Investor fear has been driving the stock market down

I like to observe the return drivers of price trends. Though I primarily focus on the direction of the price trend and volatility, I also consider what drives the price trend.

Yesterday I suggested the stock market was at a point of pause and possible reversal back up in The stock market is holding its breadth… for now.  I shared some examples of how the percent of stocks in a positive trend had declined to a point that could indicate the selling in the near term could be drying up.

So far, today’s sharp reversal up seems to confirm at least a short term low.

Up until today, the S&P 500 stock index was down about -6% off its high. In May it dropped -8% before reversing back up to a new high. I express these drawdowns in the % off high chart below. This is year-to-date, since January 1.

Just for reference, this -6% decline looks more similar to May when I expand the time frame to 1 year instead of just year-to-date. We also see the October to December waterfall decline was a much deeper -20%.

Of course, if you look close enough, the pattern prior to the much steeper and deeper part of that fall looks similar to now, with the price trend testing the prior low, recovering, then falling sharply another -10%. I’m not pointing this out to say it will happen again, but instead that it’s always a possibility, so risk management is essential.

What is driving this decline?

Fear.

It’s that simple.

Some are afraid of another recession signaled by an inverted yield curve, others of the Trump Tweets, others by the Fed lowering interest rates or not doing it fast enough. I’ve heard some hedge funds are afraid China will invade Hong Kong, others are concerned of the China tariffs. Some people probably wake up afraid and fear everything that can possibly happen, as such, they experience it as if it did.

I prefer to face my fears and do something about them.

Investors have reached an extreme level of fear in the past few weeks as evidenced by the -6% decline in the stock index. We can also see this reflected in the investor sentiment poll. The AII Sentiment Survey shows optimism is at an unusually low level and pessimism is at an unusually high level for the 2nd consecutive week.

investor sentiment extreme trading

Such extreme levels of investor sentiment often proceed trend reversals. So, these extreme fear measures along with the breadth measures I shared yesterday, I’m not surprised to see the stock market reverse up sharply today.

Another interesting measure is the Fear & Greed Index, which is a combination of multiple sentiment indicators believed to measure investor sentiment. The Fear & Greed Index has reached the “Extreme Fear” level, so by this measure, fear is driving prices.

fear greed index

Over time, we can see how the Fear & Greed Index has oscillated up and down, swinging from fear to greed and back to fear again. I highlight the current level has reached the low point it typically does before it reverses up again, with the exceptions of the sharp panics in 2018.

advisor money manager using fear greed index extreme behavior

I have my own proprietary investor sentiment models, but here I share some that are simple and publicly available. I’m not suggesting you trade-off of these, as I don’t, either, but instead use them to help modify your investor behavior. For example, rather than use these indicators to signal offense or defense, investors may use them to alert them to their own herding behavior. Most of the time, we are better off being fearful when others are greedy and greedy when others are fearful.

These measures aren’t quite robust enough to be timing indicators by themselves, my signals are coming from other systems and I’m using these to illustrate what’s driving it.

Over the past 12 months, as of right now the stock index is up 2.48%. That’s including today’s 1.5% gain.

Only time will tell if it holds the line, but as I’ve zoomed in to a 3-month time frame, we can see the first line of support that needs to hold.

We are long and strong at this point, so;

Giddy up!

 

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.

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.

 

All investors are market timers

All investors are market timers.

It isn’t just tactical traders.

I’ve been hearing more about “market timing” recently from some investment advisors saying they aren’t market timers.

But they are.

We all are.

And timing is everything. Like it or not.

I start off with general definitions of market timing from a Google search.

According to Wikipedia:

Market timing is the strategy of making buying or selling decisions of financial assets (often stocks) by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis.”

This definition indicates “by attempting to predict future market price movements” is what draws the distinction of “market timing.”

Next is Investopedia:

“What Is Market Timing?

Market timing is a type of investment or trading strategy. It is the act of moving in and out of a financial market or switching between asset classes based on predictive methods. These predictive tools include following technical indicators or economic data, to gauge how the market is going to move.

So, it seems the distinction they make for “market timing” is a prediction.

Yet, everyone must necessarily make a prediction about the future to invest or trade.

For the passive indexers who buy and hold index funds, they necessarily make a prediction those funds past performance will resemble future results. They assume the stock and bond markets will have a positive return over the long term. The truth is, that is not a certainty, but a prediction on their part. In fact, choosing a time to rebalance their asset allocation is market timing, too, especially if they do it in response to price trend changes.

For value investors who actively look to add stocks they believe have been undervalued by the market, and/or trade for less than their intrinsic values, they are necessary market timing. When they sell a stock that has reached full value, they are timing the exit. It’s market timing. Some may even reduce or hedge overall stock exposure when the broad stock indexes are overvalued, which is also a timing decision. The more aggressive value investors, such as a value hedge fund, may use leverage to buy more stocks after their prices fall in a bear market. It’s market timing.

For momentum investors. it’s about following the historical trend. Momentum investing is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period. It’s market timing as it assumes on average they’ll achieve more gains from the positive trends than losses from the negative trends. Extrapolating the recent past into the future is necessarily market timing.

What about non-directional trading strategies like certain options spreads and volatility trading? They still require and entry and an exit and timing the trade. Being invested in the stock market, buy the way, is explicitly short volatility, so when volatility expands stocks usually fall.

I want to be long volatility when it’s rising and short or out when it isn’t. I want to be in an options positions that on average result in asymmetry: more profit, less loss.

For example, an options straddle is a non-directional trading strategy that incorporates buying a call option and a put option on the same stock or ETF with the same strike and the same expiration. With a non-directional trade, we may have a two in three chance of making money because we can profit if the stock moves up or down. It requires movement, which is a prediction of the price expanding and timing it. It’s market timing.

Rather than trying to debate against “market timing” it seems more useful to admit we are all doing it in all we do, one way or another.

I embraced that long ago, and for me, I realize timing is everything.

But that doesn’t mean it always has to be perfect timing, either.

Asymmetry results from the average gains overwhelming the average losses, so the timing could have no edge if the profit-taking and loss cutting systems are robust.

All investors are market timers. The market timers who make the biggest riskiest bet are the passive index asset allocators who make no attempt to manage their risk, assuming past performance is indicative of future results.

Past performance is no guarantee of future results.

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.

Small stocks are still lagging

The chart is the price trend of the Russell 2000 Index, which is a small-cap stock market index compared to the S&P 500, the stock market index based on the market capitalizations of 500 large companies. Small-cap stocks have been lagging over the past year.

Smaller stocks lagging behind larger companies is more typical in the late stage of a bull market and economic expansion.

Looking back over three years, we see smaller stocks were leading on the upside during the uptrend. That hasn’t been the case recently.

This divergence may be an early sign of a regime change.

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.

Charting and technical analysis of the stock market trend

I usually share more of my observations of the stock market trend when the shit hits the fan. The truth is, I enjoy volatility expansions more than the quiet, calm trends. There isn’t as much for me to talk about when the trends are calm and quiet.

I also try to point out, in advance, when I believe we may see a volaltity expansion like we are now. You shouldn’t expect it from me as I’m ultimately an investment manager, not a Mark Twain, so my own tactical trading decisions are my priority. Also, what I share here doesn’t necessarily represent what I am trading in our managed portfolios. In fact, I usually try to avoid mentioning any symbol, stock, ETF, etc. that I may be trading or invested in. As such, use my observations at your own risk as it is not investment advice. With that said…

Here is the one year chart of the S&P 500 with some basic technical analysis applied. The blue trend line I drew overhead is where we would have expected to see “resistance become support,” but it hasn’t. So, there wasn’t enough buying demand to overcome selling pressure today. Based purely on quantitative measures as I’ve shared over the past week, it isn’t a surprise to see a volatility expansion and price trends widen out.

stock market momentum and support resistence

I marked how the current decline relates to the past two. This one has turned down rather sharply and quickly as of today. The SPX stock index is down about -6% from it’s high of which nearly half of the loss is today.

I now expect we’ll see some buying interest step in… at least temporarily. Only time will tell if this becomes a waterfall decline like we saw October to December, or worse.

I haven’t mentioned any news items that could be used as catalysts. Last week it was the Fed and employment, today it’s China, Hong Kong, and Trump tweets. Contrary to what most people probably believe, the range of prices broadening out and price trends falling is something I thought we may see as a normal quantitative reaction. Whatever may get the blame, it’s just the market, doing what it does. I can assure you of only one thing: I’ve heard a wide variation of reasons today from different levels of people. On the financial news, it’s one thing, from global macro hedge fund managers, it’s another. For example, one mentioned the Chinese PLA army is building on the Hong Kong border…

“May you live in interesting times” 

Ironically, it is an English expression purported to be a translation of a traditional Chinese curse.

In the meantime, my short term momentum systems are showing the broad stock index reaching its lower range of probabilities, so we “should” see it retrace up at some point, at least temporarily. Of course, there is always a chance of a waterfall decline the moves much deeper than a normal range of probabilities. In fact, we have already seen that now if you look at the chart. The price trend has moved below the “normal range of the market” as measured by the lower band.

We’ll see how it all unfolds.

If you want to follow along, sign up on the right to get automatic emails immediately when I share a new observation. 


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.

Will the stock market hold the line? or do we keep hedging risk? and opportunity for high income yield

The U.S. stock indexes declined -6.84% for the large-cap S&500, -11% for mid caps, and about -19% for small-cap stocks mostly in the single month of May.

asymmetric risk reward stock market

Since June 1st, however, these same stock indexes have started to trend back up.

stock market asymmetry

Over the past 3 months, momentum has turned negative for the stock indexes.

momnetum stocks 3 month

My strategy was to hedge off some of this downside risk. I then removed my hedges for a profit. It doesn’t always work out that way. A hedge position isn’t necessarily intended to be profitable through the entry and exit, but instead, the objective is to hedge off some of the downsides of long positions. Sometimes I hold them too long and lose their gains, other times I exit and realize a profit, and then there are times I exit them too soon with a profit but miss an even large profit. It ain’t perfect, nor does it need to be, and I’m okay with it.

My stock market observation yesterday, which I shared on Twitter, was:

This double bottom could be a likely short-term low if the holds the line… my guess is it’s more likely than not. If it breaks down further from here, though, it probably gets ugly like when it didn’t hold last December…

SPY $SPY buy signal countertrend trend following

So far, so good… as marked with a simple trend line.

SPY INVESTMENT MANAGER TACTICALA week ago the AAII Sentiment Survey showed an unusually high level of Pessimism and optimism at an unusually low level… signals to stalk the market for good risk/reward setups on the buy side.

behavioral finance economics investor sentmiment advisor

I exited my hedges a few days ago and increase my exposure to stocks. However, I did this at the same time my momentum and systematic trend following systems shifted from stocks to bonds or cash. So, my entries are based on signals from my countertrend and high-income yield systems. As prices fall in high yielding ETFs, their dividend yield increases.

Global X SuperDividend™ US ETF (DIV) is an interesting example. This is not investment advice for anyone to buy this ETF as I only provide advice and portfolio management to clients via an executed contract. It is useless to know what I would buy if you don’t know how much I would buy and when I would sell. With that said, the chart of Global X SuperDividend™ US ETF (DIV) shows as the price (blue line) declined to a double bottom, the dividend yield has increased to 7.6%. So, if I entered it here, it would be expected to yield 7.6% going forward. I am only using this for informational purposes, so I’m not including all the variables and risks it may not which can be found here.

The point is, you can see how as price falls in a high yielding asset, it’s yield rises.

Global X SuperDividend™ US ETF (DIV)

I have recently made my ASYMMETRY® High Income Yield Portfolio available to clients who seek high income from their portfolio and are willing to accept fluctuation in the balance. Up until now, I had been testing this strategy with my own capital. The portfolio focuses on asymmetric risk/reward opportunities for high-income yield and also adds an asymmetric hedging system to help with downside risk management. For more information on the strategy, contact me.

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.

Putting my short-term technical analysis tactician hat on and hedging off equity risk

I’m dialing in to look at shorter-term technical analysis as my risk management systems are suggesting a risk of a stock market decline is becoming elevated.

tactician technical analysis analyst tactical manager trader

Zooming in to shorter time frames, the U.S. stock market advance appears to be becoming exhausted.

The chart below is the SPDR® S&P® 500 ETF, yesterday on a 5-minute chart. Now that’s zooming in! I’m not a day trader, but I’m monitoring the trend for signs of buying exhaustion and/or selling pressure to potentially take over. Yesterday this index ETF was up nearly .75% in the morning, then you can see it drifted down to close well below its VWAP for the day.

SPY VWAP MOMENTUM RELATIVE STRENGTH TREND FOLLOWING

The next chart shows the SPY trend going back for about six months. The recent stock advance has been impressive and I’m sure glad we participated in it, but I’m now applying some situational awareness. The strong momentum since the late December 2018 low could be becoming exhausted and may find some resistance for higher prices, at least temporarily.

SPY

As a tactician, since we had heavy exposure to stocks, I’ve been gradually reducing exposure and today started hedged off some equity risk to offset some of my market risks. I did that as opposed to taking large profits and realizing taxable gains. Fortunately, we took advantage of last years volaltity and made the best of it by executing significant tax loss harvesting. This time I decided to hedge some of our gains rather than realize them.

I may be wrong, but my risk management systems are elevated for at least a short term exhaustion, so I expect we’ll see some selling pressure overwhelm buying at some point from here. If it doesn’t, then it’s a good sign the momentum may be here to stay a while, but I’ll probably still wait for a reversal down to add more exposure in my tactically managed portfolio. My objective is asymmetric risk/reward, and from this starting point, I see more potential for downside than upside for stocks. My systems aren’t always right, but the magnitude of the gains are larger than the losses when it’s wrong. I call it ASYMMETRY®.

 

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 solely 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.

FAANG Stocks and Momentum Trends

Markets trend in cycles and trends come and go like seasons from spring to summer to fall to winter. I like to observe a range of price trends and behavioral trends from short term to very long term secular trends.

In the 1960s and 1970s, it was the Nifty 50. The Nifty 50 were 50 stocks institutional investors admired.

The Nifty 50 stocks got their reputation during the bull market of the 1960s and early 1970s. They were considered “one-decision” stocks because investors were told they could buy and hold the shares forever. Nifty 50 stocks included IBM, General Electric (GE), and Coca-Cola (KO). Some of the Nifty 50 have had problems the past decade, like Xerox and Polaroid. More recently, we can add General Electric to not so nifty list.

The secular bear market of the 1970s started with the 1973–74 stock market crash and lasted until 1982.  Valuations of the Nifty 50 fell to low levels along with the rest of the stock market. Most of the Nifty 50 lagged the stock market indexes and then they weren’t so popular afterward. Trends can be fads and come and go, but the one thing we see driving fads in the stock market is their actual price trend. Stocks are loved at all-time highs, not so much after they decline.

Below are three of the better Nifty Fifty stocks. Buying and holding the stocks would require tremendous patience and acceptance of volatility and large drawdowns.  Coca-Cola had the best momentum overall. But, who could have held through the drawdown from the late 1990s that lasted a decade? How about Xerox?

nifty 50 ko ibm ge

Below are the % off high drawedowns of these “Blue Chips.” A -50% more decline that lasts for years is something an investor would have to tolerate more than once to own the stocks long term. This is why buy and hold investing doesn’t work for most investors. 

fifty 50 stock asymmetry ratio

Then in the 1990s, it was the tech stocks especially those involved in the Internet. More specifically, the “.com” stocks was a whole new level of popularity and euphoria. The overall stock market reached its highest valuation levels, ever. Most of the .com stocks no longer exist. Some of the technology stocks involved in building the infrastructure still do, like Cisco (CSCO), Microsoft (MSFT), Oracle (ORCL), and Qualcomm (QCOM). But, many of the momentum stocks of the 1990s aren’t around to see their charts.

tech stocks

If investors only focused on is the right side of the chart, those several thousand percent gains look exciting. But, in the real world, even a -20% decline in the stock indexes as we saw in 2018 causes investor fear and panic selling. The investors holding the above stocks would probably need to be asleep at the wheel to have held them long term.

Looking at the total return alone isn’t sufficient, so I like to observe what I call the ASYMMETRY® Ratio, which is the total return chart above along with the drawdown. The ASYMMETRY® Ratio gives us a full picture of the asymmetric risk-reward if there is one. Clearly, the downside drawdowns were brutal by any measure. Maybe even more brutal than the Nifty 50.

1990s momentum tech stocks

Those are the momentum trends of the past.

Today we have the FAANG stocks. It stated as FANG and has since extended to FAANG. The FAANG stocks are Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), and Google (GOOG). They have been some of the most popular momentum stocks and for good reason. These are some of todays greatest companies. Who can imagine Netflix going away today? Who could have imaged online Netflix taking out Blockbuster? Who can imagine Amazon eventually taking out Netflix? What if Walmart (WMT) or Target (TGT) figure out a way to compete with both? The reality is, there is probably some small company out there we don’t know about that will be the next big winner. We don’t have to attempt to find the needle in the haystack, we can just focus on the price trends and they’ll show up eventually.

I shared my observations in FANG Stocks were the Leaders but now the Laggards so I won’t rehash it. My mission here is a short term update.

So far in 2019, all of the FAANG stocks are trending up except for Apple (AAPL). Only one of the FAANG stocks have had stronger momentum than the First Trust Dow Jones Internet ETF (FDN) which is a more diversified version of FAANG type internet industry stocks. The clear leader has been Netflix (NFLX).  Here is a chart over the past month:

faang stocks fb aapl amzn nflx goog momentum asymmetric risk reward

The ASYMMETRY® Ratio looking at the total return vs. % off high drawdown gives us a better picture of asymmetric risk-reward. Below is their total returns over the past year.

fang faang stock momentum fb aapl amzn nflx goog

The FAANG stocks clearly have their downside risks and all of them are in drawdowns as we see below. However, they are recovering and the diversification of the ETF helped reduce its drawdown relative to the individual stocks.

 

faang stock asymetric risk reward momentum drawdown

We’ll see if the FAANG stocks resume their prior momentum we’ve seen over the past several years.

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 stock market analysis… continued

I guess An exhaustive analysis of the U.S. stock market wasn’t exhaustive enough, because I now have a few things to add.

First, since the financial news media, as well as social media like Twitter, is so bearish with all kinds of narratives about why the stock market is falling, I’ll go ahead and discuss it here. This observation will not be complete without first reading An exhaustive analysis of the U.S. stock market so you know where I am coming from. If you haven’t read it already, I would before continuing so you understand the full context.

It is the financial news media’s business to report new information. We all know that if they want to get people to tune in, the fastest way is to provide provocative and alarming headlines and commentary. So, we shouldn’t be surprised to see distressing news.

There are always many reasons for the stock market to trend up or down. It isn’t hard to write some narrative attempting to explain it. The reality is, there are all kinds of causes that create an effect. None of them alone drive price trends. Ultimately, what drives price trends is behavior and sentiment which drives supply and demand. Behavior and investor sentiment may be impacted by the news and what people decide to believe.

I often say “what you believe is true, for you” even if it isn’t actually true. A person’s beliefs could be completely wrong and could be scientifically disproven, but if they still believe it, it’s their truth, so it’s true – for them. So, whatever you choose to believe is going to be your truth, so I suggest weighing the evidence to determine the truth if you want it to be more accurate. In science, we can’t prove the truth to be true, we can only disprove it as untrue.

Let’s look at some truths that I believe to be true based on empirical observation of facts.

The biggest news headline is probably the government shutdown. There have been twenty U.S. government shutdowns over the budget since 1976 by both political parties. Half of the time it was followed by stock gains and half the time declines. The average result is -0.40% and the median is 0%. So, historically a government shutdown hasn’t seemed to drive prices. Below is the table. It is what it is.

What does the stock market do after government shut down

Yesterday evening Steven Mnuchin, the 77th Secretary of the Treasury, tweeted a note that he had called the nations six largest banks to confirm they have ample liquidy for consumer and business lending and other market operations. The words “Plunge Protection Team” started trending in social media. Much of the response has been negative, which seems odd to me.

Since when was doing “channel checks” not a good idea?

It seems not doing it would be imprudent…

There are many things going on all over the world all the time, so we can always find narratives to fit the price trend and believe it’s the driver. Narratives and news also seem to drive more emotional responses since people like to hear a story. I focus on the data, which is the price action. Whatever is driving the markets is reflected in the price trend. The price trend is the final arbiter. Nothing else matters.

The Morningstar table of index performance shows the 2018 total return of large, mid, small cap stocks along with growth, value, and blend.

STOCK MARKET INDEX RETURNS 2018

The most popular broad-based indexes like the S&P 500 and Dow Jones Industrial Average show 2018 is ending just the opposite of the way it started.

stock index performance return 2018

Let’s look at some price trends.

Yesterday I shared the Bullish Percent measures on the broad stock market indexes and each individual sector. We observed the percent of stocks in all sectors except for the Utility sector was already at historical lows after previous market declines. After today’s price action, we have some updated observations to explore.

The S&P 500 is in a bear market, commonly defined as a -20% decline from a prior price peak. What is most interesting is how fast it reached -20%.  In the chart below, I included the S&P 500 Total Return Index (including dividends), the S&P 500 Index price only, and the S&P 500 ETF (SPY). On a total return basis, the S&P 500 Total Return Index that includes no costs or fees didn’t quite close down -20% from its high, but the rest did. It’s close enough.

bear market 2018 October November December Crash

Though the stock indexes had declined -10% earlier this year, they had recovered to new highs by September and it appeared the primary uptrend would resume. Starting in October, the stock market declined again and attempted to recover twice in November. What came next was probably most shocking to those who follow market seasonality; the stock indexes are down over -15% in the month of December, which is historically one of the strongest months of the year. It seems this decline happening so fast and at the end of a calendar year is going to make it seem more significant.  Because it’s at year end it results in a “down year” instead of having time to recover during the normally seasonally strong period after October. The period from November to April historically has stronger stock market gains on average than the other months. Not this year.

The Utility sector reverses down to participation in the market decline. 

Yesterday I had highlighted the top range of the Bullish Percent chart in yellow to mark the high-risk zone above 70%. After today, the Utilities sector has declined below that range. Individual Utility stocks are now participating in the stock market decline.

Utilities Sector ETF XLU BULLISH PERCENT RELATIVE STRENGTH MOMENTUM

The Utilities sector ETF declined over -4% today and is now slightly down for the year.

Utilities Select Sector SPDR® ETF $XLU

During significant market declines, diversification sometimes isn’t the crutch it is promoted to be by most of the investment industry. Broad asset allocation and diversification do not assure a profit or protect against a loss in a declining market. In declining markets, we often see price trends cluster more as serial correlation. That is, prices begin to fall more just because they are falling. Investors sell because prices are falling. So, stocks, sectors, and markets can all become highly correlated to the downside. By the end of a market decline, all stocks, sectors, and markets are often participating.

The upside is, this panic selling is capitulation as the final weak holders stop resisting and begin to “sell everything!” We eventually see the selling dry up and buyers step in with enthusiasm at lower prices.

In the big picture, as I said in An exhaustive analysis of the U.S. stock market I guess we shouldn’t be surprised to see prices falling with greater velocity since this is an aged bull market at high valuations and the same Fed actions that probably drove it up are probably going to reverse it in a similar fashion. I started this year warning of complacency from the 2017 low volatility uptrend and the potential for a volatility expansion. I also pointed out during the stock market peak in September that volatility had contracted to a historically very low level in VIX shows the market’s expectation of future volatility. Specifically, on September 25th I wrote,

“Looking at the current level of 12 compared to history going back to its inception in 1993, we observe its level is indeed near its lowest historical low.”

I ended it with;

“When the market expects volatility to be low in the next 30 days, I know it could be right for some time. But, when it gets to its historically lowest levels, it raises situational awareness that a countertrend could be near. It’s just a warning shot across the bow suggesting we hedge what we want to hedge and be sure our risk levels are appropriate.”

Well, that has turned out to be an understatement I guess.

What’s more important is what I actually did. On August 23th as the stock market began to appear overbought on a short-term basis, I took partial profits on our leading momentum stock positions. In hindsight, it would have been better to sell them all. By September 26th (when I wrote the above) I had reduced our exposure to only around 30% stocks and the rest in Treasury bonds. It still didn’t turn out perfectly as the stocks we did hold declined, too, and in many cases even more than the stock indexes. As we entered October, I shared a new observation “Here comes the volatility expansion” as stock prices fell and volatility increased. As prices fell to lower and lower levels, I started adding more exposure. At this point, prices have broadly become more and more extremely “oversold” and sentiment has become more negative. This has been a hostile period for every strategy, but I’ve been here before.

By the way, I have been a tactical portfolio manager for over twenty years now. The highlight of my performance history has been the bear markets. I executed especially well in the October 2007 to March 2009 period when the S&P fell -56%. My worst peak to trough drawdown during that period was only -14.3% and I recovered from it about six months or so later. That was compared to a -56% drop in the stock index that took several years to recover. In fact, I did so well at a time when very few did that it was almost unbelievable, so I had my performance verified by a third party accountant. I have considered writing about it and sharing the commentaries I wrote during the period and the tactical decisions I made. Make no mistake, it wasn’t easy nor was it pleasant. I didn’t lose the money others did, so I was in a position of strength, but it was still a challenging time. What I will tell you is I entered and exited various positions about seven or eight times over that two year period. We never know in advance when the low is in, or when a trend will reverse back down. Buy and hold investors just take the beating, I entered and exited hoping the average gain exceeds the average losses. The swings are the challenge. It takes great discipline to do what needs to be done. Most people had very poor results, for me to create good results, I necessarily had to feel and do the opposite of most people. The market analysis I’m sharing here as observations aren’t necessarily the exact signals I used to enter and exit, but they are part of the indicators I monitored during the crash. Every trend is unique. We have no assurance my methods will do as well as in the past. But, the one thing I feel confident in is I’ve been here before. This ain’t my first rodeo. I know what I’m doing and I’m disciplined in my execution. That’s all I can do. I’m dealing with the certainty of uncertainty, so I can’t guarantee I’ll do as well the next time around, but I am better prepared now than I was then.

So bring it. Get some. I’m ready. 

Yesterday I shared the extreme levels of Bullish Percent indicators for the broad market and sectors as well as other indicators like the Put/Call Ratios. I want to add to these observations with more indicators reaching an extreme. I’ve not seen these extremes since 2008 and 2009.

The Nasdaq has declined the most which is no surprise since it’s mostly emerging companies and heavily weighted in Technology. Market conditions have pushed the number of Nasdaq stocks hitting new lows to over 1,100 as of last week. Since the total number of Nasdaq issues is about 3,200 that has caused the value, in percentage terms, to jump to over 30% of the total. As you can see, the last time this many Nasdaq stocks hit new lows was the October 2008 low and the March 2009 low. The current level has exceeded other corrections since then and even the “Tech Wreck” after 2000. At this point, it becomes a contrarian indicator.

NASDAQ NEW LOWS PERCENT OF INDEX

To no surprise, the same trend is true for NYSE stocks. As of last week, the percent of stocks listed on the New York Stock Exchange at new lows has reached the levels of past correction lows, but not as high as the 2008 period.

NYSE NEW LOWS PERCENT NYA INDEX

From here, I’ll share my observations of the relative strength and momentum of the sectors and stocks within them so we can see how oversold they have become. We already looked at the Bullish Percent of each sector yesterday, this is just more weight of the evidence.

First, I applied the Relative Strength Index to the S&P 500 daily chart. This RSI is only 14 days, so it’s a short-term momentum indicator that measures the magnitude of recent price changes to estimate overbought or oversold conditions. RSI oscillates between zero and 100, so it’s range bound and I consider it overbought above 70 and oversold below 30. Below we see the current level of 19 is very low over the past twenty years and is at or below the low level reached during past shorter-term market bottoms. However, we also see during prolonged bear markets like 2000 to 2003 and 2007 to 2009 it reached oversold conditions two to three times as the market cycles up and down to a lower low.

RSI SPX RELATIVE STRENGTH S&P 500 INDEX

Zooming out from the daily chart to the weekly chart, we see the extremes more clearly and this is one of them. On a weekly basis, this oversold indicator is as low as it’s been only at the low points of the last two major bear markets.

sS&P 500 RSI WEEKLY RELATIVE STRENGTH SPX

Zooming out one more time from the weekly to the monthly chart, we observe a monthly data point only highlights the most extreme lows. It’s the same data but ignores the intra-month data. On a monthly basis, the current measure isn’t as low as it reached at the bear market lows in March 2009 or October 2002. For it to reach that level, I expect the green area I highlighted in the price chart to be filled. In other words, this suggests to me if this is a big bear market, we could ultimately see the price trend decline to at least the 2015 high. It only takes about -10% to reach that level. However, as we saw in the shorter term readings, if history is a guide, it would most likely cycle back up before it would trend back down.

RSI S&P 500 MONTHLY RELATIVE STRENGTH INDEX SPX

You can probably see why I stress that longer-term price trends swing up and down as they unfold. Within a big move of 50%, we see swings around 10 – 20% along the way.

Let’s continue with this same concept to see how each sector looks. The broader indexes are made of the sectors, so if we want an idea of the internal condition of the broader market it is useful to look at each sector as I did yesterday with the Bullish Percent indexes.

Since we just had a -15% correction in August 2015 and January 2016, we’ll just focus on the daily RSI looking back four years to cover that period. Keep in mind, none of this is advice to buy or sell any of these sectors or markets. We only provide advice and investment management to clients with an executed investment management agreement. This observation is for informational and educational purposes only.

The Consumer Discretionary sector is as oversold as it’s been at historically low price points. A trend can always continue down more and stay down longer than expected, but by this measure, it has reached a point I expect to see a reversal up.

CONSUMER CYCLICAL SECTOR RELATIVE STRENGTH MOMENTUM RSI TREND

The price trend of Consumer Staples that is considered to be a defensive sector initially held up, but then the selling pressure got to it. It’s oversold as it’s been at historical lows.

consumer staples etf relative strength trend RSI XLP

The Energy sector has declined the most in 2018 and is oversold similar to prior price trend lows. We can see the indicator isn’t perfect as a falling trend sometimes reverses up temporarily, then trends back down to a lower low only to get oversold again. We’ll observe this same behavior at different times in each sector or market.

energy sector etf xle relative strength rsi momentum trend following buy signal.jpg

The Financial sector is deeply oversold to the point it has reached at prior lows. Any market could always crash down more, but Financials have reached a point we should expect to see at least a temporary reversal up.

FINANCIAL SECTOR ETF XLE IYF RELATIVE STREGTH MOMENTUM RSI

Healthcare is a sector that isn’t expected to be impacted by the economy, but it has participated in the downtrend. It’s also reached the oversold point today. You can see what happened historically after it reached this level. If history is a guide, we should watch for a reversal.

XLV HEALTH CARE ETF RSI MOMENTUM RELATIVE STRENGTH

The Industrial sector is trending down but has now reached a point we could see a reversal back up.

XLI INDUSTRIAL SECTOR ETF MOMENTUM RSI

Clearly, the market decline has been broad as every sector has participated. The Materials sector reached the oversold level today.

XLB BASIC MATERIALS SECTOR ETF RSI MOMENTUM RELATIVE STRENGTH

Real Estate has not been spared during the selloff. It has now reached an oversold level normally seen at lows, but historically it’s cycled up and down a few times before reversing up meaningfully. That can be the case for any of them.

XLRE REAL ESTATE ETF IYR MOMENTUM TREND FOLLOWING RSI

The Technology sector had been one of the best-looking uptrends the past few years. It’s now oversold after today’s action.

TECHNOLOGY ETF XLK IYR MOMENTUM RSI RELATIVE STRENGTH ASYMMETRIC RISK REWARD

Up until today, the Utility sector was the lone survivor, but it was one of todays biggest losers. It’s falling so sharply so fast it’s now oversold with the other sectors.

XLU IDU UTILITIES UTILITY SECTOR ETF ETFS MOMENTUM RSI

After prices have declined, I look for indications that selling pressure may be getting more exhausted and driving prices to a low enough point to attract buying demand. That’s what it takes to reverse the trend.

I’ve been here before. I’ve executed through these hostile conditions as a tactical operator. The more hostile it gets, the more focused in the zone I get. After the stock market has already declined, I start looking for this kind of panic selling and extreme levels for a countertrend. We’re seeing those levels now. Sure, it could get worse, but we have reached a point that lower prices are more and more likely to result in a reversal back up.

I’m just going to do what I do.

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.

 

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.

 

The stock market has reached a short-term extreme as investor sentiment indicates fear

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

“Be fearful when others are greedy and greedy when others are fearful.”

– Warren Buffett

If you want to be like Warren Buffett, you’re probably enjoying the recent rout in stocks.

The U.S. stock market is now oversold based on short-term relative strength measures. Our 14 day RSI reading has declined to 28, which is at oversold levels that have historically signaled countertrend reversals up.

RSI RELATIVE STRENGTH INDEX STOCK MARKET ASYMMETRIC

The trouble is, market prices can reach oversold levels and just keep getting more oversold for a while. For example, when the S&P 500 declined -56% from October 9, 2007 to March 9, 2009 it got deeply oversold several times as the price trend cycled up and down. We can visually observe the Relative Strength Index spent more time in the lower range as prices were falling. Then in 2009 as prices finally trended up momentum stayed elevated.

2008 and 2009 oversold stock crash

Another indication of an oversold condition I observed today is when we draw bands of ATR around the price trend to measure volatility expansion. ATR is the average true range of the price over the past 14 days, a short-term measure of range and volatility. When the prices spread out, so does the band as it indicates volatility expansion. Today the price of the S&P 500 declined below the band, so the recent price action on the downside is an outlier by this measure. As you can see, the last time the price traded below the volatility band was the February low. What this observation suggests is the price has moved down low enough that it’s a short-term outlier, so it should trend the other way (at least temporarily).

STOCK MARKET ATR SPX

Stock market breadth indicators measure the participation of a stock advance or decline. The percent of stocks above their 200 day moving average tells us how many stocks are still in longer-term uptrends vs. downtrends. After today, only 18% or 89 stocks are above their 200-day trend. It’s now down to the low level reached during the August 2015 to January 2016 lows. After it reached this low in 2016, stocks went on to trend up to a new all-time high.

stock market breadth percent of stocks above 200 day moving average

At this point, the S&P 500 and Dow Jones have declined -15% from their September high. If this is a cyclical “correction” within an ongoing bull market, we should see prices trend up soon and eventually trend to a higher high.

However, even if this is the early stages of a bear market that declines over -20% or a big bear market like 2000-2003 and 2007-2009 that declines -50%, the stock market will still likely swing up and down along the way. As we saw in the above chart that included the last bear market, the stock indexes swing up and down 10% to 20% on their way down just as they do on their way up. Some of these swings can be traded, some not so well. This recent decline since September was probably more challenging for tactical traders. Though the stock market got overbought enough in September to signal reducing exposure near the high, after prices fell to a lower level and signaled a countertrend entry, the price trend has since kept falling. But, at this point, countertrend systems now have a stronger entry signal than before. The challenge with countertrends is a trend can always continue trending farther. That is, oversold can get more oversold until sellers have been exhausted and buyers are attracted by the lower prices. Prices keep trending until the supply and demand shifts direction.

By the way, on September 1st I shared the countertrend signal reduce exposure in The U.S. stock market was strong in August, but… when I concluded:

The bottom line is the broad stock indexes are trending up and led by a few strong sectors, but they’ve reached levels that my countertrend momentum systems suggest the risk of at least a temporary decline is elevated.

Because of this, I reduced my exposure to only 70% long stocks around the September high. However, we still participated in the October rout more than I planned because the 30 % of stocks we held that were former leaders declined the most. I then started adding exposure to stocks at lower prices and so far, they’ve only trended lower. Everything is always probabilistic, never a sure thing.

Anytime we see stock prices decline more than -10% the narrative we hear in the media changes from “correction” to speculation of a “bear market”. As I mentioned a few days ago, this is the longest bull market in U.S. history and the second highest valuation. As such, anything can happen. However, at this point, this decline of -15% is around the range of the 2015-16 decline and the 2011 decline.

Here is what the August 2015 to January 2016 declines looked like.

2015 stock market decline asymmetric risk

In 2011, the correction was the deepest we’ve seen since this bull market started in March 2009.

2011 stock market drawdown asymmetric risk reward

To put it all in context of a major bear market like the last one 2007 to 2009 when the stock index declined -56% over two years and took another four years to return to its 2007 high, I marked -15% green. The stock market was already down -15% from its October 2007 high by January 2008 – two months later. The bear market had many countertrend swings back up giving many who were holding some hope, but it ultimately cycled its way down to cut stock portfolio values in half.

2008 stock market crash drawdown

Many say they are “long-term investors.” The long-term investors who buy and hold stocks or the stock indexes have to be willing to hold through an astonishing loss like -50%.

I am not willing to hold on to losing positions near that long or let my losses get that large. But even for a tactical portfolio manager like myself, I have to be willing to expose our capital to risk and endure some drawdowns. I just choose to limit my drawdowns by predefining risk through my exits and/or hedging. I prefer to avoid the price action below the green line in the chart above.

This has been one of the worst ends of the year in history. In fact, as of now, this is the 2nd worst December in S&P 500 history. It is the worst in MSCI World global stock index history.

worst decemember in history

The only good news I can share is the stock market has reached an oversold level based on short-term momentum and investor sentiment measures are at extreme bearish levels. Both are contrary indicators. These indicators normally signal a reversal back up at some point. Although, if enough investors wish they had sold, they may sell as prices trend up, so the trend could swing around for a while. It means volatility may continue for some time.

Todays AAII Investor Sentiment Survey shows optimism and pessimism remain outside their typical ranges: bullish sentiment is unusually low and bearish is unusually high. Historically, both have been followed by higher-than-median six- and 12-month returns for the S&P 500 index, particularly unusually low optimism. Again, this is a contrary indicator as investors as a crowd tend to feel the wrong feeling at the wrong time at extremes.

AAII Sentiment Survey

The fear and greed index that measures investor sentiment using multipe indicators is down to five, which is about the most extreme fear level it’s ever been.

investor sentiment fear greed index

One of the indicators in the Fear and Greed Index is the Put/Call Ratio is used as a contrarian indicator to gauge bullish and bearish extremes. The sentiment is considered excessively bearish when the Put/Call Ratio is trading at relatively high levels. One a normal day, the Put/Call Ratio is less than one since options traders tend to trade calls more than puts. Today the Put/Call Ratio is at 1.82, so options traders are buying many more puts for protection against a market decline or as a directional bet. Put/Call Ratio is at 182% is an extremely high level, the highest ever recorded. The Put/Call Ratio data goes back to 1995 and 1.2 has historically been an extreme high.

Put Call Ratio 2018 December highest ever recorded

The bottom line is, fear of lower prices is driving the stock market, and the bears have been in control. However, sentiment has reached such an extreme we would expect to see a countertrend reversal up at least temporarily. Even if this is the early stage of a lower low and a bear market, it will include many swings up and down along the way. What the trend does once it finally drifts up will be telling of the bigger picture. Bear and bull markets are both a process, not an event. In a bear market, prices trend up down to lower lows and lower highs. The swings along the way result in fear of missing out and the fear of losing more money which leads to overbought and oversold conditions.

I believe risk must be actively managed through increasing and decreasing exposure to the possibility of loss because markets are risky. The stock market can decline -50% or more and take years to trend back up, so I believe drawdown controls are necessary to preserve capital rather than allowing losses to get too large. Once a portfolio declines more than -20%, the losses grow exponentially and become harder to recover.

We’ll see how it all plays out. We’re still waiting to see those investors who are “greedy when others are fearful” overwhelm the sellers enough to change the trend.

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.

Will the stock market hold the line?

The popular U.S. stock market indexes almost formed a potential inverse head and shoulders reversal pattern, however, the right side was met with selling pressure that exceeded enthusiasm to buy. For those who care to observe the price action as it unfolds, I’ll share my observations of what I’m watching for to identify a reversal or continuation of the trend. I don’t necessarily make my tactical trading decisions based on these things, it’s instead market analysis I do for observation of the shifts in supply and demand that ultimately drive trends.

At this point, these stock indexes we use as a proxy for the stock market have reached the October lows as we knew they could.

stock market trend following momentum

The bad news is we’ve continued to see the desire to sell exceed the enthusiasm to buy. When selling pressure is dominant, prices fall.

The good news is the price level has now reached a point were another potential reversal pattern could form; a double bottom reversal. A double bottom reversal is commonly seen when prices reach a prior low and then find enough buying interest to shift the trend from down to up. Such a shift necessarily requires prices to fall to a low enough point that buyers become willing to buy.  For the trend to change; buying demand overwhelms selling pressure. So, the shift involves some combination of the desire to sell becoming exhausted and the desire to buy becoming dominant. Prices trend in the direction of the most asymmetry.

I don’t get caught up in the semantics of the names of patterns, but instead what the formation is showing about the shift in supply and demand. When a potential inverse head and shoulders pattern fails on the right shoulder, the possibility of a double bottom reversal exists, but still needs to be confirmed. For me, the whole point is; in a downtrend (uptrend), no matter what the time frame, I look for signs of a reversal of the trend through a shift in the supply/demand seen in price action. None of them are ever 100% predictive or accurate, it’s always about possible outcomes and observing the trend. It’s always probabilistic, never a sure thing. But, that’s all we need.

We’ll see if the stock indexes can hold the line, or not.

It’s a process, not an event, so we just watch it all unfold.

Let’s see what it does from here.

Have a Happy Thanksgiving!

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.

 

 

Pattern Recognition: Is the S&P 500 Forming a Head and Shoulders Bottom?

I don’t always share when I observe stock market patterns unfold, but when I do, it’s usually to inform (or aggravate) my friends who don’t understand (or want to understand) technical analysis.

Long before I started developing computerized trading systems based on quantitative signals I learned and applied chart patterns and trend lines to determine if a trend was up, down, or sideways. Said another way, up until 15 years ago I identified the direction of price trends visually looking at a price trend on a chart. I later defined up, down, and sideways with mathematical equations that help to systematize the process of trend identification. I believe my starting out learning trends by hand and visual representation helped me to develop better quantitative trend systems. The two go hand in hand.

We can define the direction of a trend with an equation as simple as momentum. For example, I have 14 different definitions of momentum and equations that define it. A simple one is X period rate of change. If it’s positive, the trend is up. If it’s negative, the trend is down. The factor that determines the trend direction is the time frame. Many academic types like using simple time series momentum methods like this because it’s easy to backtest. Pattern recognition is more difficult, so fewer have developed systems to automate pattern recognition and make it testable.

Chart patterns have historically been more visual. Chartists or technical analysts look at the chart of a price trend to determine if there is a pattern. The pattern we are looking for tells the story of supply and demand. The chart of a price trend shows us what has been going on with the battle between supply and demand from buyers and sellers. We may get an idea of who may be winning the battle and position our capital in that direction. For example, when prices are rising the buyers are in control and when prices all falling selling pressure is dominant. So, pattern recognition is just another form of trend following. Instead of using X-day breakouts, moving average, or channel breakouts, it’s using a pattern that is believed to tell the story of price action. We don’t make decisions based on a pattern, but the underlying asymmetry between buyers and sellers that caused the pattern and the direction of the price trend.

Simple > Complex

To me, it’s a much more simple way to determine if buyers or sellers are in control of the price trend than trying to find a fundamental narrative. There are so many different reasons for buying demand and selling pressure we could never really know why one is dominating the other. The news attempts to explain it, but the truth is, investors could be buying or selling based on perceived fundamentals, trend lines, moving averages, stop losses, buy stops, fear of missing out, fear of losing money, or tax reasons. Rather than trying to figure out what the majority is thinking, the pattern of the price trend tells the net result of all the buying and selling. It fits the idea of simple beats complex and if we simply stay with the direction of the trend we can’t be too wrong for too long. Someone making decisions based on things other than the price trend itself has the potential to stray far away from the reality of the price.

To me, chart patterns are really just a little more elaborate versions of trend lines. A trend line is just a line marking a chart such as how I marked the higher highs and higher lows yesterday in Divergence in the Advance-Decline Line May be Bullish. 

I observed today the S&P 500 seems to be forming a head and shoulders bottom pattern. The head and shoulders pattern happens when a market trend is in the process of reversal either from a bullish or bearish trend.  There are two kinds of head and shoulders.

  • A head and shoulders top is a pattern that forms after an uptrend. After it is completed, it signals a reversal of the trend from up to down.
  • A head and shoulders bottom is an inverse of the head and shoulders top. The head and shoulders bottom forms after a downtrend and signals a change of trend from down to up.

Below is the chart of a theoretical index used to represent an idealized head and shoulders. It includes both head and shoulders tops and head and shoulders bottoms. Stockcharts offers this index for educational purposes to see what idealized head and shoulders look like. You may notice each top and bottom are a little different – they aren’t perfect.

head and shoulders pattern recognition

I put the green box around a head and shoulders bottom. You can see why when you look at the S&P 500 stock index chart below.

head and shoulders bottom patterns recognition

An inverse head and shoulders pattern is simply a downtrend caused by selling pressure, interrupted by a brief reversal (left shoulder), a selling climax (head), an interruption again (right shoulder), then it would move on to new highs. Moving on to new highs will determine if it is completed as a reversal bottom, or not. To reverse the downtrend, selling pressure must be exhausted as buying demand becomes dominant.

Many patterns like the head and shoulders rely on volume as confirmation, so chartists can make it as complicated as they want, or keep it simple by looking at the pattern. For my purpose, I’m going to keep it simple and say we’ll know if this is indeed a head and shoulders bottom reversal pattern if it follows through on the upside. If it does, we would expect the price trend of this index to at least reach its old highs. If the price doesn’t hold and it doesn’t follow through to the upside, it’s probably going to at least test the prior low again.

Either way, patterns are never completely accurate. It’s probabilistic, never a sure thing. The head and shoulders is simply a pattern formation commonly seen after a downtrend that, if completed, may signal the end of the downtrend and reversal into a new uptrend. It’s based on the visual representation of the battle between supply (selling pressure) and demand (buying interest). For example, when the head and shoulders bottom completes the low point in the (inverse) head, it marks the point when those who wanted to sell have sold. So, the right (inverse) shoulder signals selling has dried up and buyers are taking over. It is completely normal to observe profit-taking after an advance, so the last few days is normal even if this is a reversal up. You can probably see how volume gets involved to confirm the pattern. In the case recently, the volume was high at the lows signaling selling pressure. The volume is declining on the right shoulder. The good news is, the volume didn’t expand on these recent down days.

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.

 

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.

Observations of the stock market downtrend

Observations of the stock market downtrend

In the last observation I shared about the stock market, “The stock market trends up with momentum,” we saw the stock market reverse back up with strong momentum. The S&P 500 stock index had declined about -7% from its high, then reversed back up 3%. I discussed how investor behavior and sentiment drives market prices. Many investor sentiment measures signaled investor fear seemed to be in control, driving down prices. Volatility had spiked and then started to settle back down. Many individual stocks in the S&P 500 had declined enough to signal shorter-term downtrends, but then they reversed up. I closed by saying:

In summary, today was a strong upward momentum day for the stock market and most stocks participated in the uptrend. After sharp declines like we’ve seen this month, the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low. After the test, we then find out if it breaks down or breaks out.

One day doesn’t make a trend, but for those who are in risk taker mode with stocks, so far, so good.

The part I bolded with italics has turned out to be the situation this time.

Below is a year to date price trend of the S&P 500 stock index. As of today, my observation “the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low” is what we are seeing now.

stock market trend

I’ve always believed investment management is about probability and possibilities, it’s never a sure thing. The only certainty is uncertainty, so all we can do is stack the odds in our favor. As I said before, “After the test, we then find out if it breaks down or breaks out.” 

The positive news is, investor sentiment measures are reaching levels that often precede short-term trend reversals back up.

The bad news is if the current trend becomes a bigger downtrend these indicators will just stay at extremes as long as they want. We have to actively manage our exposure to loss if we want to avoid large losses, like those -20% or more that are harder to overcome.

Down -10% is one thing, down -20% is another. Any investor should be willing to bear -10% because they will see them many times over the years. Only the most passive buy and hold investors are willing to bear the big losses, which I define as -20% or more.

Nevertheless, I see some good news and bad, so here it is. I’ll share my observations of the weight of the evidence by looking at relatively simple market indicators. I don’t necessarily make my tactical decisions based on this, but it is instead “market analysis” to get an idea of what is going on. Observations like this are intended to view the conditions of the markets.

Fear is the dominant driver. 

The Fear & Greed Index tracks seven indicators of investor sentiment. When I included it a week ago, it was at 15, which is still in the “Extreme Fear” zone. The theory is, the weighting of these seven indicators of investor sentiment signals when fear or greed is driving the market. Clearly, fear is the dominant driver right now.

fear greed index investor sentiment behavioral finance

At this point, we can see investor sentiment by this measure has now reached the low level of its historical range. In this chart, we can see how investor sentiment oscillates between fear and greed over time in cycles much like the stock market cycles up and down.

fear and greed back test over time investor sentiment indicator

I believe investor behavior is both a driver of price trends, but investors also respond to price trends.

  • After prices rise, investors get more optimistic as they extrapolate the recent gains into the future expecting the gains to continue.
  • After prices fall, investors fear losing more money as they extrapolate the recent losses into the future expecting them to get worse.

Investor sentiment and price trends can overreact to the upside and downside and the herd of investors seems to get it wrong when they reach an extreme. We observe when these kinds of indicators reach extremes, these cycles are more likely to reverse. It is never a sure thing, but the probabilities increase the possibility of a reversal. But, since there is always a chance of a trend continuing longer in time and more in magnitude, it is certainly uncertain. Since there is always a chance of a bad outcome, I  have my limits on our exposure to risk with predetermined exits or a hedge.

Speaking of a hedge. 

I started pointing out my observation several weeks ago of a potential volatility expansion. If you want to read about it, most of the past few weeks observations have included comments about the VIX volatility index. Over the past few days, we’ve observed a continuation in the volatility expansion.

vix hedge volatility expansion asymmetric hedge asymmetry

Implied volatility has expanded nearly 100% over in the past 30 days.

vix volatility expansion trading

As a tactical portfolio manager, my first focus is risk management. When I believe I have defined my risk of loss, I become willing to shift from risk manager to risk taker. I share that because I want to point out the potential for hedging with volatility. Rather than a detailed exhaustive rigorous 50-page paper, I’m going to keep it succinct.

My day job isn’t to write or talk about the markets. I’m a professional portfolio manager, so my priority is to make trading and investment decisions as a tactical investment manager. I’m a risk manager and risk taker. If I never take any risk, I wouldn’t have any to manage. The observations I share here are just educational, for those who want to follow along and get an idea of how I see things. I hope you find it helpful or at least interesting. It’s always fun when it starts new conversations.

To keep the concept of hedging short and to the point for my purpose today, I’ll just share a simple chart of the price trend of the stock index and the volatility index over the past 30 days. The stock index has declined -8.3% as the implied volatility index expanded over 95%. You can probably see the potential for a hedge. However, it isn’t so simple, because these are just indexes and we can’t buy or sell the VIX index.

vix volatility as a hedge stock market risk management

The purpose of a hedge is to shift the risk of loss from one thing to another. The surest way to reduce the possibility of loss is to simply sell to reduce exposure in the thing that is the risk. That’s what I do most of the time. For example, when I observed a potential volatility expansion, I reduced my exposure to positions that had the possibility of loss due to increased volatility. Once prices fall and volatility contracts, maybe we increase exposure again to shift back to risk-taking. If we take no risk at all, we would have no potential for a capital gain. So, tactical portfolio management is about increasing and decreasing exposure to the possibility of gain and loss. If we do it well, we create the kind of asymmetric risk/reward I aim for.

So, any hedging we may do is really just shifting from one risk to another, hoping to offset the original risk. Keep in mind, as I see it, a risk is the possibility of loss. I’ll share more on hedging soon. I have some observations about hedging and hedge systems you may find interesting.

Most stocks are participating in the downtrend. Below is an updated chart of the percent of the stocks in the S&P 500 that are above their 50-day moving average. If you want to know more about what it is, read the last observations. The simple observation here is that most stocks are declining.

stock market breadth risk indicator

Much like how we saw investor sentiment cycle and swing up and down, we also see this breadth indicator oscillate from higher risk levels to lower risk levels.

  • After most stocks are already in uptrends, I believe the risk is higher that we’ll see it reverse.
  • After most stocks have already declined into downtrends, it increases the possibility that selling pressure may be getting closer to exhaustion.

The good news is, at some point selling pressure does get exhausted as those who want to sell have sold and prices reach a low enough level to bring in new buying demand.

That’s what stock investors are waiting for now.

These are my observations. I don’t have a crystal ball, nor does anyone. I just predetermine my risk levels in advance and monitor, direct, and control risk through my exits/hedging how much I’m willing to risk, or not. We’ll just have to see how it all unfolds in the days and weeks ahead.

Only time will tell if this is the early stage of a bigger deeper downtrend or just another correction within the primary trend.

I hope you find my observations interesting and informative.

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 trends up with momentum

When the stock market indexes swing up or down 1% or more I try to share my observations of the directional trend and changes in volatility. Continuing from my observation yesterday in Observations of the stock market decline and volatility expansion when I shared:

The good news is, we’ve now experienced some volatility expansion, stocks have now pivoted down to the lower end of their cycles, so maybe volatility will contract and stock prices resume their uptrend.

We’ll see.

Well, today we saw.

The U. S. stock market gains were broad across all sectors. Communication Services, Consumer Discretionary, Healthcare, and Technology were the relative momentum leaders.

stock market trend sector ETF momentum

Continuing with the % of S&P 500 stocks above their 50 day moving average as breadth indicator was another indication of broad upward momentum. 86% more stocks are trading above their shorter-term trend, an expansion from a low level. For those of us who like to enter trends early in their stage, this is a positive sign of improvement for the stock market.

percent of stocks above below 50 day moving average trend following momentum

We observe the same in the percent of stocks trending back above their longer-term trends. There was a 16% expansion in the stocks in the S&P 500 index trending above their 200 day moving average. The longer-term trend indicators are slower to respond, but this is more evidence of positive directional movement.

stock momentum percent of stocks above 200 day moving average trend following asymmetric

This is happening at a time when many investor sentiment indicators suggest fear has been driving stocks recently. A simple example is the Fear & Greed Index, which reached “Extreme Fear” a week ago.

CNN FEAR GREED INDEX SENTIMENT

As a portfolio manager for the past two decades, I have observed investor sentiment oscillate between fear and greed, but as a contrarian pendulum. Most investors feel the wrong feeling at the wrong time.

  • After prices rise, investors get more optimistic as they extrapolate the recent gains into the future expecting the gains to continue.
  • After prices fall, investors fear losing more money as they extrapolate the recent losses into the future expecting them to get worse.

What happens, though, is market trends move in multiple time frames of cycles up and down. Prices can overreact to the upside and downside and the majority of investors seem to get it wrong.

The level and direction of implied volatility is an indication of investor sentiment. I’ve shared my observations of the volatility expansion and noted some volatility contraction yesterday. So far, the volatility expansion has reversed to contraction, so the expected volatility as implied by options prices now suggests the market expects lower volatility in the weeks ahead.

VIX VOLATILITY CONTRACTION EXPANSION ASYMMETRIC RISK HEDGE ASYMMETRY

But, just as I pointed out on September 25th in VIX level shows market’s expectation of future volatility implied volatility can get it wrong. I pointed out then the implied volatility was very low signaling to me the market may have been wrong to expect such low future volatility, so it can reverse back up again.

In summary, today was a strong upward momentum day for the stock market and most stocks participated in the uptrend. After sharp declines like we’ve seen this month, the stock market sometimes reverses up like this into an uptrend only to reverse back down to test the low. After the test, we then find out if it breaks down or breaks out.

One day doesn’t make a trend, but for those who are in risk taker mode with stocks, so far, so good.

 

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.

U. S. Sector Trends

Yesterday I shared my observations of the overall stock market in The Stock Market Trend. Here are my observations of U. S. Sector trends to see which sectors are trending, which sectors have experienced declining momentum, and where they are year-to-date. Keep in mind, I use the actual index ETFs for observations since they represent real-world price trends including expenses, none of this is advice to buy or sell any of them for anyone.

Below are the sector trends year-to-date.

SECTOR ETF TRENDS TREND FOLLOWING MOMENTUM RELATIVE STRENGTH

Ok, I know that looks like a hurricane spaghetti chart to show potential cyclone paths, so here is a table showing the year-to-date price trends using the Select Sector SPDRs. In 2018, Healthcare, Consumer Discretionary, and Technology are still the leading sectors. I’ll point out the divergence with sectors like Basic Materials and Consumer Staples lagging in relative momentum.

SECTOR ETF MOMENTUM TREND FOLLOWING

A more interesting view is a visual observation of drawdowns year to date and recently. Here, we see that Basic Materials, Communication Services, Financials, and Consumer Staples are down over -10% from their highs.

dradown stock market year to date

For a stock market decline to stop and reverse, it has to reach a low enough point to attract enough buying demand to support higher prices.

The good news is the stock indexes, and many of these sectors are testing their longer-term trend lines. At the same time, they are reaching a point we could see at least a short-term reversal up from here.

Only time will tell if the recent price declines are just a correction in an ongoing uptrend in the U. S. stock market or the beginning of a more significant downtrend.

As a portfolio manager, I am a risk manager and risk taker.

The only way to create gains is to take some risk. The way to manage risk is to predefine how much I’m willing to lose in advance. My focus is on asymmetric risk/return. So, my objective is to take a risk when it is more likely to result in positive asymmetry.

The essential parts necessary to create asymmetric risk/return are:

Risk manager: decide in advance at what price to exit as a declining trend to manage the size of the loss. Determine how much of our portfolio we are willing to lose to see if price trends will become profitable.

Risk taker: decide when to enter a position to take that predefined risk to see if the potentially profitable trend unfolds in our favor to become a profit.

You can probably see how these market cycles and trends create both the potential for risks and rewards and we can decide how to tactically operate with them.

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 Trend

The stock market declined with heavy selling pressure on a major stock market anniversary that I haven’t heard anyone mention.

October 10, 2018, is the 10-year anniversary of the waterfall decline of 2008.

Below is the S&P 500 stock index from October 9, 2007 to October 10, 2008. I remember it very well. It was the first part of the waterfall decline up to this day 10 years ago.

stock market decline 2008

But, as a reminder, while this bear market is often called the “2008 Financial Crisis” and misquoted as being only about the year 2008, it actually continued through March 9, 2009.

average length of bear market crash 2008.jpg

With stock indexes only about -5% or so off their all-time highs, we are far from that today.  But, the stock market decline today was impressive in magnitude and broad across all sectors.

stock market sector ETF October 10 2018

The breadth of the decline was unmistakable by the 50% decline in the % of stocks in the S&P 500 trading above their 50 day moving average. The percentage of stocks trading above the moving average is a breadth indicator that measures internal strength or weakness in the stocks in the index and the index itself. We say that breadth is strong when the majority of stocks in an index are trading above their moving average. Since the 50-day moving average is used to measure the short-medium term trend, it reveals that only 24% of the 500 stocks in the S&P 500 index are above their short-term trend.

percent of stocks above 50 day moving average SPX SPY.jpg

I colored the top red and the bottom green because the extreme highs and extreme lows can signal overbought and oversold levels.

The indicator is an oscillator that cycles between 0% and 100%.

After most stocks have trended up, we say an uptrend has broad participation, which is positive. However, markets cycle and oscillate up and down, so once most stocks have already been in uptrends at some point they reverse back down.

After most stocks have trended down, we say a downtrend becomes washed out. As selling eventually gets exhausted because those who want to sell have already sold.

Next, we observe the % of stocks in the S&P 500 index that are trending above their 200 day, which a longer term trend signal. 19% of the stocks declined below their 200 day moving average today leaving about half of the stocks still in a longer-term uptrend.

SPX BREADTH PERCENT OF STOCKS ABOVE 200 DAY MOVING AVERAGE

Since we are talking about moving averages and the S&P 500, below is the index itself with the 50 and 200 day moving average. Notice the 50 day moving average has been too tight to contain the uptrend. In other words, entering and exiting it would lead to many buys and sells and whipsaws like in June. The 200 day has better contained the trend since April, but notice if it were used as an exit it would have resulted in selling at the low. This observation is just using these moving averages as a very simple way to define uptrend vs. downtrend, it is not a complete trading system. Such measures are never perfect, and they don’t have to be.

stock market SPX 200 day moving average trend following

Today’s decline was impressive because the stock indexes declined over -3% in a single day. One day doesn’t make a trend, but it was enough to erase most of the year to date gains for the stock index.

stock market year to date 2018 trend following momentum

 

The Dow Jones Industrial Average of 30 of America’s largest companies declined even more than the S&P 500. There was even more weakness in small companies, momentum stocks, and an ETF tracking the top-ranked growth and momentum stocks by Investor’s Business Daily declined nearly -6%. As a proxy for leading growth and momentum stocks, this is an indication the leaders declined the most today.

stock market momentum ETF trend following asymmetric

You can probably see why I believe it’s essential to actively manage risk by knowing in advance when to exit a loser to cut losses short as well as understanding the market risk level. For those of us who weren’t fully exposed to the decline who have the capital to eventually buy at lower prices, we get to take advantage of a falling trend.

Over the past week, I shared observations of volatility expansion as the implied volatility index has been trending up. Below is its year to date trend.

VIX VOLATILITY EXPANSION

Here it is over the past week since I mentioned it. I included the S&P 500 stock index to illustrate as the stock market declined about -5% the past week, implied volatility expanded 98%.

SPY SPX VIX ASYMMETRIC RISK REWARD

We’ll see in the days and weeks ahead if this is the beginning of a more significant downtrend that becomes a waterfall decline or if it was enough to exhaust the selling pressure of those who wanted to sell.

 

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.

 

Earnings season is tricky for momentum growth stocks

Momentum stocks are stocks that show high upside momentum in their price trend. Momentum stocks are trending not only regarding their absolute price gains but also relative strength vs. other stocks or the stock market index.

Momentum stocks are usually high growth stocks. Since momentum stocks are the strongest trending stocks, their trends are often driven by growth in sales and earnings. Growth stocks are companies that are growing earnings at a rate significantly above average. Growth stocks have high increases in earnings per share quarter over quarter, year over year, and may not pay dividends since these companies usually reinvest their strong earnings to accelerate growth.

Now that we have defined what I mean by “momentum stocks,” we can take a look at some examples of momentum stocks and their characteristics like how their prices trend.

Grubhub Inc. ($GRUB) is an online and mobile food-ordering company that connects diners with local restaurants. GrubHub is a great example today of a high momentum growth stock.  GrubHub stock has gained 24% today after smashing Wall Street’s expectations. Earnings grew 92% to 50 cents a share, marking the fifth quarter in a row of accelerating EPS growth. Revenue soared 51% to $239.7 million, a quarterly best.

Grubhub $GRUB GRUB

Before today, GrubHub stock was in a positive trend that developed a flat base since April (highlighted on the chart). GRUB had already gained 60% year to date, but after such as explosive uptrend in momentum, it trended sideways for a while.

It is earnings season, which can be tricky for the highest momentum stocks. Once a stock has already made a big move, it could already have a lot of good news expectations priced in. That concerns some momentum stock traders. In fact, I know some momentum stock traders who exit their stocks before their quarterly earnings announcements. If they had exited GrubHub, they would have missed today’s continuation of its momentum. However, they would avoid the downside of those that trend in the other direction.

I’ve been trading momentum stocks for over two decades. Over the years I’ve observed different regimes of how they act regarding trend strength and volatility. There are periods of volatility expansion and contraction and other periods when momentum is much stronger.

Volatility is how quickly and how far the price spreads out. When price trends are volatile, it’s harder to stick with them because they can move against us. We like upside volatility, but smart investors are loss averse enough to dislike downside volatility that leads to drawdowns. To understand why the smart money is loss averse, read: “Asymmetry of Loss: Why Manage Risk?“.

Strong upward trending stocks are sometimes accompanied by volatility. That’s to be expected because momentum is a kind of volatility expansion. Upward momentum, the kind we like, is an upward expansion in the range of the price – volatility.

That’s good vol.

But, strong trending momentum stocks necessarily may include some bad volatility, too. Bad volatility is the kind investors don’t like – it’s when the price drops, especially if it’s a sharp decline.

I mentioned GrubHub had gained 60% YTD. I like to point out, observe, and understand asymmetries. The asymmetry is the good and the bad, the positive and the negative, I prefer to skew them positively. What I call the Asymmetry® Ratio is a chart of the upside total return vs. the chart of the downside % off high. To achieve the gain for GrubHub, investors would have had to endure its price declines to get it. For GrubHub, the stock has declined -10% to -15% many times over the past year. It has spent much of the time off its high. To have realized all of the gains, investors had to be willing to experience the drawdowns.

grubhub stock GRUB

I point this out because yesterday I wrote “Asymmetry of Loss: Why Manage Risk?” where I discussed the mathematical basis behind the need for me to actively manage the downside risk. To achieve the significant gain, we often have to endure at least some of the drawdowns along the way. The trick is how much, and for me, that depends on many system factors.

Earnings season, when companies are reporting their quarterly earnings, is especially tricky for high momentum stocks because stocks that may be “priced for perfection” may be even more volatile than normal. Accelerating profit growth is attractive to investment managers and institutional investors because increasing profit growth means a company is doing something right and delivering exceptional value to customers. I’m more focused on the direction of the price trend – I like positive momentum. But, earnings are a driver of the price trend for stocks.

Earnings can trend in the other direction, too, or things can happen to cause concern. This information is released in quarterly reports.

Another example of a momentum stock is NetFlix. By my measures, GrubHub is a leading stock in its sector and NetFlix (NFLX) is the leader in its industry group, too, based on its positive momentum and earnings growth. As we see in the chart below, NFLX has gained 88% year to date. That’s astonishing momentum considering the broad stock market measured by the S&P 500 has gained around 5%, and its Consumer Services Sector ETF has gained 11%.

NetFlix NFLX $NFLX

However, NetFlix stock regularly declines as much as -15% as a regular part of its trend. It has fallen over -10% five times in the past year on its way to making huge gains. The latest reason for the decline was information that was released during its quarterly earnings announcement. The stock dropped sharply afterward.

netflix stock risk downside loss

But, as we see in the chart, it’s still within its normal decline that has happened five times the past year.

While some of my other momentum stock trader friends may exit their stocks during the earnings season, I instead focus more on the price trend itself. I predefine my risk in every position, so I determine how much I’ll allow a stock to trend to the downside before I exit. When a stock trends down too far, it’s no longer in a positive trend with the side of momentum we want. To cut losses short, I exit before the damage gets too large.

How much is too much? 

A hint is in the above charts.

If we want to experience a positive trend of a momentum stock, we necessarily have to give it enough room to let it do what it does. When it trends beyond that, it’s time to exit and move on. We can always re-enter it again it if trends back to the right side.

Sure, earnings season can be tricky, but for me, it’s designed into my system. I’m looking for positive Asymmetry® – an asymmetric risk/reward. What we’ve seen above are stocks that may decline as much as -15% as a normal part of their trend when they fall, but have gained over 50% over the same period.

You can probably see how I may be able to create a potentially positive asymmetric risk/reward payoff from such a trend.

 

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

 

 

 

 

 

Sector Trends are Driving Equity Returns

Sector Trends are Driving Equity Returns

In Growth Stocks have Stronger Momentum than Value in 2018 I explained the divergence between the return of the two styles of Growth and Value. I suggest the real return driver between size and style is primarily the index or ETF sector exposure. To be sure, we’ll take a look inside.

As I said before, the reason I care about such divergence is when return streams spread out and become distinctive, we have more opportunity to carve out the parts we want from the piece I don’t. When a difference between price trends is present, it provides more opportunity to capture the positive trend and avoid the negative trend if it continues.

Continuing with the prior observation, I am going to use the same Morningstar size and style ETFs.

Recall the year-to-date price trends are distinctive. Large, mid, and small growth is notably exhibiting positive momentum over large, mid, and small value.

growth stock momentum over value morningtar small mid large cap

To understand how these factors interact, let’s look at their sector exposure. But first, let’s determine the sector relative momentum leaders and laggards for 2018.

The leaders are Consumer Discretionary (stocks like Netflix $NFLX and Amazon $AMZN), Information Technology (Nvidia $NVDA and Google $GOOG). In third place is Energy and then Healthcare. The laggards are Consumer Staples, Industrials, Materials, and Utilities, which are actually down for the year. Clearly, exposure to Consumer Discretionary and Information Technolgy and avoiding most of the rest would lead to more positive asymmetry.

sector trend returns 2018

Below we see strongest momentum Large Growth is heavily weighted (41%) in Technology. The second highest sector weight is Consumer Discretionary, and then Healthcare is third. Large-Cap Growth is the leader just because it has the most exposure in the top sectors.

iShares Morningstar Large-Cap Growth ETF

On the other hand, Large Value, which is down -3% YTD, has its main exposure in the lagging Financial and Consumer Staples sectors.

iShares Morningstar Large-Cap Value ETF

Dropping down to the Mid-Cap Growth style and size, similar to Large-Cap Growth, we see Information Technology and Healthcare are half of the ETFs exposure.

iShares Morningstar Mid-Cap Growth ETF

We are starting to see a trend here. Much like Large-Cap Value, the Mid-Cap Value has top holdings in Financials, Consumer Discretionary, and Utilities sectors.

 

iShares Morningstar Mid-Cap Value ETF

Can you guess the top sectors of Small-Cap Growth? Like both Large and Mid Growth, Small-Cap Growth top sector exposures are Information Technology, Healthcare, and Consumer Discretionary.

iShares Morningstar Small-Cap Growth ETF

And to no surprise, the Financial sector 26% of Small-Cap Value.

iShares Morningstar Small-Cap Value ETF

So, Information Technology, Healthcare, and most Consumer Discretionary tend to be more growth-oriented sectors. Financials, Consumer Staples, Utilities, Real Estate, that is, the higher yielding dividend paying types, tend to be classified as Value. Each sector has both Growth and Value stocks within them, but on average, some sectors tend to include more Growth stocks or more Value stocks.

Value stocks are generally defined as shares of undervalued companies with lower prospects for growth.

A growth stock has higher earnings per share and often trade at a higher multiple since the expectation of future earnings is high. Growth stocks usually don’t pay a dividend, as the company would prefer to reinvest retained earnings back into the company to grow.

The Information Technology sector includes companies that are engaged in the creation, storage, and exchange of digital information. The Information Technology sector offers potential exposure to growth with the emergence of cloud computing, mobile computing, and big data.

Another Growth sector is Consumer Discretionary sector manufactures things or provides services that people want but don’t necessarily need, such as high-definition televisions, new cars, and family vacations. Consumer Discretionary sector performance is closely tied to the strength of the overall economy. Consumer Discretionary tends to perform well at the beginning of a recovery when interest rates are low but can lag during economic slowdowns

The Health Care sector is a Growth sector involved in the production and delivery of medicine and health care-related goods and services. Healthcare companies typically have more stable demand, so they are less sensitive to the economic cycle, though it tends to perform best in the later stages of the economic cycle.

It turns out, the three primary Growth sectors that tend to best strongest at the late stage of an economic cycle have been the recent leaders.

Consumer Staples sector consists of companies that provide goods and services that people use on a daily basis, like food, clothing, or other personal products.

The Financial sector is businesses such as banking and brokerage, mortgage finance, and insurance which are sensitive to changes in the economy and interest rates. They tent to perform best at the beginning of a business cycle.

This is why I prefer to focus my U. S. equity exposure on sectors and maybe the strongest momentum stocks within those sectors. Many traditional asset allocations use style and size to get their exposure to the stock market, but as a tactical portfolio manager, I prefer to get more specific into the trending sectors and their individual stocks.

 

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.

 

 

 

 

 

Growth Stocks have Stronger Momentum than Value in 2018

Growth Stocks have Stronger Momentum than Value in 2018

After a sharp decline in stock prices in February that seemed to shock many investors who had become complacent, the stock market indexes have been trying to recover.

At this point, the popular S&P 500 has gained 1.75% year-to-date and the Dow Jones Industrial Average is down -2.56%. I also included the Total Stock Market ETF, which tracks an index that represents approximately 98% of the investable US equity market. Though it holds over five times more stocks than the 500 in the S&P 500 SPY, it is tracking it closely.

stock market index returns 2018 SPY DIA

The Dow Jones Industrial Average was the momentum leader last year, but the recent price action has driven it to converge with the other stock indexes. Past performance doesn’t always persist into the future.

Dow was momentum leader

What is more interesting, however, is the divergence at the size, style, and sector level.

The research firm Morningstar created the equity “Style Box.” The Morningstar Style Box is a nine-square grid that provides a graphical representation of the “investment style” of stocks and mutual funds. For stocks and stock funds, it classifies securities according to market capitalization (the vertical axis) and growth and value factors (the horizontal axis).

equity style box

  • The vertical axis of the style box graphs market capitalization and is divided into three company-size indicators: large, medium and small.
  • The horizontal axis seeks to represent stock funds/indexes by value, growth, and blend which represents a combination of both value and growth.

Looking at their distinct trends, we observe a material divergence this year. As we see below, the S&P 500 Growth Index ETF has gained 16.45% % over the past 12 months, which is triple the S&P 500 Value ETF. So, Growth is clearly exhibiting stronger momentum than value over the past year. But, notice that wasn’t the case before the February decline when Growth, Value, and Blend were all tracking close to each other.

 

Equity Style and Size Past 12 Months

Year to date, the divergence is more clear. Growth is positive, the blended S&P 500 stock index is flat, and Value is negative.

momentum growth stocks 2018

Showing only the price trend change over the period isn’t complete without observing the path it took to get there, so I’ve included the drawdown chart below. Here, we see these indexes declined about -10% to as much as -12% for the Value index.

The Value index declined the most, which requires more of a gain to make up for the decline. The Value ETF hasn’t recovered as well as the others.

To look even closer, we can get more specific into the style and size categories. Below we show the individual Morningstar ETFs that separate the stock market into the Large, Mid, and Small size stocks and then into Growth vs. Value.

All three at the top are Growth. The three at the bottom are Value. So, the divergence this year isn’t so much Large vs. Small cap, it’s Growth vs. Value.

Clearly, Growth stocks are leading the stock market so far in 2018.

Why do we care about such divergence?

When there exists more difference between price trends, it provides more opportunity to capture the positive direction and avoid the negative trend if it continues.

In part 2, we’ll discuss how sector exposure is the primary driver of style/size returns.

 

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.

The enthusiasm to sell overwhelmed the desire to buy March 19, 2018

The enthusiasm to sell overwhelmed the desire to buy. The S&P 500 stock index closed down -1.42% today. Stocks trended down most of the day and at 2:35pm it was down -2%. As you can see on the chart, it reversed up in the last 90 minutes and closed with positive directional movement. It almost closed above its Volume Weighted Average Price (VWAP).

There are many notable economic reports out this week, so maybe investors are concerned about to the jobs report and the Fed FOMC Meeting. The options market has priced in a 94% chance of a rate hike, so it shouldn’t be a surprise. But, this week is the first FOMC meeting for the new Chairman Powell.

Implied volatility in recent weeks is one of many signals that suggest a volatility regime change. The CBOE Volatility Index® (VIX® Index®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The VIX® doesn’t seem to want to go back to those prior low levels, so the expectation is higher volatlity.

At this point, the decline today was nothing too abnormal. The stock index is -3.% off it’s high a few weeks ago and -5.4% off its all-time high. However, as you can see below it is within a normal trading range. Speaking of trading range, notice the bands of realized volatility I added to the chart are drifting sideways rather than trending up or down. I see higher lows, but equal highs in the most recent trend and lower highs looking back to January. The VIX is expected volatility, the blue bands are realized volatility.

My systems define this as a non-trending market. When I factor in how the range of price movement has spread out more than double what it was, I call it a non-trending volatile condition. It is useful for me to identify the market regime because different trend systems have different results based on the situation. For example, non-trending volatile market conditions can be hostile situations for both passive and trend following strategies. However, countertrend systems like the swings of a non-trending volatile market.

Trend following systems thrive in markets that are trending and smooth. When a market is trending and smooth, the trend following system can earn gains without having to deal with significant adverse price action. When a market trend shifts to non-trending and volatile, the trend following signals can result in whipsaws. A whipsaw is when the price was moving in one direction (and the trend follower buys) but then quickly reverses in the opposite direction (and maybe the trend follower exits with a loss). Even if the trend following system doesn’t enter and exit with a loss, in a non-trending volatile market the trend follower has to deal with the same hostile conditions as a passive investor as the market swings up and down.

My U. S. equity exposure since early February has come from my shorter term countertrend systems. My focus and the focus of my systems isn’t to predict the direction of markets but instead to identify when a market is undergoing a regime change or shifts to a distinct environment. I don’t analyze the markets to try to predict what it will do next. I look at what the market is actually doing and react to it.

 

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 @MikeWShell

The is no guarantee that any strategy will meet its objective.  Past performance is no guarantee of future results.

 

When I apply different trend systems to ETFs

In my portfolio management, I primarily want to identify trends and get positioned with that trend. As long as there is uncertainty, we’ll see trends. Investor sentiment and expectations underreact to information causing the price to adjust gradually and that’s what produces a trend. The trend following systems I wrote about in My Introduction to Trend Following are designed to buy an asset when its price trend goes up, and sell when its trend goes down, expecting price movements to continue.

We also see the overreaction of investor sentiment and their expectations. After price keeps rising, investors may become overly enthusiastic, which causes prices to overreact and move up to an extreme that matches their sentiment. We saw that the last part of 2017 and it continued in January. We say these markets have become “overbought” and mathematical indicators can signal a countertrend.

We also sometimes see investor sentiment and their expectations plunge as they panic when prices are falling. We say these markets have become “oversold” and mathematical indicators can signal a countertrend. Looking back over the past two months, we may have seen an overreaction on the upside, then an overreaction on the downside. I say that because the stock market very quickly dropped -10%, then recovered most of it a few weeks later.

Someone asked recently “Do you invest and trade in all ETFs and stocks using the same trend system?” The answer is “not necessarily.” As I described above, trend following and countertrend systems are very different. Trend following systems can be multiple time frames, but usually longer trends of at least several months to years. Countertrend moves are normally shorter term as a market may get overbought or oversold, but it doesn’t usually stay that way a long time. For example, the S&P 500 was overbought the last few months of 2017 and that was an anomaly. It was one of the most overbought periods we’ve seen in the stock indexes. So, it was no surprise to see a fast -10% decline.

My point is, different trend systems can be applied to markets. Both trend following and countertrend are trend systems, they just intend to capitalize on a different trend in behavior – overreaction or underreaction.

When I apply my countertrend systems to markets, a great illustration is the high dividend yield market. A great example is the Global X SuperDividend® ETF $SDIV which invests in 100 of the highest dividend yielding equity securities in the world.

Below is a price chart in blue and it’s dividend yield in orange over the past five years. As you can see, the price trend and dividend yield have an inverse correlation. As the price goes up, the dividend yield from that starting point goes down. That is, if we invest in it at higher prices, the dividend yield would have been lower. But, as the price goes down, the dividend yield from that starting point goes up. If we invest in it at lower prices, our future income from dividend yield is higher.

 

For example, I highlighted in green the price was at its low when the yield was also at its highest at 8%. Investors who bought at the lower price earn the higher yield going forward (assuming the stocks in the index continue paying their dividend yields). If we invested in it in 2014 the yield was 6%. High yielding stocks are not without risks. 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 ETFs performance. You can probably see how an ETF that includes 100 of these stocks may be more attractive to gain exposure rather than risking a few individually.

This is an example of when we may use a countertrend system. As I am more inclined to invest in positive trends, this is an example of a situation I may be more willing to buy low. But, I always focus on Total Return. All of my systems include Total Return data that includes the dividend yield, not just the price trend. So as I explain this, keep in mind we still apply my risk management and trend systems but we consider and account for the high yield that makes up its total return.

Below is a chart of the Global X SuperDividend® ETF $SDIV from the low point in 2016 (I highlighted in green above). I charted both the price trend by itself as well as the Total Return which includes dividends. Had someone invested in it at the low, we saw above their yield would be 8% and the impact is evident in the difference. With the dividend yield included, the return was 36% and 18% without it. In other words, the dividend was half the return over this period. The higher the dividend yield at the point of entry, the more it can have an impact on Total Return.

As a special note for our investment management clients who are invested in ASYMMETRY® Global Tactical. We do not reinvest dividends. Instead, we want the cash dividends to go into the cash portion of our portfolio. Since we usually have some positions that generate a monthly yield, it provides the cash balance we need to cover any slippage between trades, investment management costs, as well as provide cash for other investments. I mention this, because any position we hold like this with a high yield may not appear to have as large of a percentage gain since it only represents the price return, not the total return. That is simply because we are using the cash instead of reinvesting the dividends.

 

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.

 

 

Asymmetric force was with the buyers

In Asymmetric force direction and size determines a trend, I explained how the net force of all the forces acting on a trend is the force that determines the direction. The force must be asymmetric as to direction and size to change the price and drive a directional trend.

The asymmetric force was with buyers as they dominated the directional trend on Friday.

Friday’s gain helped to push the stock market to a strong week and every sector gained.

The S&P 500 stock index is about -3% from it’s January high and closed slightly above the prior high last week. I consider this a short-term uptrend that will resume it’s longer-term uptrend if it can break into a new high above the January peak.

After declining sharply -10% to -12%, global equity markets are recovering. The good news for U.S. stocks is the Russell 2000 small company index is closest to its prior high. Small company leadership is considered bullish because it suggests equity investors are taking a risk on the smaller more nimble stocks.

As you can see in the chart, the Dow Jones Industrial Average and International Developed Countries (MSCI EAFE Europe, Australasia and Far East) are lagging so far off their lows but still recovering.

So far, so good, but only time will tell if these markets can exceed their old highs and breakout into new highs, or if they discover some resistance force at those levels and reverse back down. As we discussed in Asymmetric force direction and size determines a trend it’s going to depend on the direction and size of the buyers vs. sellers.

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.

Buying demand dominated selling pressure in the stock market

Past performance is no guarantee of future results and that was the case today. After last weeks Selling pressure overwhelms buying demand for stocks for the third day in a row the enthusiasm to buy overwhelmed the desire to sell. Market prices are driven by simple Economics 101: when buying enthusiasm overwhelms sellers, prices rise. The S&P 500 gained 1.16% today and seems to have found some buying interest at the prior range I highlighted in green.

stock market florida investment advisor

Sector breadth was strong with Utilities, Real Estate, and Financials leading the way.

Sector rotation trend following

We don’t just invest and trade in U.S. stocks and sectors, I look for trends globally across the world. Though the Global ETF Trends monitor below shows many international countries were in the green, the good ole USA was one of the biggest gainers today.

global tactical asset allocation trend following global tactical rotation

Back to the U.S. stock market, in the chart below, I added Kelner Channels to illustrate a few things.

Keltner Channels are volatility-based envelopes set above and below an exponential moving average. This indicator is similar to Bollinger Bands, which use the standard deviation to set the bands. Instead of using the standard deviation, Keltner Channels use the Average True Range (ATR) to set channel distance.

Kelner Channels show the range of volatility has spread out and got wider since the stock market price trend trended above the upper channel in January, suggesting its uptrend was abnormal.  Since then, the trend reversed down and again traded outside the range of the Kelner Channel on the downside. It’s a good example of how the market can overreact on both the upside and downside.

stock market trading range ATR

In the chart above, I also include the Relative Strength Index, which is on its 50-yard line. You can see how it was reading “overbought” in January (and had been for months), then after that extreme it became oversold. This kind of price action presented us with an opportunity to turn on the swing trading systems. My countertrend systems signaled short-term entries in several stocks and ETFs very near the low prices.

I pointed out in Stock Market Analysis of the S&P 500 on February 9th near the lows the breadth of the stock market was oversold at a lower risk. Market analysis is best used as a weight of the evidence. You can probably see how these different indicators signaled a countertrend move was possible and this time that has happened so far. I say this time because it’s always probabilistic, never a sure thing. If the stock market were going to trend down -50% over a two year period it would start off this way being “oversold” and look “washed out”, only to get worse as it swings up and down on it’s way to a lower low. During times like this, a skilled swing trader or countertrend systems can help to generate profits as price trends swing up and down.

Below is an updated chart of the percent of stocks in the S&P 500 that are trading above their 50-day moving average. 12% more stocks are trading above their 50-day moving average after today, bringing it to 32%. I point this out because it gives us an idea of how many stocks are still left to trend back up. That is, based on this breadth indicator, there is room for stocks to keep trending up if buyers continue their enthusiasm. This is the opposite of the condition in the last months of 2017 and January when 80% or more stocks were already in positive trends. To revisit this concept I encourage you to read Stock Market Analysis of the S&P 500. 

SPX S&P 500 stocks above the 50 day moving average SPY

The bottom line is, the supply and demand for the stock market seems to be shifting back in control of buyers for now. Only time will tell if it continues in the days and weeks ahead. This is just a quick market analysis to look at what is going on, not investment advice. Our investment management and advice are only offered through an investment management agreement. If you want investment management or advice, contact us.

 

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.

Investment results are probabilistic, never a sure thing. Past performance is no guarantee of future results.

Fear and Greed is Shifting and Models Don’t Avoid the Feelings

Investors are driven by fear and greed. That same fear and greed drives market prices. It’s Economics 101 “Supply and Demand”. Greed drives demand, fear drives selling pressure. In fact, investors are driven by the fear of losing more money when their account is falling and fear missing out if they have cash when markets go up. Most investors tend to experience a stronger feeling from losing money than they do missing out. Some of the most emotional investors oscillate between the fear of missing out and the fear of losing money. These investors have to modify their behavior to avoid making mistakes. Quantitive rules-based systematic models don’t remove the emotion.

Amateur portfolio managers who lack experience sometimes claim things like: “our quantitive rules-based systematic models removes the emotion”. That couldn’t be further from the truth. Those who believe that will eventually find themselves experiencing feelings from their signals they’ve never felt before. I believe it’s a sign of high expectations and those expectations often lead to even stronger reactions. It seems it’s the portfolio managers with very little actual performance beyond a backtest that make these statements. They must believe a backtested model will act to medicate their feelings, but it doesn’t actually work that way. I believe these are the very people who over optimize a backtest to make it perfectly fit historical data. We call it “curve-fitting” or “over-fitting”, but it’s always “data mining”. When we backtest systems to see how they would have acted in the past, it’s always mining the data retroactively with perfect hindsight. I’ve never had anyone show me a bad backtest. If someone backtests entry and exit signals intended to be sold as a managed portfolio you can probably see how they may be motivated to show the one that is most optimized to past data. But, what if the future is very different? When it doesn’t work out so perfectly, I think they’ll experience the very feelings they wish to avoid. I thought I would point this out, since many global markets have been swinging up and down. I’m guessing some may be feeling their feelings.

The CNN Fear & Greed Index shows investor fear and greed shifted to Extreme Fear a month ago as the popular U.S. stock indexes dropped about -12% or more. Many sectors and other markets were worse. Since then, as prices have been trending back up, Greed is now the driver again. I believe fear and greed both drives market prices but also follows price trends. As prices move lower and lower, investors who are losing money get more and more afraid of losing more. As prices move higher and higher, investors get more and more greedy. If they have reduced exposure to avoid loss, they may fear missing out.

CNN Fear and Greed IndexSource: http://money.cnn.com/data/fear-and-greed/

This is the challenge in bear markets. In a bear market, market prices swing up and down along the way. It’s these swings that lead to mistakes. Below is a chart of how the Fear and Greed Index oscillates to high and low points over time. Investors who experience these extremes in emotion have the most trouble and need to modify their behavior so they feel the right feeling at the right time. Or, hire a manager with a real track record who can do it for them and go do something more enjoyable.

Fear and Greed Over time investor sentiment

Source: http://money.cnn.com/data/fear-and-greed/

The Trend of the U.S. Stock Market

When I say “The Trend” that could mean an infinite number of “trends“. The general definition of “trend” is a general tendency or course of events.

But when I speak of “The Trend” I mean a direction that something is moving, developing, evolving, or changing. A trend, to me, is a directional drift, one way or another. When I speak of price trends, I mean the directional drift of a price trend that can be up, down, or sideways.

Many investors are probably wondering about the current trend of the U.S. stock market. So, I will share a quick observation since one of the most popular U.S. stock indexes seems to be right at a potential turning point.

Below is a 6 month price chart of the S&P 500 stock index. The S&P 500® is widely regarded as a gauge of large-cap U.S. equities. Clearly, prior to late August the stock index was drifting sideways. It was oscillating up and down in a range of 3% to 4% swings, but overall it wasn’t making material higher highs or lower lows. That is, until late August when it dropped about -12% below its prior high. Now, we see with today’s action the stock index is attempting reach or breach it’s very recent peak reached on August 27th. If the index moves above this level, we may consider it a short-term uptrend. We can already observe the index has made a higher low.

S&P 500 stock trend

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

You can probably see how the next swing will determine the direction of the trend. If it breaks to the upside, it will be an uptrend as defined by “higher highs and higher lows”. Although, that is a very short-term trend, since it will happen within a more intermediate downtrend.

My point is to observe how trends drift and unfold over time, not to predict which way they will go, but instead to understand and define the direction of “the trend”. And, there are many different time frames we can consider.

If this trend keeps going up, supply and demand will determine for how long and how far. If it keeps drifting up, I would expect it may keep going up until some inertia changes it. Inertia is the resistance to change, including a resistance to change in direction.

But if it instead goes back down to a new low, I bet we’ll see some panic selling driving it even lower.

The real challenge of directional price trends is if this is the early stage of a larger downward trend (like a bear market), there will be many swings along the way. In the last bear market, there were 13 swings that ranged from 10% to 27% as this stock index took about 18 months to decline -56%.

Below is the same stock index charted with a percentage chart to better show the percent changes over the past 6 months. You can probably see how it gives a little different perspective.

S&P 500 stock index percent chart average length of bear markets

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

I don’t necessarily make my tactical decisions based on any of this. I enjoy watching it all unfold and I necessarily need to define the trend and understand it as it all plays out. I want to know what the direction of the trend is based on my time frame, and know when that changes.

I believe world markets require active risk management and defining directional trends. For me, that means predefining my risk in advance in each position and across the portfolio.

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For informational and educational purposes only, not a recommendation to buy or sell and security, fund, or strategy. Past performance and does not guarantee future results. The S&P 500 index is an unmanaged index and cannot be invested into directly. Please visit this link for important disclosures, terms, and conditions.

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