engineer, turned real estate developer, turned technical analyst, and best known for his work in technical analysis. Wilder created the Average True Range, the Relative Strength Index (RSI), Average Directional Index, and the Parabolic SAR, which he published in 1978 in New Concepts in Technical Trading Systems

is a momentum oscillator that measures the speed and magnitude of directional price trends. The RSI oscillates between zero and 100, so it is range bound.I The RSI is defined as overbought when it reaches 70 or higher and oversold below 30.

Another useful measure of market trend conditions is breath. The percent of S&P 500 stocks above their 50 day moving average shows us how many stocks are participating in the uptrend. Since June 1st, 97% of the stock are trending above their 50 day moving average, so they are in short term uptrends.

Strong breadth of participation is a good thing, until it reaches an extreme. A breath thrust as we saw begin the start in April was a good sign as the stock market was trending up, more and more stocks were entering uptrends. However, once all of the stocks are already in uptrends, we eventually have to wonder what is going to keep driving them higher.

Much of investment management is an understanding of what other market participants are likely to do next. When I see the percent of SPX stocks above their 50 day moving average at the highest level in twenty years, it simply tells us most of the stocks are in short term uptrends, but, the next direction for buying enthusiasm is going to be down.

On a longer term time frame, which is the 200 day moving average, only about 60% of the S&P 500 stocks are in longer term uptrends, so there is plenty of room for continuation.

Next up is the good ole NYSE Bullish Percent.

The NYSE Bullish Percent was the first breadth indicator. The NYSE Bullish Percent was developed by Abe Cohen, the founder of Investors Intelligence in 1955. Abe Cohen was an early pioneer of point & figure charting , which he believed provided the ideal building blocks for a market barometer. By recording stock prices, P&F charts effectively map out the relationship between demand (buyers) and supply (sellers). The advantage of P&F charts is the supply/demand asymmetries are clear cut and easy to identify:

If demand outstrips supply, a P&F buy signal is generated

If supply outstrips demand a P&F sell signal is generated.

The Bullish Percent, then, is a breadth indicator that shows the percentage of stocks on Point & Figure Buy Signals. As with other oscillators, the Bullish Percent Index is range bound and fluctuates between 0% and 100%. In its most basic form, the Bullish Percent Index favors the bulls when above 50% and the bears when below 50%. Bullish Percent is considered overbought and a higher risk zone when above 70% and oversold and a lower risk level when below 30%.

At the current reading of 83, it’s clearly in the “high risk” zone.

So, I wouldn’t be surprised to see this uptrend at least stall here, temporarily.

If we’re going to see a second leg down, this is where I believe it will start.

The Federal Reserve is fully committed to keeping this trend going, so we’ll see…

Risk management is essential for all investments because all investments have a risk of loss.

As a tactical decision to reduce our exposure to loss in response to the elevated risk levels I’m seeing, I sold to take profits on our remaining stock positions on Tuesday and invested in US Treasuries.

“But my greatest discovery was that a man must study general conditions, to size them so as to be able to anticipate probabilities. ”

– Jesse Livermore, Reminiscences of a Stock Operator, by Edwin Lefèvre, first published in 1923.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Volatility contraction, sentiment shifts, and most are participating in the uptrend

On February 6th, I shared and observation in “19 is the new 20, but is this a new low volatility regime?” the lower level of implied (expected) volatility at the time may be driven by two factors that may have been resulting in less concern for volatility. I wrote:

The current bull market that started in March 2009 is the longest bull market in history. It exceeded the bull market of the 1990s that lasted 113 months in terms of time, though still not as much gain as the 90s.

The U.S. is in its longest economic expansion in history, breaking the record of 120 months of economic growth from March 1991 to March 2001, according to the National Bureau of Economic Research. However, this record-setting run observed GDP growth far slower than previous expansions.

The aged bull market and economic expansion can naturally lead to some level of complacency and expectation for less downside and tighter price trends. When investors are uncertain, their indecision shows up in a wide range of prices. When investors are smugger and confident, they are less indecisive and it’s usually after a smooth uptrend they expect to continue.

Well, so much for that.

Here we are, the bull market was interrupted by a -37% in the Dow Jones. So, any higher highs from here will be labeled a new bull market.

The US is now in a recession. The longest economic expansion is over, interrupted by a -4.8% GDP, as discussed in “The longest economic expansion in U.S. history is over, but…

What about volatlity?

I shared several observations of volatility and

Back in December, I wrote “A volatility expansion seems imminent” which was a follow up to November 16th, “Periods of low volatility are often followed by volatility expansions”.

Don’t say I didn’t tell so, in advance.

I also wrote:

Is the volatility expansion over? in December.

On January 27th, published “Here comes the volatility expansion, but is the coronavirus outbreak in China to blame?

January 30th “Global Macro: is the coronavirus outbreak crushing the China ETF and causing the volatility expansion?

February 26th was “What volatility expansions tell us about expectations for stock market trends”

March 3rd was pretty clear “Expect wider price swings in a volatility expansion

Then, on March 10th I wrote again about the volatility expansion “
Why I’m not surprised to see such a volatility expansion

This chart was featured in the Wall Street Journal by one of the few outside research I read; The Daily Shot.

Average True Range ATR use in portfolio management trading volatlity

Oh yes, did that chart reverse trend as expected.

Now there’s this. The CBOE Volatility Index (VIX) spiked to 82, the highest level of implied vol on record.

But since then, it is gradually trending down.

The options market is pricing in less expected volatility for the S&P 500 stocks over the next 30 days.

It’s a volatility contraction.

Will it continue?

It will as long as expected vol keeps declining. I know; captain obvious.

VIX is trending down, but it’s still at 31, and still a wider than average range of prices spreading out.

If we see a reversal down in stocks, then we’ll see volatility spike again. But for now, it’s a volatility contraction, so I’ll take it.

The Fear & Greed Index is only dialed half way up.

Only two of the Fear & Greed Index indicators are showing greed. Safe haven demand is the biggest, which is the difference between the 20-day stock and bond returns. Stocks have outperformed bonds by 16.29% the last 20 trading days. This is close to the strongest performance for stocks relative to bonds in the past two years and suggests investors are rotating into stocks from the relative safety of bonds.

The other is the Put/Call Ratio. During the last five trading days, volume in put options has lagged volume in call options by 44.87% as investors make bullish bets in their portfolios. However, this among the lowest levels of put buying seen during the last two years, indicating greed on the part of investors.

By my measures, the stock market is just now entering the overbought range, technically, on a short term basis.

For example, the percent of S&P 500 stocks above their 50 day moving average is now up to 74% after todays close. It’s the higher risk zone.

As a testiment to the internal damage done, I present the percent of S&P 500 stocks above their 200 day moving average, which is only at 30%. It tells us most stocks are still in a longer term downtrend after reaching a low of only 3% of stocks above their trend line on March 20th.

And yes, it was very near the March 23rd low only three days later.

Most stocks are participating in the uptrend, as measured by 70% of them above their average of the past 50 days.

Volatiltiy is contracting.

Investor sentiment is gradually shifting. Nothing drives sentiment like the price trend. The price trend is the leading indicator, investors enthusiasm follows it.

All while we just saw the largest drop in economic growth since 2008.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Panic selling drove a waterfall decline and washout for the stock market

Growing up in East Tennessee and the Great Smoky Mountains, I observed a lot of waterfalls.

Wiki says a fall of water is an area where water flows over a vertical drop or a series of steep declines in the course of a stream or river.

According to National Geographic, a waterfall is a river or other body of water’s steep fall over a rocky ledge into a plunge pool below. Waterfalls are also called cascades. The process of erosion, the wearing away of earth, plays an essential part in the formation of waterfalls.

waterfall decline in stocks stock market

What we have witnessed in the global equity markets is a waterfall decline, the question now is if the plunge pool has developed.

water fallAn overhang in a waterfall can sometimes protrude out enough to form a base, or even drive the water to flow upward for a while, but the waterfall isn’t over until the plunge pool develops.

waterfall overhang spring hill

Using the S&P 500 stock index as a proxy, it’s pretty clear there wasn’t much of an overhang along the way. For example, in the middle of this 3-year chart, we see how the decline in late 2018 played out. It had a lot of overhangs as the stock market was swinging up and down for several weeks.  Now, compare that to this time…

SPY SPX

What we have here is panic selling.

Investors tend to underreact and overreact to new information.

Underreaction: Trends begin to drift in a direction as people initially underreact to change, so the price trend unfolds gradually.

Overreaction: Sometimes, investors overreact to new information, so the price is driven too far, too fast. When the market overreacts, prices overshoot too high, or too low.

At the bottom of a waterfall is a plunge pool, where the water settles. What does the plunge pool look like as it develops? It’s a floor that has enough support the water stays were it is.

The trouble is, in the market, we don’t physically see the rock bottom. Unlike in physical science, an exchange market is a social science because it’s human behavior. Don’t think this is humans? Maybe it’s the computer algorithms? They are created and operated by humans.

I apply quantitative tools to get a read on how extreme investor sentiment is.

In analyzing market trends and price action, we can see what is going on with market internals, such as breadth. The NYSE Bullish Percent was developed by Abe Cohen was the first breadth indicator. Abe Cohen was an early pioneer of Point & Figure charting and created the NYSE BP in the mid-1950s. The NYSE Bullish Percent is a market risk barometer that measures the percent of stocks listed on the New York Stock Exchange that have a Point & Figure buy signal, so they making higher highs, so they are in uptrends. The NYSE Bullish Percent is washed out. It hasn’t been this low since the waterfall decline in October 2008.

NYSE BULLISH PERCENT

The challenge with countertrends is they can also trend farther than you would ever believe is possible. It’s because markets don’t follow a normal distribution. Instead, market trends have fat tails, meaning some gains and losses exceed an otherwise normal distribution, as we see in physical science. As such, the overreactions can overshoot and just keep overshooting. We never know for sure when a trend has stopped. What we can do, however, is apply quantitative tools to gauge and guide. I use these as a guide and barometer for overall market risk.

The percent of the S&P 500 stocks above the 50-day moving average is washed out to 1%. In fact, only 7 of the 505 stocks in the S&P 500 are in a short term uptrend. While in a big bear market such as 2008-09, these conditions can continue for a long time, historically, this lower level of risk eventually offers the potential for asymmetric risk/reward. That is, the possibility for reward is greater than the risk it takes the achieve it. Or, the magnitude for a reward is greater than the downside risk, which can be predetermined with options or an exit (i.e., stop-loss.)

$SPXA50R breadth is washed out crash 2020

A material change that has occurred the past week is the percent of S&P 500 stocks above their 200 day moving average, or longer-term uptrends have washed out. Only 5% of the stocks are in uptrends now, so 95% of them are in long term downtrends. That doesn’t sound good, but when it reaches an extreme, it suggests to me the selling pressure is intense and could eventually dry up.

percent of stocks above 200 day

This is about as oversold the stock market gets, both internally looking at the individual stocks and the indexes. Sure, it can get more oversold and stay there for as long as sellers have the desire to sell, but it has reached the point the odds of a short term reversal is increasing the lower it goes.

Yesterday I asked: where do you think we are in the cycle of market emotions?

THE CYCLE OF MARKET EMOTIONS

Clearly, when stock indexes drop 8-10% in a single day after already well off their highs, it is driven by emotional panic.

The US Investor Sentiment poll from AAII is released on a few day’s time lag, but Bearish % of those polled is another measure up to 2008-09 levels.

AAII INVESTOR SENTIMENT MARKET CRASH 2020

 

To no surprise, the Fear & Greed Index was penned all the way back to 1 after yesterday’s close.

fear greed panic market crash 2020

What we have here is a washout. A washout is an event or period that is spoiled by constant or heavy rain. We may see more rain, but it’s a washout nonetheless. A washout in the stock market is when prices have been flooding down so hard, so broad, it seems like a washout of rain.

As you can imagine, with a waterfall, heavy rains increase the volume and speed of water flow. A washout pushes the river to its limits.

The desire to sell has been overwhelming any buying interest that remains for a few weeks now. This has been the fastest decline in US stock market history. I guess we shouldn’t be so surprised if we believe a trend stretched far in one direction is more prone to snap back harder and faster. That’s what we’ve seen here.

This is the end of the longest bear market in US history, and it has indeed ended with a bang. That also means this is the beginning of a bear market. What we don’t know in advance is how long it will last or how low it will go. If we knew it would be -50%, we could simply sell short and profit from the fall. If we knew this was “the bottom,” we could use leverage to maximize gains on the upside. But, none of us know the outcome in advance, not the biggest banks, not the largest asset managers, and neither you nor I. The edge I do have is accepting this reality and embracing it to the point I drove me to create risk management systems to limit the downside when I’m wrong and focus on the things I can control. I’ve operated tactically through periods like this many times before in the last two decades, so I’ll just do what I do, which means I’ll execute many entries and exits until we find the trend. In conditions like we’ve seen this year, they’ll be countertrends. Once trends do develop, they’ll be trend following.

What I’ve typically seen in past bear markets is many cycles up and down along the way. That isn’t what we’ve seen this time, so far. This reminds me more of September 11, 2001, after the World Trade Center was attacked. The difference is, the S&P 500 was already down about -17%, and since the planes hit the World Trade Center in New York, the NYSE was closed. The New York Stock Exchange remained closed until the following Monday. This was the third time in history that the NYSE experienced prolonged closure, the first time being in the early months of World War I[2][3] and the second being March 1933 during the Great Depression.

It may not play out this way this time, but countertrends should be expected. Here is what the stock market did after the exchange opened after September 11. The SPX dropped -12% quickly, but then investors become patriotic, and it recovered a few weeks later. Of course, this happened inside a bear market that started in 2000 and didn’t end until 2003.

stock market v recovery september 11 9:11

Is this so different than 9/11? Of course, it is. Every new moment is always different. But, we’ve experienced these things before. I was much more of a rookie 20 years ago when I walked into my investment firm office to see the planes hit. It was an incredibly emotional and panicked time in American history. At the time, it wasn’t just the one attack, we wondered what would be next. It was the Pentagon, and another plane was hijacked. We didn’t know what to expect, it was uncertain. When would we be attacked again? Where? Would it wipe us out?

We didn’t know.

Portfolio managers and tactical traders must be here, now, in the present moment, not dwelling on the recent past, there will be time for that later when things are calm and quiet. But even then, we can’t do anything in the past, we can only do it now.

I hope this helps.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas. Shell Capital is focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

 

 

Is the panic selling drying up?

After yesterday’s continued selling pressure, only 7% of the S&P 500 stocks remain in uptrends as measured by the 50-day moving average.

percent of stocks above moving average

As most stocks are participating in the downtrend, this breadth measure is about as low as it was in December 2018.

In case you are wondering, here are some of the few stocks in the index that are still above their trend line. I don’t consider this a buy list and we don’t own any of them directly.

stocks above moving average

Another sign of a strong desire to sell is the new highs-new lows as a percentage. It’s as low as it’s been the past year, as new lows are dominating.

new highs new lows percent

As expected, a chart of advance – declining stocks as a percentage is at the low end of its range and about as low as it can get as declining stocks are dominant.

advance decline percent

When investors are panic selling, prices can always trend lower, but this data shows mathematically prices have reached an extreme level on the downside that now appears to be an overreaction. We should be close to seeing this panic selling dry up as selling becomes exhausted and these lower prices attract buyers. After that, we’ll see if any countertrend back up continues, or eventually reverses back down. As I’ve said recently, given this bull market is very aged and we’ve seen the longest economic expansion in history, I believe the years ahead will require tactical trading and risk management.

I hope this helps!

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

The stock index falls below its long-term trend, but stocks are now getting oversold

The stock index falls below its long-term trend, but just as stocks are getting oversold. The 200-day moving average was about 11% below the high February 19th, just eight days ago.

spx spy 200 day moving average trend 11 percent Feb 2020

As you can see in the chart, this has been a sharp waterfall decline and one I’m glad we avoided so far. For those of us in a position of strength, we stalk the market actively looking for a lower-risk entry point that offers the potential for asymmetric risk-reward payoff. An asymmetric payoff is when we structure our positions so our potential for downside loss is limited to much less than the potential for capital gains.

The stock market is now getting more oversold on a short term basis.

Only 21% of S&P 500 stocks are above their 50 day moving average. That’s a lot of broken uptrend lines shifting into downtrends.

stock market oversold

In the chart, I colored the “buy zone” in green. As you can see, it’s now down to a level I consider an indication that selling pressure may become exhausted as long as prices have been sold down to a low enough level to attract buying demand.

The stock market, and stock prices, are driven by supply and demand. It’s that simple. Measuring supply and demand isn’t so simple for most investors.

In the bigger picture, the longer-term trend lines are still at the 50-yard line, which is where all but one of the past five declines stopped. Of course, the one time stocks really got sold down was late 2018. Only time will tell if this becomes another period like that, but right now, those of us who had reduced or removed exposure to the market losses are probably looking to buy.

stock market breadth

The longer-term trend lines are holding better, which is no surprise because stocks had trended up well above their longer trend lines. For example, the S&P 500 index was trading about 11% above its own 200 day moving average and it just now crossed below it. When many stocks are trending that far above their trend line, it takes more of a price decline to trigger the percent of stocks to fall.

february 2020 stock market loss decline

Stocks market declines to tend to be asymmetric. Prices trend down faster than they trend up. After prices trend down, contagion sets in the lower prices fall. Prices then get driven down even more simply because investors are selling to avoid further loss. But, someone has to be on the other side of their panic selling. It’s those who had the cash to buy.

If you sell higher, you can buy lower.

Need help? Contact us here.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Stock market recoveries are a process, not an event

After yesterday’s close, the popular stock market indexes, including the S&P 500, Dow Jones Industrial Average, and NASDAQ were down around -3% for the day.

stock market

Adding volatility bands around the price trend and its 20 day moving average illustrates a volatility expansion as prices have spread out to a wider trading range. The S&P 500 stock index traded below its lower volatility band, which expands as the price action becomes volatile. Volatility bands and channels help to answer: Are prices high or low on a short term relative basis? The recent price action is relatively high at the upper band and low at the lower band. By the way, I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. 

volatility expansion bollinger band

At this point, the stock index has traded below its band, demonstrating panic level selling pressure outside what I consider a normal range of price action. 

Volatility channels are even more useful when combined with other indicators for confirmation. Next, I add a momentum measure for confirmation the index is oversold on a short-term basis. It can get more oversold, but a short term reversal now becomes likely if the desire to sell has become exhausted. 

spx spy countertrend trend following asymmetric risk reward

The potential good news for those with exposure to loss, in the short term, we may see a countertrend move back up to retrace some of the stock market losses. However, this will be the test to see if selling pressure has been exhausted or if prices have been driven down low enough to attract sufficient buying interest to push the price trends back up.

Another observation I’ll share is after the close, we recalculated the percent of S&P 500 stocks above their 200 day moving average using the end of day prices. The percent of stocks above their 200 day moving average is now at the 50-yard line, whit bout half of the SPX stocks in a longer-term uptrend and a half in a downtrend. Obviously, that’s more stocks now below the trend line than when I shared it yesterday.

percent of spx stocks above below 200 day moving average

A more significant decline is seen in the percent of stocks above their 50-day moving averages, which fell 38% to only 23% of S&P 500 stocks trading above their shorter-term moving average trend line.

percent of stocks above below 50 day moving average breadth

So, at least on a short term basis, selling pressure has pushed stocks down to the point more are in downtrends than uptrends.

Next, we’ll see if sellers have pushed prices low enough to attract significant buying demand. I expect to see at least a short term countertrend back up, as investors overreacted to the downside, but only time will tell if any countertrend up is sustainable long term. My longer-term indicators are neutral at this point, so there could be more selling if investors and traders anchor to prior highs wishing they’d sold previously and sell into an uptrend.

My objective is asymmetric returns, so I focus on asymmetric risk-reward. After prices seem to trend up too far, too fast, by my quantitative mathematical calculations, the asymmetric returns from future prices are limited, and the asymmetric risk is increased. After prices seem to fall too far, too fast, by my quantitative mathematical calculations, the asymmetric risk-reward profile becomes more positive. And, all of it is probabilistic, none of it is ever a sure thing.

It’s a process, not an event.

As I shared yesterday; Stock prices may not be finished falling, but some opportunities for asymmetric risk-reward may be present for those willing to take risks.  

Need help? Contact us here

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. I observe the charts and graphs to visually see what is going on with price trends and volatility, it is not intended to be used in making any determination as to when to buy or sell any security, or which security to buy or sell. Instead, these are observations of the data as a visual representation of what is going on with the trend and its volatility for situational awareness. I do not necessarily make any buy or sell decisions based on it. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

 

Stock prices may not be finished falling, but some opportunities for asymmetric risk-reward may be present for those willing to take risks

Based on my velocity measuring algorithms, the stock indexes are now starting to get oversold. That is, the stock indexes are reaching a point we could see at least a short term countertrend back up, on a short term basis. These measures are based on short term market overreactions, such as when price decline sharply beyond a point we expect mathematically over a period. It certainly doesn’t mean the price trend can’t fall farther as they often do but instead signals a potential countertrend that could drive prices to retrace some of their loss. However, if the downtrend price trend becomes a prolonged and deeper downtrend, these countertrend measures fail to perfectly time the low. Investment management is probabilistic, never a sure thing, so I never expect anything more.

What matters most is if I wanted to take some risk right now on a short term oversold market, I would predefine my exit to cut my loss short if it doesn’t work out and let it rip. We never know for sure in advance when prices will reverse, I can only determine when it is more likely.

The challenge right now, in addition to some other observations I’ve shared recently about valuation, etc. is stock market breadth is far from oversold. So, my breadth measures do not yet suggest any significant selling pressure has been exhausted. I believe when investors sell stocks with great enthusiasm, it shows up in the percent of stocks above and below the trend lines. After prices have plummeted and most of the stocks have fallen into downtrends I start to wonder if the desire to sell is losing steam. At this point, these indicators don’t yet signal a significant panic level selling, so that’s the risk from this point.

I’ll share some of the price trends and indicators I look at when stock prices are falling.

First up is the percent of S&P 500 stocks above their 50-day moving averages. As the chart shows, last month about 82% of the stocks were above their shorter-term trend line. I consider levels above 80% to be a higher risk zone. As we see below, the percent of S&P 500 stocks above their 50-day moving averages made a lower high since January and now is falling at 38%.

breadth percent of stocks below 50 day

While we don’t use it as a market timing indicator, it instead provides some situational awareness of the risk of decline. After most stock prices have already risen, where does more demand come from? At higher levels, I consider the enthusiasm to buy may be becoming exhausted. It once again seems to be what has happened here as investors were enthusiastic about stocks until recently.

Another warning shot across the bow was when this breadth measure failed to confirm an all-time new high in the stock market. Below is the same indicator as above, but I overlayed it with the price trend of the S&P 500. As the SPX trended up to an all-time new high, the percent of S&P 500 stocks above their 50-day moving averages showed a material divergence, indicating fewer stocks were participating in the uptrend. I’ve been monitoring these indicators for two decades now and from my experience, a divergence like this that indicates less participation and “breadth” of the trend is a warning sign. In a healthy uptrend, most stocks are trending higher, so the percent of S&P 500 stocks above their 50-day moving averages is increasing, not decreasing.

breadth failed to confirm new stock market high february 2020

For a longer-term context, below is the percent of S&P 500 stocks above their 200 day moving averages. I consider below 20 or 30% to be an overreaction to the downside, but currently, 66% of stocks are above this longer-term trend line. On the one hand, higher participation is positive, but it’s declining from a relatively high level, which makes it more negative. It also provides us with the awareness that stocks could certainly fall a lot more. The times when less than 20% of these stocks were above their 200-day moving average was periods of notable stock market drawdowns.

percent of stocks above 200 day moving average long term breadth

So, these are some examples of why I started reducing our exposure to zero a month ago and only recently have been increasing exposure by rotating back out of US Treasuries into high dividend yield positions. The nice thing about high dividend yield positions is as the price falls, the dividend yield increases. It’s one time when I buy after prices fall, so we earn the dividend yield from that point forward. My timing is rarely perfect and it doesn’t have to be.

By way of example only, below is a chart of the Alerian MLP Index price and dividend yield. MLP’s are Master Limited Partnerships and in this case, they are publically traded. The Alerian MLP Index is the leading gauge of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities, is disseminated in real-time. I’m using this index for illustration to show how (1) the price trend of the MLP index has fallen with energy prices and (2) since its holdings pay high dividend yield, as the price falls, the yield trends up as seen in the chart.

MLP high dividend yield strategy

The purple line shows the dividend yield is 9.41% based on the current price and the price is making a new low. This is one of the most extreme examples right now to make the point. It not only makes the point that buying lower prices in high yield securities can potentially capture asymmetric risk-reward, but also these high yielding securities are not without risks that need to be managed. The risk is made obvious by the price trend chart, which is down -27% over the past year.

As with most things in life, timing is everything. If we had entered a position with the risk/reward profile that existed a year ago, it was more risk than reward, as the high yield income from dividends wouldn’t have been enough to offset the loss from the price decline. But, in the case of exposures that provide higher potential income streams from dividend yield at lower prices, you can probably see how to offset the potential from asymmetric returns from an asymmetric risk-reward payoff. But again, it isn’t so simple and requires risk management, because there is no guarantee stocks, bonds, or MLPs will always keep paying their yields.

In summary, my short term velocity algorithms suggest the popular stock indexes are nearing a short term level we could see a countertrend, but the bigger picture isn’t so positive as there remains plenty enthusiasm to be exhausted. In other words, in late December 2018, my indicators suggested an extreme level of panic selling has happened and it was likely becoming exhausting. It turned out to be exactly what happened. The current measures are nowhere near that level of oversold, but if sellers aren’t panicking to sell it will not get there, either.

At this point, the stock index is only -6% off its high, which is just short of the decline last summer and well within a normal decline. We typically see 2-3 price declines of -5% annually.

february 2020 stock market decline drawdown amount

To put it into context, the current stock market decline is less than 1/3rd of the waterfall decline over a year ago.

stock market historical drawdowns

Only time will tell if the desire to sell is being exhausted. Fortunately, we had already de-risked our portfolio before this started and are now looking to take on new asymmetric risk-reward positions as they present themselves. My risk management and drawdown control systems handle the rest.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global TacticalMike Shell and Shell Capital Management, LLC is a registered investment advisor in Florida, Tennessee, and Texas focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change.  Do not make any investment decisions based on such information as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of  Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

The stock market is holding its breadth… for now

The stocks in the S&P 500 index that are above their 50 day moving average has stopped at the same level it reversed in May. The percent of stocks in up or downtrends is a measure of breadth, which means how actively stocks are participating in uptrends and downtrends. 

spx percent of stock above 50 day moving average

At 30% of stocks above their short term trend line isn’t nearly as washed-out as they were last December, we’ll see if this is the end of the selling pressure.

The percent of stocks above their 200 day moving average is at 54%, also around the same level as the May correction.

spx stocks above 200 day moving average asymmetric risk reward

But, notice that is nowhere near the December washout, which as an asymmetric risk-reward opportunity.

Of course, nothing is more important than the actual price trend itself. In the really short term, today paused at the low two weeks ago. If this line doesn’t hold, the next one is the May low. So, we shouldn’t be really surprised to see it fall to that level.

spx spy trend following

So far this stock index is -6% off it’s high, a normal correction within an ongoing uptrend.

So, if this is just a normal pullback within an ongoing uptrend, we should soon see the enthusiasm to buy overwhelm the desire to sell. Otherwise, the stock market will obviously fall some more, and that would still be within a normal decline.

Fortunately, I anticipated this volatility and some decline and shifted to defensive stocks and some bonds to help avoid some of the declines. I also had some hedges early on that helped offset the initial losses in long exposure.

I hear there’s a lot of noise and many geopolitical themes getting the blame, but it’s really just the market, doing what it does. Something and someone always gets the blame. If you believe that’s the real driver, you aren’t paying enough attention to my observations.

We’ll see how it all unfolds from here.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Strong stock market momentum was accompanied by broad participation

Not only has the broad stock market indexes like the S&P 500 advanced sharply with great momentum since late December 2018, but its breadth has also been impressive.

The percent of stocks trading above their 50 day moving averages shows about 92% of stocks are in short term uptrends. This advance not only confirmed the price trend momentum but suggests participation has been broad. More stocks are above their 50-day moving averages that late 2017.

percent of stocks above the 50 day moving average trend following asymmetric risk reward

The downside is we are necessarily observing only the past and the past doesn’t assure future performance. In fact, once 92% of stocks are already in shorter-term uptrends, we can start to wonder at what point the buying enthusiasm is exhausted. That is, indicators like this may be observed for signs of an inflection point.

percent of stocks above 200 day moving average trend following

However, the percent of stocks above their 200 day moving averages is at 63%. So applying that same line of thinking, though we shouldn’t be surprised to see short term weakness, we could suppose the longer term trend still has room to run.

We’ll see…

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information provided is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Stock market internals are signaling an inflection point

Indicators of the internal strength of the market measure the breadth of the market trend using the number of individual stocks participating in a move.

On December 24, 2018, I shared my observation in An exhaustive stock market analysis… continued that the stock market was washed out since most stocks had fallen. This gave us a signal the selling may have been exhausted and we could look for signs the prices had reached a low enough level to attract buying interest.

That’s exactly what we’ve seen since.

But, what is the current state of the stock market and those indicators?

The percent of the S&P 500 stocks above their 200 day moving average is a longer-term indicator since the lag is 200 days. It takes more time for more stocks to trend above this longer moving average, so by the time they all do, it may be a better long term indicator of a higher risk level. The thinking is once most stocks are already above their longer trend line, it could be closer to the end of the trend and visa versa. In the chart below, we see the only 10% of stocks were in a positive trend at the December low and today it’s closer to midfield. I consider this to be within a normal range. It shows us the current uptrend could have plenty of room to keep trending up before this breadth indicator would suggest longer-term buying exhaustion.

percent of stocks above 200 day moving average asymmetric

However, it’s possible this is the early stage of a bigger bear market. If it is, we’ll see swings up and down to eventually lower highs and lower lows. In that scenario, we’ll see the shorter term indicators reach extreme highs and extreme lows as bear market trends historically unfold as cycles.

The percent of the S&P 500 stocks above their 50 day moving average is a shorter term indicator. Here we see most stocks were participating in the uptrend and have trended above their short term 50-day moving average. In fact, by this measure, we should be surprised to see at least a short term decline in stocks. Price trends don’t often trend straight up, they are more like a stair step as they pause along the way.

percent of stocks above 50 day moving average asymmetric

The NYSE Bullish Percent is another breadth indicator showing the percent of stocks trading on the NYSE stock exchange that is in a positive trend. Specifically, it’s the percent on a Point & Figure buy signal. The NYSE listed stocks are mostly larger companies so we can see the 40% range is about midfield like the % of stocks above their 200 day. No extreme here. New buy signals are expanding when the indicator is rising.

nyse bullish percent asymmetric risk reward 2019

I don’t see any extreme level in the S&P 500 Bullish Percent, either, so there is plenty of room for trends in either direction.

s&p 500 bullish percent asymmetric risk reward

Record High Percent is a breadth indicator that confirms when new highs outnumber new lows and when new highs are expanding. Record High Percent is new 52-week highs divided by the sum of new 52-week highs plus new 52-week lows. When the indicator is above 50, new highs outnumber new lows. New highs are expanding when the index is above 50 and rising. We can see visually this is a faster moving breadth indicator, so it reaches extremes faster and more often.

record high percent

Overall, since the most recent low on December 24th, the breadth indicators suggest there has been broad participation in the uptrend, and the trend may have entered a stage where we could see some short term momentum and buying interest wane. However, the longer term indicators signal there is plenty of room for a continuation of the recent uptrend if it doesn’t instead reverse down to a lower low.

These midfield levels are harder to read since they don’t get so extreme the probability is high of a reversal. In the price trend between the extremes, I prefer to ride the trend and maybe hedge.

For tactical traders and risk managers, this is probably a good time to reduce exposure or hedge off some downside risk and get more neutral in the short term to see how it all unfolds.

asymmetric risk reward trend following

In fact, all of the above is just confirming what I see in the above price trend of the S&P 500. It’s oscillating around the line where there could exist some prior resistance, or it could become support. It’s at an inflection point.

We’re seeing some pause around the level and we’ll soon see what direction supply and demand drive it next.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Stock Market Update

After gaining over 6% since the low on Christmas Eve, the S&P 500 declined -2.45% today. We can expect a wider range of prices in a volatility expansion after a -20% decline.

spx january 3 2019

I say it’s a volatility expansion because implied volatility is relatively elevated at 25.45, implying a 25% range of prices is implied by options prices on the S&P 500 stocks.

vix volatility expansion

Looking over its full history, we’ve seen the VIX trend higher, but it’s relatively elevated. Its long-term average is about 20. But, for mean reversing indicators like the VIX, the average doesn’t mean much since it doesn’t stay there.

vix long term history

Another way I define a volatility expansion is realized volatility. The VIX is expected volatility implied by options prices, realized volatility is actual historical volatility. In the chart below I added an average true range over the past 14 days above the S&P 500 stock index price trend. We can see how volatility expanded as the price trend fell. Prices tend to spread out in a wider range in a downtrend. We can see this in the chart. There was a regime change from a low volatility uptrend to a downtrend with volatility expansion.

atr volatilty expansion realized vol asymmetric risk reward

The CBOE Put Call Ratios spiked up today. Zooming in to a 30 day period, we see the Index Put Call Ratio is about where it was at the lows in December. I believe the Index Put Call Ratio is a better indication of extremes in fear of lower prices because index options are mostly traded by professionals and used for hedging. The Equity Put Call Ratio is options on individual stocks and more non-professionals and tends to be more speculative. I explained it in Investor Sentiment into the New Year 2019. 

put call ratio january 2019

To get a longer view below is the past five years of the Put Call Ratios. They’ve been higher in 2015, but are clearly at elevated levels. It indicates the put volume on index options is 155% more than call volume, which suggests hedging or speculative bets the index will decline.

put call ratio peaks past years 2018

Prices decline until the selling pressure is exhausted. Selling pressure is exhausted after those who want to sell have sold, which pushes prices down to a low enough point to attract buyers. To get an indication of when prices have trended down far enough to exhaust sellers and attract buyers, I look at the price trend itself as well as extremes investor sentiment and breadth. Below is the percent of stocks in the S&P 500 below their 200 day moving average. The percent of stocks above their 200 day moving average reversed back down… only 14% are in a positive uptrend. There are currently 505 stocks in the S&P 500. Of the 18 that are above their 50 day moving average, two are because they are being bought out Celgene CELG and Redhat RHT. Some of the others are kind of recession stocks like auto parts, discount store, and a gold stock: AZO ORLY DLTR NEM.

percent of stocks above 200 day moving average $spx $spy spx

The percent of S&P 500 stocks above their 50 day moving average reverses back down… only 3% are in an uptrend…

percent of stocks above 50 day how to use it spx

The stock market is approaching oversold levels again but may get more oversold before reversing back up.

One advantage of falling stock prices is as price falls, the dividend yield rises from that new price. This is not a recommendation to buy or sell any security, but below is the price trend and dividend yield the Global X SuperDividend® ETF (SDIV). It invests in 100 of the highest dividend yielding equity securities in the world. We can observe as the price trends down, the dividend yield trends up. That is, if we buy high yielding assets at lower prices, the dividend payment is higher from that starting point assuming the companies keep paying their dividends. Below we can see how this ETF yield has increased to 9% as its price has fallen -35% off its high.

high yield income strategy sdiv dividend etfLike any investment, it isn’t risk-free. Investing always involves risk, including the possible loss of principal. High yielding stocks are often speculative, high-risk investments. These companies can be paying out more than they can support and may reduce their dividends or stop paying dividends at any time, which could have a material adverse effect on the stock price of these companies and the Fund’s performance. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. The bottom line is; there is no free lunch. If we want the potential for return, we have to take risks.

If this is the early stage of a larger decline, it will unfold with many up and down swings along the way. It will get overbought/oversold over and over and sometimes stay that way longer. I shared it in An exhaustive stock market analysis… continued. 

Emotional undisciplined investors, traders, and portfolios managers will be destroyed in a volatility expansion. They’ll swing from the fear of missing out to the fear of losing money as the stock market swings up and down.

Self-discipline and emotional fortitude are essential to be an investment manager.

We’ll see how it all unfolds from here.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

An exhaustive analysis of the U.S. stock market

It’s a big task for me to use the word exhaustive when it comes to stock market analysis. Exhaustive is examining, including, or considering all elements or aspects; fully comprehensive. There is no way to consider all elements, but we can focus on how the price trends are actually trending and the behavior and sentiment that is driving the trend.

Many years ago a friend of mine once tried to debate me about what trend following is or is not. He argued that trend following is all lagging moving averages or breakouts. The more we discussed it, the more we both realized that isn’t true. What made us realize it was when I said:

A skillful trend follower wants to catch a trend early in its stage and capitalize on it until it ends.

That’s hard to argue against. Who would rather enter a trend later in its stage? Who wants to catch less of the trend? My point is: we should want to capture as much of a trend as possible and for me, that necessarily means I want to not only determine the direction of a trend but also observe when trends are likely to change direction.

I want to share this with you so you know where I’m coming from. My objective is all about ASYMMETRY®. For me, it’s all about asymmetric risk/reward. Asymmetric risk/reward is an expectation of average gains larger than average losses. It could be as simple as risking a loss of 10% for the potential to earn a gain of 20%. That’s an asymmetric payoff. If I did that with just a 50% probability, I would earn 5% on average. How much total return we would achieve over time would be controlled by how much capital I risk in each position. How much I risk in each position across the portfolio dictates my portfolio drawdown. The portfolio drawdowns relative to total return since inception creates an asymmetric risk/reward profile. So, everything I do involves ASYMMETRY® and that’s why it’s my trademark. As you read my observations you can probably see how I’m looking for exposure at lower risk levels and less exposure at higher risk levels and that can be counterintuitive. It can certainly go against investor sentiment and emotions at times.

Every decision we make is in the present moment. We can do nothing in the past. We can do nothing in the future. The only time we can do something is now, or not.

To get an understanding of an asymmetric risk/reward let’s look at an idealized situation. The chart below, unnamed because it doesn’t matter, is a price trend that gained over 100%. If your objective is an asymmetric payoff and you have perfect hindsight, what would be your best entry point?

asymmetric risk reward investment

Clearly, the price is trending from the lower left to the upper right, so the answer is the lowest price possible. As I said, in the real world we don’t know in advance the trend will continue, so we have to be willing to place our bet and let it unfold. When I enter a trend, I determine how much capital I’ll risk to see if it becomes an asymmetric payoff. If we were looking at the trend in 2016 with perfect hindsight, where would be the very best entry? Of course if would be the -15% dips in 2015 and 2016. The trouble is, as the price is falling sharply, it never seems there will be a catalyst to make the market trend back up. The news is always bad. Investor sentiment is very bearish. The sky is falling and all people want to do is duck for cover.

After trends have moved, I find it more productive to look for a change of trend.

After price trends up, I start looking for signs of a potential countertrend back down.

After prices have fallen, I start looking for signs of a potential countertrend back up.

What I do as a tactical portfolio manager is systematic rules-based. Although, it isn’t so mechanical that my computers are doing it all and executing trades. I am Man + Machine, not Machine – Man. I make no bones about it. I ultimately make tactical decisions that are informed by all of the proprietary systems I’ve developed over the past two decades. Some of my systems are more automated than others, but ultimately I am the portfolio manager.

So, when I share market analysis observations, this is something different than specific trading signals to enter and exit. Market analysis is something I do to gain insights from my observations.

Observations are the action or process of observing something carefully in order to gain information.

Insights are the capacity to gain an accurate and deep intuitive understanding of something.

Observations are “what is going on” and insights are “understanding what is going on.”

I can share my observations of what is going on, but I can’t necessarily give you the insight to understand it. Understanding is up to you. To gain an accurate and deep intuitive understanding of something you have to study it closely.

So, you can probably see why I believe it’s useful to do market analysis to get an understanding of the probabilities and possibilities. I do it by looking at the current price trend and where it’s been and more likely to go next.

Here we go.

I said this is going to be exhaustive, so I’m going to share my top down macro view of the U.S. stock market. I also do this for International stock markets, bonds, commodities, etc. but this is going to be focused on the U.S. stock market. However, I may throw in some relative comparisons of other markets to make a point. The top-down macro view is going to be in this order;

  1. Broad stock market index price trends and breadth
  2. Sectors within the stock market price trends and breadth
  3. Stocks within those sectors price trends and momentum

THE BIG PICTURE

The big picture is the overall long-term secular situation. In April I presented my big picture observations to a group of advisors. The two things I shared are:

  1. This is the longest bull market in history. At 9 years old, it’s very aged. The average length of a bull market is 4 to 5 years. Twice the average is aged by any measure.
  2. The Shiller PE Ratio was the second highest, ever. Only the 1999 bubble was higher. When the stock market is trading so expensive, we have to be prepared for the trend to reverse the other direction.

Below is a 20-year monthly chart of the S&P 500. I added the green highlight to show the current price is only -35% from the October 2007 high eleven years ago. Losses are asymmetric as they compound exponentially. Losses erode gains asymmetrically. For example, the price gain from the 2007 high to the current price is 56%, but it only takes -35% to decline back to that point. You may also consider the stock index is only 56% higher than its 2000 peak eighteen years ago.

stock market secular trend

In The REAL Length of the Average Bull Market I wrote: “Whether you believe the average bull market lasts 39 months, 50 months, or 68 months, it seems the current one is likely late in its stage at 54 months as of September 2013.” Yes, I was saying 5 years ago the trend seemed late stage – and it was. It just continued anyway, though was interrupted by two declines in the range of -15% in 2015 and 2016.

At the same time in late 2013, the Shiller PE Ratio was increasing to a very overvalued level. It only kept going higher. By January of this year, it reached 33x earnings, the second highest ever. In fact, the only two times it reached this extreme the stock market followed with the Great Depression crash and the -46% decline after 2000. After the current -18% decline in the S&P it is now down to 26.74. The median is around 15, secular bear markets often begin at 20 or higher, secular bull markets begin below 10.

The bottom line is:

Shiller PE Ratio

I’m guessing the unprecedented Quantitative Easing of the Federal Reserve helped to push the valuations to an extreme. The Fed is now unwinding the QE and raising interest rates, which may be partly why we are seeing prices fall. So, we certainly can’t overlook the situational awareness that this could eventually become a much worse bear market to the -50% level. However, if it does, it will usually unfold with many swings up and down along the way. Falling prices are eventually followed by sharp countertrend moves up. It’s when we see lower highs and lower lows over time that it becomes more evident it’s a big bear market.

One thing that’s been talked about a lot lately is the risk of an inverted yield curve. An inverted yield curve is when the short-term 3-month interest rate is higher than the long-term 30-year interest rate. The yield curve hasn’t inverted like it did in December 2006 and August 2000. The yield curve doesn’t suggest a recession anytime soon.

Here’s what an inverted yield curve looks like… when it inverted December 2006. A year later, the stock market started its decline of over -56%.
Here is the inverted yield curve in August 2000. In 2000, the yield curve was more accurate as to timing. The broad stock market declined -50%.
The normal yield curve, 3 month vs 30 year, has not inverted. The long-term interest rate is higher than the short-term rate. For the yield curve to invert, the short-term interest rate will have to increase higher than the longer-term interest rate. Or, the long-term interest rate decrease below the short term. Either way, that hasn’t happened yet.

How big are the stock market losses in 2018? 

Starting with a top-down view. First, the broad asset classes and styles like large, mid, small and value, growth, and blend using Morningstar Small Value is down the most at -19% YTD. Small Cap stocks are down the most. Large Growth and Large Cap generally have declined the least. The average U.S. Market index is down -8.58%. Keep in mind that index performance does not include any costs or fees and may not be invested in directly.

stock market sector asset class performance 2018

The table above also includes sectors. Energy and Basic Materials are down over -20%, so any tactical system that avoided them had an advantage.

Most investors don’t necessarily invest all of their money in the stock market all the time. Many instead do global asset allocation like I wrote about in Global asset allocation takes a beating in 2018. Fewer have an objective like mine; a global tactical strategy that shifts between markets by increasing and decreasing exposure aiming for asymmetric risk/reward. Here are iShares asset allocation ETFs YTD as a proxy for low-cost exposure to a global asset allocation of stocks and bonds all the time with no active risk management or tactical decisions. Each “risk level” has a different exposure to stocks/bonds. Even the most conservative allocation which is mostly invested in bonds is down -4% in 2018.

global asset allocation etf

I shared more detailed observations of global asset allocation Global asset allocation takes a beating in 2018.

For a more exhaustive observation of GAA trends, here I included some of the more popular active global allocation funds along with the iShares ETFs that track allocation indexes. Clearly, 2018 has been a hostile year for most every strategy; static, balanced, or tactical.

global asset allocation funds 2018 ETF ETFs

So, that’s the big picture. From there, let’s zoom in for a closer look for a shorter term observation.

The downside very quickly erodes the progress. However, the asymmetric nature of losses starts to really compound against capital after -20%. At this point, the S&P 500 is down -18%. It’s a little lower than 2016 and about the same as the decline in 2011.

2018 stock market loss

Though this has been a very long bull market, it has been interrupted by deeper “corrections” of more than -10%.

stock market drawdown bear markets asymmetric risk

In comparison, the 2003 to 2007 bull market corrections were less than -10%.

stock market corrections bear market average

When does the bleeding stop? 

After prices have already fallen, I start looking for signs of a potential countertrend and divergence.

The price trend itself is the final arbiter. It is what it is. A price that is trending down is going to continue to trend down until the desire to sell has been exhausted and drives prices low enough until the enthusiasm to buy takes over. After sharp selling pressure like we’ve seen since September, we’ll likely see some similarly sharp countertrend reversals up. Market trends don’t usually drift in a direction until it’s over, instead, we observe swings up and down as the price trend cycles. Short term cycles develop the longer term cycles.

Though the price trend itself is the final arbiter, the best way I have identified when trends are most likely to change direction at extremes is to observe extremes in investor sentiment and breadth. Ultimately, investor sentiment and the breadth is evident in the price, but at extremes, these measures can be a warning shot across the bow at high levels and indicate panic selling exhaustion at lows. From here, we’ll look at investor sentiment measures. We’ll also look at breadth indicators that quantitatively tell us the breadth of participation in the decline. The thinking is at some point these measures reach an extreme, suggesting the selling may be becoming exhausted and to prepare for a potential reversal. Since asymmetric risk/reward is my objective, I’m looking for lower-risk entries that have the potential for greater payoff than the amount I risk.

Investor Sentiment: Fear is Driving the Stock Market

A simple way to quickly observe overall investor sentiment is the Fear & Greed index, which tracks seven different indicators.

Fear Greed Index Low 2018 lowest levelIt’s the lowest level I’ve seen it, suggesting we’ve observed panic level selling. If you read my observations from the beginning of this year, you’ll see the opposite was true at the start of 2018.

FEAR GREED INDEX 2018 LOW

We’ve observed a round trip this year from Extreme Greed to Extreme Fear. Investor sentiment obviously swings up and down over time. As sentiment oscillates, it drives price tends to cycle, too. Even in bull markets, there are declines and in bear markets, we’ll see sharp upswings.

When investor sentiment is so bearish we see a spike in the words “bear market.” Google Trends shows the bear market talk on the Internet has spiked to the highest level in five years, even higher than 2015-16 and February this year.

GOOGLE TRENDS BEAR MARKET STOCK

I’m also hearing the typical talk about a 1987 type crash. The October 1987 -20% single day crash was 32 years ago but it’s still talked about today when prices fall. Markets are risky, so a crash is something we risk when we invest our money. The risk is partially why markets generate a return. We have to be willing to have exposure to risks that can come when no one expects it. Has modern market regulation and technology created any prevention of an ’87 type crash? Around 2012 circuit breakers were created to theoretically prevent a single day crash.

Circuit breaker thresholds: trading is halted market-wide for single-day declines in the S&P 500. Circuit breakers halt trading on the stock market during dramatic drops and are set at 7%, 13%, and 20% of the closing price for the previous day. There are also single stock limits and halts by the exchanges

Buy and hold, long-only asset allocation investors may take comfort in knowing there is some limit, but for those of us who actively manage our risk we prefer to deal with risk sooner if we can, but there is no assurance any strategy will always do as intended.  You can read more about circuit breakers in Measures to Address Market Volatility. The bottom line is these circuit breakers are intended to limit a single day waterfall decline, they do not control overall drawdowns.

How many stocks are participating in the decline? 

Another way to say it; How “washed out” is the stock market? To understand the internal condition, I look inside the indexes at the sectors and stocks. We’ll start with Breadth indicators, which quantitatively measure the percent of stocks in uptrends vs. downtrends.

  • When 70% of stocks are already in uptrends it signals a strong market trend but also suggests as most stocks have caught up and participated, buying enthusiasm may be getting exhausted.
  • When less than 30% of stocks are in uptrends, 70% of them are in downtrends, so the market trend is bearish. However, after most of the stocks have already fallen, at some point, it suggests we look for the exhaustion of selling pressure that could reverse the downtrend.

The percent of the S&P 500 stocks above their moving averages tells us how many of the 500 stocks are in an uptrend vs. a downtrend. When it’s declining, the market is bearish so we can see how many stocks are participating in the decline. When it reaches an extreme low, it may be an indication selling could be becoming exhausted. As we see, it has reached the low levels of past stock market lows with the exception of the low in March 2009.

PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE

Notice the low was reached October 2008 and stayed down until late March 2009. In the massive crash when stocks fell over -50%, it stayed “oversold” for over 6 months. It’s an example of the limitations of countertrend signals in outlier events.

For a view of the short-term trends, I do the same for the 50 day moving average. Only 6% of the S&P 500 stocks are in uptrends, so 94% are in short-term downtrends. That’s the bad news for stock investors. The good news is, it’s reached the low range where we have historically seen a reversal up. A reversal up from here would be bullish, at least temporarily.

PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE

The S&P 500 Bullish Percent Index is the number of stocks in the S&P that are trading on a Point & Figure buy signal. By this measure, only 17% of the 500 stocks are in uptrends. I highlighted the top are in red to note the contrary indicator of breadth and green on the bottom to mark the contrarian bullish zone where downtrends may reverse to uptrends when selling gets exhausted. The S&P 500 Bullish Percent Index is below 2011, 2015 and 2016 stock market correction lows. BPI is considered overbought when above 70% and oversold when below 30%. Once it reaches the green zone, I start looking for a reversal up from a low level, which is a bullish signal. 

S&P 500 BULLISH PERCENT $BPSPX

Notice the current level is below the 2011 and 2015-16 decline, but not as low as the 2008-09 bear market when the stock index fell -56%.

We see the same scenario in the NYSE Bullish Percent, which applies the same method to the stocks trading on the NYSE.

NYSE BULLISH PERCENT

We’re not seeing any divergence in the breadth indicators, they are all down as most stocks have fallen. These are now at the level to look for countertrend signals.

The High-Low Index is a 10-day moving average of new highs vs. new lows. This breadth indicator shows when new highs outnumber new lows and when new highs are expanding. In general, new highs outnumber new lows when the indicator is above 50. New highs are expanding when the indicator is above 50 and rising. As with most range bound oscillator indicators, high is over 70 and low is below 30. Here we see it’s about as low as it has been. We also see how it can swing around for a year or two in a bear market. Since it can take time for prices to reach all-time highs and lows, the High-Low Index is more lagging than similar indicators.

High Low HILO SPX

Before we look inside the sectors, we’ll look at some other indicators of sentiment. This week, the CBOE Total Put/Call Ratio spiked to 1.82, which is its highest put volume over call volume ratio ever. We have data going back to 1995. As you can see in the chart, we normally see this ratio less than one as more calls trade than puts. A reading over 1 is usually a signal of pessimism as options traders appear to buy buying put options for protection or to speculate the stock market will fall. We’ve never seen put volume so high. Options traders appear to be very bearish, which has historically been a contrarian indicator at some point.

PUT CALL RATIO HIGHEST EVER 2018

By the way, big bear markets unfold in cycles as the trend swings up and down. In the last bear market, the stock indexes fell -15%, then gained 10%, then fell 20%, then gained 15%, along the way you never know in advance which direction it is going to trend next. Many tactical traders had trouble with the 2007 to 2009 period because of whipsaws. By the time they exited, the market trended up without them, then they reentered just in time for the next fall. This is the risk of tactical trading, whether the method is breakouts, momentum, relative strength, or any other rotation style. I know this because I’ve known over 100 other tactical traders for over two decades. The price swings are the challenge. For example, below is the 2008 – 2009 -56% decline. As you can see, the Equity Put/Call Ratio is on top. I drew green lines at its peaks to show they typically indicate a short-term price low, but probably not as well as it would in a correction within a primary bull market. The point is, sometimes signals work out well, other times they don’t. They don’t have to be perfect and none are. The key is asymmetry: higher average profits than losses over full market cycles.

2008 spx put call ratio study

One indicator showing some divergence is the VIX CBOE Volatility Index. Although the S&P 500 is about -5% lower than its February low when the VIX spiked up to nearly 40, the VIX is only at 30 this time. However, I point out it did the same thing in the lower low in January 2016. The VIX initially spiked more in the first decline in August 2015 but remained less evaluated at the lower low in January 2016. It appears the options market  expects elevated volatility, but not as much as an expansion as before. We’ll see.

VIX DIVERGENCE VOLATILITY EXPANSION

Drilling down, what about sectors? Below are the individual sectors YTD. Energy and Materials are down the most. Ironically, they are tied to inflation. Where is the rising prices (inflation) the Fed is supposed to be fighting?

SECTOR SPDRS MOMENTUM RELATIVE STRENGTH

Sector Trends and Breadth 

To get an underatnding of the individual stock trends within a sector, I look at the bullish percent of the sectors.

First, we’ll observe the bullish percent of the Energy sector. Energy is down the most and only 3% of stocks in the index is an uptrend as measured by a point & figure buy signal. It’s as low as its been in 20 years. Though it could stay at this low level in a bear market as it did around 2008, it still swings up and down for those willing to trade it.

BULLISH PERCENT ENERGY SECTOR

The next biggest loser sector is Basic Materials, another commodity-related sector. I highlighted the current low level in green, which is nearly as low as it’s ever been in 20 years. These indicators are range bound, so they can only fall to 0% and as high as 100%.

BASIC MATERIALS SECTOR BULLISH PERCENT

The Financial sector is the third largest weight in the S&P 500 stock index at 13%. It’s down -18%, making it one of the biggest laggards. Banks, brokers, etc. are leading the market down and that isn’t a good sign for the economy of the market. Financials often lead in bear markets. However, as we see below, their participation in the fall is about as high as it’s ever been. On the other hand, we see how volatile and weak Financials were in 2007 to 2009. During that “Financial Crisis”, they were among the worst.

financial sector bullish percent momentum relative strength

The industrials sector, down about -18%, continues the trend of broad participation in the sell-off. It’s also reached the lowest it did in 2008 and 2011.

industrial sector bullish percent momentum

Consumer Staples is a sector that is supposed to hold up in market declines, but the index is down -12% year to date, which is more than the S&P. Staples stocks have participated as much as they did in prior corrections in 2011 and 2016, but not as much as around 2008.

consumer staples sector bullish percent index

The Technology sector is a big one because at 20% it has the largest weighting in the S&P 500. The Technology sector is down about -7% YTD. The Technolgy sector bullish percent is down below its lows in prior corrections and nearing the 2008 and 2009 lows. Keep in mind, once prices have moved to a low point, they eventually attract buying demand and reverse the other direction. These indicators help us see the levels it is more likely to happen and a reversal in these indicators increases the potential even more.

BULLISH PERCENT TECHNOLOGY

Consumer Discretionary is 10% of the S&P and down -5% YTD. Its bullish percent is as about as low as it’s been.

BULLISH PERCENT CONSUMER DISRCRETIONARY SECTOR

Another major sector is Healthcare, it’s the second largest weighting at 16% of the S&P 500. It’s flat for the year, but its bullish percent is very washed out.

HEALTHCARE SECTOR BULLISH PERCENT MOMENTUM RELATIVE STRETGH

The Utility sector is the lone survivor so far in 2018. Like Consumer Staples, Utilities are considered “defensive.” That expectation hasn’t held true for Consumer Staples down -12% this year, but the Utility sector is up 2% YTD. The first half of the year, Utilities were laggard as they are sensitive to rising interest rates, but the last half they’ve found some buying interest. As we see, the Utility sector momentum has been strong enough to keep its stocks in uptrends and into the higher risk zone. However, notice they tend to stay at higher bullish percent levels over time. Utilities don’t usually have strong momentum against other sectors, but they do tend to have less volatility. Of course, in the last big bear market that wasn’t the case as everything fell.

UTILITY SECTOR MOMENTUM TREND BULLISH PERCENT RELATIVE STRENGTH

The bottom line is the stock market could certainly be entering another big bear market. It’s long overdue as this bull is very aged and overvalued. Even if it is, it will include swings up and down along the way. That’s the challenge for all strategies that trade or invest in stocks. For buy and hold investors, it’s a challenge as stocks swing up and down and they have full exposure all the time and unlimited downside risk. For tactical traders, the swings are a challenge as we increase and decrease our exposure to risk and reward and none of our methods are perfect. The key, for me, in dealing with it is to hold the lowest risk, highest potential reward exposure. Barring we don’t see some waterfall decline, most of the market is at a point we should see a countertrend move up at least temporarily. If prices keep trending down, I’m guessing the upswing that does come will be just as sharp.

After prices have fallen, I start looking for signs of a potential countertrend and it could come at any time.

Someday in the future, stock investors will be giddy again and completely forget about how they feel right now. But for now, the trend is down, but the sentiment and breadth are at such extremes we should be alert to see at least a short-term reversal in the days ahead.

I hope you find this market analysis helpful. If you don’t believe it is exhaustive enough, I encourage you to read some of the other recent observations since they cover more detail on some of the topics above.

Have a Merry Christmas!

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

What’s going to happen next for the stock market?

The popular stock indexes are now down about -5% year to date.

dow jones stock market

The popular stock indexes are now about -13% off their highs.

stock market dow jones spx spy dia

I don’t normally include the NASDAQ since it’s so overweight the Technology sector, but it’s down -17% off its high and the Russell 2000 small-cap index is down -19%. The year started off very strong and is ending with weakness so far.

nasdaq russell 2000 dow jones

I pointed out earlier this year that Emerging Markets and Developed countries stock markets were already in a bear market if we define it as -20% off highs. Here we see they are down even more than the U.S. stocks year to date.

emering markets stocks

I warned before that with interest rates rising, bonds may not provide the crutch they have in past stock market declines. That has been the case in 2018. Even with the long-term Treasury gaining recently from being down -12%, it’s still down -6% year to date.

BOND ETF TLT LQD AGG ETFS

Many investors are probably wondering what’s going to happen next. I said a week ago in Stock Market Observations that stocks have fallen far enough that “We would expect to see some potential buying support at these levels again.” For these popular stock indexes, they are now at the point of the February and April lows and reaching an oversold level by my momentum measures.

We are looking for signs that selling pressure is drying up as those who want to sell have been exhausted and new buying demand increases to take over. Some signs of stock prices reaching a low enough point to attract more buying than selling are observed in investor sentiment measures and breadth indicators.

A simple easy to follow gauge of investor sentiment is the Fear & Greed Index, which is a composite of seven Investor sentiment measures. The investor sentiment reached an “Extreme Fear” zone again.

investor sentiment fear greed index

Investor fear by this measure has been high for the past few months. At some point, we would expect to see those who want to sell have sold. However, if this stock trend becomes a bear market we would expect to see this gauge remain low for a long time. Although, the stock indexes will swing up and down along the way.

fear and greed over time investor sentiment stock market

Another observation of investor sentiment reaching an extreme was last week’s AAII Investor Sentiment Survey. Last week pessimism spiked to its highest level since April 2013, while optimism fell to an unusually low level.

bearish investor sentiment

For some historical context, the % of bearish investors has reached the high level it did at the 2016 stock market low. When investor fear reaches such extremes, it’s a contrary indicator.

bearish sentiment

A bear market is a process, not an event. At -13% it’s hard to say if this will become a bear market, though there are some potential drivers that could cause stocks to fall more over time.

The first warning sign for the big picture is earlier this year the Shiller PE ratio for the S&P 500 reached the second highest level ever, with data going back before 1880.

Shiller PE ratio for the S&P 500

The only two times the Shiller PE ratio for the S&P 500 had reached this “overvalued” level was 1929 and 1999. Of course, 1929 was followed by The Great Depression and 1999 was followed by the Tech Bubble Burst. The only time I pay attention to the PE ratio is for a big picture assessment of valuation when it reaches extreme highs or lows. At such a high level of valuation, we shouldn’t be surprised to see volatility and stocks decline. The unknown is if it keeps declining much more to reach an “undervalued” level at some point. So far, with -13% decline, the Shiller PE ratio for the S&P 500 has declined from 33 at the beginning of the year to 28 now. Twenty or higher is considered high, 10 or less is considered low. It is what it is.

A bear market is a process, not an event, which means the stock market will swing up and down along the way. For example, historical bear markets are made up of swings of -10%, +8%, -14%, +10%, each swing doesn’t make a higher high, but instead prints a lower high and lower lows. The good news is, the swings are potentially tradable. However, for those tactical traders who attempt to trade them, it isn’t easy and it doesn’t always feel good. These kind of periods are volatile, so a skilled tactical trader has to increase and decrease exposure to the possibility of gain and loss. For me, predefining risk is essential, but so is holding the predetermined exposure to give a trend room to play out.

Some potentially positive news is the breadth indicators suggest most stocks are participating in the downtrend. That doesn’t sound positive unless you realize as stocks get washed out on the downside the selling pressure is eventually exhausted, at least temporarily. Below is one indicator we observe to see what is going on inside S&P 500 stock index. It’s the percent of the 500 stocks in the index that are trending above their 50-day moving average. When this indicator is low, it signals stocks may be nearing a level of selling exhaustion as most of them are already in downtrends. However, if this does become an actual bear market of -20% or more, we’ll see this indicator swing up and down along with the price trend. At this point, it’s in the green zone, suggesting the stocks may be near the “washed out” area so we could see some demand take over supply in the days or weeks ahead.

As you can see below, the percent of stocks above their 50 day moving average has now reached the low level it did in February and back in August 2015 and January 2016 that preceded a reversal back up.

percent of stocks above 50 day moving average

I shared my observations of this breadth indicator back in February when I explained it in more detail if you want to read it Stock Market Analysis of the S&P 500. I also shared it in October when the current downtrend started. In October, the percent of stocks above their 200 day moving average was still high and hadn’t declined much. That isn’t the case now. As you can see, even this longer term breadth indicator is now entering the green zone. As more stocks have already declined, it becomes more and more likely we’ll see selling exhausted and shift to buying demand as prices reach lower more attractive levels for institutional investors.

As you can see below, the percent of stocks above their 200 day moving average has now reached the low level much below February and now down to the levels reached in August 2015 and January 2016 that preceded a reversal back up in stocks.

stock market breadth percent of stocks 200 day

Another indicator that measures the participation in the trend is the S&P 500 Bullish Percent index that I have been observing for over two decades. This is the percent of stocks on a Point & Figure buy signal, which often traces a pattern something similar to the 50 day and 200-day moving averages as it has the past four years. As we see below, this indicator is reaching the low level not seen since August 2015 and January 2016 that preceded a reversal back up.

buliish percent index

At this point, we haven’t yet seen enough buying enthusiasm to overwhelm the desire to sell. But, many of these indicators I’ve been monitoring for nearly two decades are reaching a level we should see some shift at some point. If we don’t, the stock market may enter into a more prolonged and deeper bear market. However, historically lower lows are made up of cycle swings along the way, so we should still see at least some shorter-term uptrends.

I’m starting to hear a lot of “bear market” talk in the news and on social media, so I thought I would put the current decline into context. My mission isn’t to take up for the stock market, but instead to present the facts of the trends as they are. I was defensive at the beginning of the year and then added more exposure after prices fell. I predefine my risk by predefining my exits in all of my positions, so any exposure I have has a relatively short leash on how low I’ll allow it to go before I cut my loss short, rather than let the loss get large. I am never a market cheerleader, but because I was already defensive near the peaks, I may have the potential to take advantage of the lower prices. I’m almost always going to be a little too early or a little too late and that is fine. It’s never been perfect but has still achieved the results I want the past two decades.

To put the current decline into historical contacts, we can simply compare it to the last decline of -10% or more, which was around August 2015 and January 2016. For nearly two years, the stock index was range bound with no upside breakout.

stock market 2015 2015 decline bear market

Looking closer at the % off highs, we see the late 2015 decline was -12% and the first few months of 2016 was about -15%.

stock market decline 2015 2016 asymmetric risk reward

Here is 2018. So far, it isn’t actually as much of a decline.

bear market stocks stock market

Another interesting observation I’ll share is the trend in the CBOE S&P 500 Volatility Index (VIX). Below is the 2015 to 2016 period again with the S&P 500 in the top panel and VIX volatility index in the bottom panel. We see the VIX spiked up sharply around August 2015 when the stock market decline. However, when the stock market recovered the loss and then declined again to a lower low, the VIX index didn’t reach the same high level the second time. The volatility expansion wasn’t nearly as high even though the stock index reached an even lower low.

VIX VOLATILITY expansion 2016

We are observing that same divergence in volatility this year. The VIX spiked over 100% when stocks fell -12% around February this year. The stock market recovered and printed a new high in September, then has since fallen -13% from that high. This time, however, the implied volatility VIX index hasn’t spiked up nearly as high.

divergence volatility expansion vix

What could it mean? When the VIX increases it is an indication of expected future 30-day volatility implied by the options on the stocks in the S&P 500. When the VIX increases, it means options traders are probably using options to hedge against market declines. I’m guessing it could signal that hedging and possible selling enthusiasm could be drying up. That seems to be what it suggested in 2015 to 2016 when it did the same, then the stock market trended up into 2017.

We’ll see how it all unfolds from here, but the stock market has clearly reached an inflection point. Stocks have trended down to a low enough level we should see some buying demand if it’s there. You can probably see why I believe markets require me to actively manage my risk through predefined exits and hedging to extract from it the asymmetric risk-reward I want.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Divergence in the Advance-Decline Line May be Bullish

With the stock market swinging up and down with the volatility expansion we’ve seen since February many investors are probably wondering which way stocks are going to trend.

Individual investors should be aware of the big picture.

The primary trend has been up since March 2009 with several declines interrupting it along the way. In fact, there have been eight declines more than -10% and three of them were between -15% and -20%. But, none have been over -20%, which is the level most define as a “bear market”. So, this is the longest bull market in U.S. stocks in history.

Many investors may realize that trends cycle up and down and when a trend moves longer or farther than normal, they may be expected to swing the other way longer and farther. For this reason, the intelligent investor is probably on alert for signs of the beginning of a change in the primary trend from a bull market to a bear market.

Market cycles aren’t just the longer primary trends, they are made up of many smaller trends that may be tradeable swings up and down. Avoiding a large bear market isn’t as simple as predicting it and then exiting the stock market until it’s over. We never know for sure in advance when a primary trend shifts from positive to negative and back to positive. In the real world, we focus on shorter time frames and have to deal with the short-term price swings that happen as a trend unfolds.

Despite the recent volatility and the down days, at this point, the U.S. stock market primary trend remains up. We say that because this two-year chart shows higher highs and higher lows. For that to change, we would need to see the stock index decline and stay below the prior lows. Of course, that is a possibility, but those who are following the trends respond to the actual change of trend.

stock market trend following

One positive confirming indicator is improving breadth during the recent swing up from the October low.

The Advance-Decline Line is a breadth indicator that indicates the level participation of the stocks in an index like the S&P 500. For example, a broad advance shows the internal strength that is lifting most boats, which is bullish. A narrow advance would show a  mixed market that is selective instead of broad participation. So far, we’ve seen the S&P 500 Advance-Decline Line make a higher high in the upswing, even though the S&P 500 index itself has declined the past few days.

bullish divergence advance decline line $spx $spy

One of the characteristics of the Advance-Decline Line is that it treats all 500 stocks the same, giving them equal weight. The standard S&P 500 stock index that investors track is a capitalization-weighted index that weights the largest stocks in the index much more heavily. Since the Advance-Decline Line gives each of the 500 stocks equal power, it emphasizes small and mid-cap stocks more. To get a more accurate view of the Advance-Decline Line relative to the stock index, we can use the S&P 500 Equal Weighted Index. I included it below. As we see, the equal-weighted stock index has trended up more similar to the Advance-Decline Line – and both of them made a higher high.

advance decline bullish divergence spx equal weight

We continue to observe a much more volatile market condition than we saw in 2017. That should be no surprise since the CBOE Volatility Index indicates implied volatility has been elevated as we’ve seen this volatility expansion. However, it’s at 20 today, which is its long-term average.

vix volatlity expansion asymmetric asymmetry

Looking back over two years, the next chart shows how much more elevated implied volatility was over last year.

volatility expansion 2018 vix $VIX trading asymmetry asymmetric

Volatility is mean reverting, which means volatility tends to swing from higher states to lower states. Although the VIX long-term average is 20, it rarely stays at that level. Instead, it swings up and down.

2018 has been a volatile year for stocks by any measure, but it may seem even more volatile since 2017 was so quiet.

So far in 2018, the S&P 500 stock index has been down -1% or more on 21 days.

In 2017, stocks only had a -1% or more down day 4 days the whole year.

By that measure, does it make 2018 a volatile year? Or 2017 a calm year?

2016 had 22 days the S&P 500 stock index was down over -1%

2015 had 32 days the S&P 500 stock index was down over -1%

By this measure, 2017 was an unusually calm year for U.S. stocks. 2018 isn’t a lot different than 2015 and 2016.

Individual down days don’t make a trend unless you are a day trader, which we are not. We measure market risk by actual drawdown. Below is a chart of the drawdowns for the stock index year to date. The S&P 500 has declined -10% twice. A -10% within a year is normal, along with a couple of -5% drops. But, two -10% declines in a 12 month period isn’t all that abnormal, either.

stock market drawdown 2018 $SPX $SPX

One thing that may make the price trend swings and volatility seem unusual this year was the lack of it last year. Below is last year, when we didn’t see any drops more than -4%.

stock market volatility drawdown

On January 24, 2018, I said:

I tell ya what… we haven’t seen a drawdown in the popular stock indexes in nearly a year and a half. We would normally see three or four. Those who don’t think that is important will probably be the investors who are dazed when we do see one.

Markets cycle and swing up and down over time, and so does volatility. At this point, we are observing an overall primary uptrend in U.S. stocks but the shorter-trend trend this year has shown us broader swings of +/- 10% or so as volatility has expanded and price swings have spread out.

Despite the down days Friday and today, the short term trend is relatively positive with positive participation as measured by the Advance-Decline Line. Only time will tell how it all plays out from here.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

The stock market is swinging its way to an inflection point

Trying not to sound like a broken record, I’ll share a few updates from what I said last in Observations of the stock market downtrend. 

The stock market is at an inflection point. An inflection point is a time of meaningful change in a situation; a turning point. The reality is, there are many inflection points within market cycles and price trends. So, we observe different inflection points across different time frames. For those who watch the stock market daily as a professional portfolio manager, we observe every move. But, the overall focus needs to be on the bigger trends. Every market cycle and price trend is made up of smaller cycles as prices swing up and down on their way to forming a directional trend. Market cycles don’t trend straight up or down.

The U.S stock indexes have dropped about -10% in October, giving up gains for the year. Many investors probably believe October is historically the worst month of the year for the stock market because of famous October declines. September is actually the worst month historically, but October is historically a volatile month. It just so happens, this decline occurred inside of October.

I don’t use seasonality as a signal for my decisions, but we’ve all heard of “sell in May and go away.” The period from May through October is supposed to be the weak season and November to April is the stronger season for stocks. The S&P 500 had defied the expectation that stocks would be weak last summer and gained nearly 10% from May through September, then lost the gain in October. Many leading growth stocks that previously showed the strongest momentum declined even more than the stock indexes. I pointed out a few months ago that international stock indexes including both emerging and developed countries were already in downtrends. So, the global equity markets were generally down in October.

That’s the bad news for anyone invested in these markets.

The good news is after those who wanted to sell have sold, prices eventually reach a low enough point to attract new buying interest.

I focus on what the price trends are actually doing, so I’ll share my observations of the trends and update some sentiment and breadth indicators I’ve discussed in previous observations.

First, we look at what the price trend is actually doing. Below is the S&P 500 stock index year-to-date. We see after declining about -10% from its September high, the stock index has reversed back up to the price of the prior low on October 11th.

 

In technical analysis of price trends, we say “prior support may become resistance” and that may be what happens next. We shouldn’t expect prices to trend straight up or down, they swing up and down. Prices making higher highs and higher lows form uptrends or lower lows and lower highs form downtrends. So, it wouldn’t be abnormal to see the stock index trend back down to the low again, or it could pause and continue the recent upward direction.

For a sustained move higher, those who want to sell need to have sold and prices need to have reached a low enough point to attract new buying demand.

Have those who want to sell, sold?

To get an idea for observation of investor sentiment, we can look at a few simple indicators. I explained the thinking behind the Fear & Greed Index in Observations of the stock market downtrend.

The Fear & Greed Index is based on 7 indicators of investors sentiment and can be a useful gauge to help investors keep their own sentiment in check. It currently remains at an “Extreme Fear” level, which is typical after a stock market decline and a high level of bearish sentiment that has historically preceded stock prices reversing back up- as those who want to sell have sold. However, in a prolonged bear market, this oscillating indicator could stay low for a long time or it could swing up and down along with price trends.

But, nothing illustrates buying and selling, supply and demand, better than the actual price trends. Another interesting indicator I’ve shared in recent observations is the percent of stocks in the S&P 500 that are trading above their short-term moving average.

 

It shows us how many stocks have participated in an uptrend or downtrend. When it reaches a high point and most stocks have participated in an uptrend, it may be nearer a reversal back down. Price trends don’t move straight up. When it reaches a low level is indicates most stocks have declined and at an extreme, it can suggest capitulation – those who want to sell may have sold. But, prices don’t trend straight down. Prices swing up and down along the way to drifting directionally. At this point, this indicator has reached the February and April lows and reversed up.

Shorter term, it’s an inflection point as I highlighted. If more stocks trend back up, we’ll see this trend higher.

Let’s see how it all unfolds…

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Is it a stock pickers market?

Is it a stock pickers market?

Sometimes the stock market is trending so strongly that the rising tide lifts all boats. No matter what stocks or stock fund you invest in, it goes up. That was the case much of 2017.

Then, there are periods when we see more divergence.

When we observe more divergence, it means stocks, sectors, size, or style has become uncorrelated and are trending apart from each other.

I pointed out in Sector Trends are Driving Equity Returns; there is a notable divergence in sector performance, and that is driving divergence in size and style. Growth stocks have been outperformance value, and it’s driven by strong momentum in Technology and Consumer Discretionary sectors.

When specific sectors are showing stronger relative momentum, we can either focus more on those sectors rather than broad stock index exposure. Or, we can look inside the industry to find the leading individual stocks.

For example, Consumer Discretionary includes industries like automobiles and components, consumer durables, apparel, hotels, restaurants, leisure, media, and retailing are primarily represented in this group. The Index includes Amazon, Home Depot, Walt Disney, and Comcast. Consumer Discretionary is the momentum leader having trended up 9.7% so far this year as the S&P 500 has only gained just under 1%.

momentum sectors

If we take a look inside the sector, we see the leaders are diverging farther away from the sector ETF and far beyond the stock market index.

momentum stocks consumer discretionary sector NFLX AMZN AAPL

In fact, all the sectors 80 stock holdings are positive in 2018.

The Consumer Discretionary sector is about 13% of the S&P 500. As you can see, if these top four or five sectors in the S&P 500 aren’t trending up it is a drag on the broad stock index.

ETF Sector Allocation exposure S&P 500

So, Is it a stock pickers market? 

When we see more divergence, it seems to be a better market for “stock pickers” to separate the winners from the losers.

Another way to measure participation in the market is through quantitative breadth indicators. Breadth indicators are a measure of trend direction “participation” of the stocks. For example, the percent of the S&P 500 stocks above or below a moving average is an indication of the momentum of participation.

Below is the percent of stocks above their 50 day moving average tells us how many stocks are trending above their moving average (an uptrend). Right now, the participation is symmetrical; 52% of the stocks in the S&P 500 are in a positive trend as defined by the 50 day moving average. We can also see where that level stands relative to the stock market lows in February and April and the all-time high in January when over 85% of stocks were in an uptrend. By this measure, only half are trending up on a shorter term basis.

SPX SPY PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE 1 YEAR

The 200-day moving average looks back nearly a year to define the direction of a trend, so it takes a greater move in momentum to get the price above or below it. At this point, the participation is symmetrical; 55% of stocks are above their 200-day moving average and by this time frame, it hasn’t recovered as well from the lows. The percent of stocks above their 200-day moving average is materially below the 85% of stocks that were participating in the uptrend last year. That is, 30% fewer stocks are in longer trend uptrends.

SPY SPX PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERGAGE 1 YEAR

In the above charts, I only showed a one-year look back of the trend. Next, we’ll take a step back to view the current level relative to the past three years.

The percent of stocks above their 50 day moving average is still at the upper range of the past three years. The significant stock market declines in August-September 2015 and December-January hammered the stocks down to a very washed out point. During those market declines, the participation was very asymmetric: 90% of the stocks were in downtrends and only about 10% remained in shorter-term uptrends.

SPX SPY PERCENT OF STOCKS ABOVE 50 DAY MOVING AVERAGE 3 YEARS

The percent of stocks above their 200 day moving average also shows a much more asymmetrical situation during the declines in 2015 and 2016 when the stock index dropped around -15% or more. Only 20% of stocks remained in a positive trend.

SPX PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE 3 YEARS

Is it a stock pickers market?

Only about half of the stocks in the index are in uptrends, so the other half isn’t. So, if we avoid the half that are in downtrends and only maintains exposure to stocks in uptrends and the trends continue, we can create alpha.

But, keep in mind, that doesn’t necessarily mean we should have any exposure at all in the S&P 500 stock index because happens to have the highest sector exposure in the leading sectors.

But, for those who want to engage in “stock picking”, the timing has a higher probability now to diverge from the stock index than last year because so fewer stocks are in uptrends and more are in downtrends.

For individual stocks traders willing to look inside the box, this is a good thing.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.

Stock Market Decline is Broad

We typically expect to see small company stocks decline first and decline the most. The theory is that smaller companies, especially micro companies, are more risky so their value may disappear faster.  Below, we view the recent price trends of four market capitalization indexes: micro, small, mid, and mega. We’ll use the following index ETFs.

Vanguard ETFs small mid large micro cap

Since we are focused on the downside move, we’ll only observe the % off high chart. This shows what percentage the index ETF had declined off its recent highest price (the drawdown). We’ll also observe different look-back periods.

We first look back 3 months, which captures the full extent of the biggest loser: as expected, the micro cap index. The iShares Micro-Cap ETF (IWC: Green Line) seeks to track the investment results of an index composed of micro-capitalization U.S. equities. Over the past 3 months (or anytime frame we look) it is -13% below its prior high. The second largest decline is indeed the small cap index. The Vanguard Small-Cap ETF (VB: Orange Line) seeks to track the performance of the CRSP US Small Cap Index, which measures the investment return of small-capitalization stocks. The small cap index has declined -11.5%. The Vanguard Mega Cap ETF (MGC) seeks to track the performance of a benchmark index that measures the investment return of the largest-capitalization stocks in the United States and has declined -9.65%. The Vanguard Mid-Cap ETF (VO) seeks to track the performance of a benchmark index that measures the investment return of mid-capitalization stocks and has declined -9.41%. So, the smaller stocks have declined a little more than larger stocks.

Small and Micro caps lead down

Source: Shell Capital Management, LLC created with http://www.ycharts.com

Many active or tactical strategies may shift from smaller to large company stocks, hoping they don’t fall as much. For example, in a declining market relative strength strategies would rotate from those that declined the most to those that didn’t. The trouble with that is they may still end up losing capital and may end up positioned in the laggards long after a low is reached. They do that even though we may often observe the smallest company stocks rebound the most off a low. Such a strategy is focused on “relative returns” rather than “absolute returns“. An absolute return strategy will instead exit falling trends early in the decline with the intention of avoiding more loss. We call that “trend following” which has the objective of “cutting your losses short”. Some trend followers may allow more losses than others. You can probably see how there is a big difference between relative strength (focusing on relative trends and relative returns)  and trend following (focusing on actual price trends and absolute returns).

So, what if we look at the these stock market indexes over just the past month instead of the three months above? The losses are the same and they are very correlated. So much for diversification. Diversification across many different stocks, even difference sizes, doesn’t seem to help in declining markets on a short-term basis. These indexes combined represent thousands of stocks; micro, small, medium, and large. All of them declined over -11%, rebounded together, and are trending down together again.

stock market returns august 2015

Source: Shell Capital Management, LLC created with http://www.ycharts.com

If a portfolio manager is trying to “beat the market” index, he or she may focus on relative strength or even relative value (buy the largest loser) as they are hoping for relative returns compared to an index. But a portfolio manager who is focused on absolute returns may pay more attention to the actual downside loss and therefore focuses on the actual direction of the price trend itself. And, a key part is predefining risk with exits.

You can probably see how different investment managers do different things based on our objectives. We have to decide what we want, and focus on tactics for getting that.

Asymmetric Returns of World Markets YTD

As of today, global stock, bond, commodity markets are generating asymmetric returns year to date. The graph below illustrates the asymmetry is negative for those who need these markets to go “up”.

Asymmetric Returns of World Markets 2015-04-10_10-52-47

source: http://finviz.com

 

Stock Market Peak? A Tale of Two Markets

One of the early warning signs that a bull market in stocks is nearing its end is increasing selectivity. As more investors begin to believe a peak may be near based on statistical analysis or valuation, they may get positioned more defensively. Eventually we observe some stocks participating in a rising trend as others trend down early. Over the past several weeks we have observed a material divergence between large company stocks like those in the Dow Jones Industrial Average (DIA) vs. small company stocks like those in the Russell 2000 Index (IWM). As you can see below, the Russell 2000 index has declined nearly 9% while the Dow Jones Industrial has gained about 2%. Since the Dow Jones Industrial is more popularly quoted in the media, most investors probably believed “the market was still rising”. But unless you only have positions in the largest company stocks, you’re noticing that isn’t the case in terms of the broad market. Small company stocks tend to lead on the downside, so we shouldn’t be surprised if we see the larger companies follow them down at some point. You can probably see how this basic observation leads to further study of market breadth: looking at what percent of stocks are rising vs. falling.

Is this the “tail” of two markets?

stock market peak small cap large company stocks

Data: http://www.stockcharts.com

Of course, the direction of the overall market is interesting to monitor, but it only matters what positions we have at risk.