News networks need ratings. They achieve those ratings by getting you to watch TV. They get you to watch TV by finding your hot buttons and playing on those nerves. News networks implement extensive psychological and demographic marketing research to determine what generates fear or excitement – and then they put it on blast for as long as they can until they see trends of weakening interest in viewership… and they go find more new stuff to strike more nerves. But that’s how they make their money…viewer ratings.
We get paid differently. We don’t latch onto a theme in the market like CNBC or Bloomberg Television does. We’re “agnostic,” if you will. The only way we can keep you reading, keep our business growing, and keep clients from leaving us, is to remain absolutely unbiased to the markets. This means that we should not play on the fears of investors as the market starts to decline in hope that they’ll give us their money – even if we don’t honestly believe the market is crashing.
Furthermore, it also means that we cannot perpetually spew the same optimistic garbage peddled by mutual fund companies that only get paid if investors leave their money in the market – with their mutual funds. As the late Yogi Berra once said, “You can observe a lot just by watching.” And that’s what we do. We watch, we react, and we adapt to changes in the market landscape as the landscape changes. No one can predict what the market is going to do in a month and anyone who tells you they can is lying to you. However, the market gives us signs all the time. We just have to pay attention.
So today I wanted to show our readers six charts that we can “observe” (as Yogi said) that tell us a lot about what the stock market is doing today and where it might be headed. This isn’t a prediction, but a simple observation of a six different charts, using historical statistics, probabilities, and technical analysis, all of which, combined, have proven to act as significant “flags,” both to optimism and danger lurking ahead.
The first chart I’ll share with you is one I’ve mentioned a couple times this summer. Below you can see the average U.S. stock market in a pre-election year, followed by the average return of the same index during a pre-election year within the 7th year of a two-term election cycle. Lastly, you can see the market thus far in 2015. On average, whenever there is a president in office for two terms, we see a significant decline from September to mid-October during a pre-election year in that 7th year. However, this year, we may have seen that correction roughly 45 days early. Needless to say, the 4th quarter is typically a good time for the market in general – but the last two months of the year have statistically been great months for the market.
The chart below is a Point & Figure (PnF) chart that shows us the trend in the percentage of stocks on a “buy signal. Said another way, this chart represents the percentage of stocks on a “higher high,” or put as simply as possible… showing trends that are higher now than before. When a PnF chart is in a column of O’s, it is declining in value. When it is in a column of X’s, it’s increasing in value. D
You can see that since 2013, we have seen lower lows and lower highs in this chart, indicating that the percentage of stocks on “higher highs” have been decreasing steadily. Even so, the market in 2013 and 2014 did fairly well. It wasn’t until June of 2015 that we started to see a decline, which also happened to occur at the beginning of the “seasonally weak months of the year” for the market (starts with May). As a result, we started playing defense, generally avoiding new purchases, and selling investments as they broke down. With some exceptions, if an investment we owned fell more than -10% from its most recent high, I sold it.
While this market indicator has reversed back down as of late, it would not surprise me if it turned around again to the north side sometime in the next few weeks. Such an upward reversal would tell us that it’s time to take a more offensive approach to our portfolios. It is also worth mentioning that this indicator reversed up at extremely low levels. Levels we haven’t seen this since the U.S. Treasury downgrade in 2011, which also happens to be the last time we experienced an official -10% “correction” in the U.S. stock market. Reversing up at such extreme lows indicates a “low risk investment time frame” because the likelihood of things getting much lower from here is relatively small.
It’s not advisable to start aggressively selling everything you have in your portfolio just because one indicator (such as the percentage of stocks on a buy signal chart, above) displays a defensive posture. I like to use multiple short-term indicators, compare them to each other, and allow each chart to “confirm” the other. This helps us avoid “head-fakes” or “whipsaws,” where the market fakes us out, making us think that it’s headed downward when it’s just taking a mild breather.
Below is a PnF chart that shows us the percentage of stocks trading above their 10-week trend. This is a shorter-term indicator that we use for short-term decision making. This chart bottomed out at only 8% just a few weeks ago, which means that 92% of stocks on the NYSE were trading below their 10-week moving average (trend)! As mentioned above, when charts like these hit such extreme levels, it’s almost like a “gift.” We don’t often get opportunities to buy into a market that is so oversold on a short-term basis and there’s not a lot of room for this thing to go down from here. Where you should worry is when it’s at a high water mark, indicating that probabilities are higher for a downturn than an upswing.
We’ve already taken a look at three different charts – one a representation of statistical and historical probabilities and two technical charts. When deciding when to “push chips back onto the table” and buy back into the market again (which I began doing two weeks ago), I like to use the chart below as one of my other few, short-term indicators.
This is what’s called a Hi/Lo chart, which is a little more confusing than the others. In short, we take the total number of stocks on the NYSE hitting their 52-week high and divide that number by the total of both A) the number of stocks hitting 52-weeks highs and B) the number of stocks hitting 52-week lows. That equation gives us a number that can then be plotted on a chart, giving us a good idea of the relationship between stocks reaching new highs and those hitting new lows.
What you might find interesting is how similar this chart looks to the previous. It also reversed up in the same week the other chart did, effectively “confirming” the upward momentum I’ve been waiting to see confirmed. This confirmation is a result of all three PnF charts mentioned (above and below) moving upward together. These trends will be confirmed if the recent downward reversals eventually move back up again, which would create a new, “Higher Low” on all three charts. We like higher lows – and we like higher highs!
Let’s step away from the nerdy stuff for a second and get back to history. The seasonally weak months in the market ironically end on Halloween. However, going back 20 years, the traditionally poor months of September and October tend to mark their lows at the end of the first week in October, which is only six days away. Naturally, this begs the question, “Have we seen, or will we see the ‘official’ bottom in this year’s stock market correction within the next week?”
All the indicators I follow are telling me that this is statistically probable, but only time will tell. As we like to say at our office, “We can never see the right side of the chart – only the left.” This will change as soon as someone invents a time machine that actually works.
Our last picture today is one that shows the S&P500, which is a great proxy or representation of the U.S. stock market as a whole. It includes small companies, mid-sized companies, and large companies of all kinds of sectors and industry groups.
This last week has killed the probability of what we would call a “V-bottom” in the market. You can see below that, on September 21st, the market started to reverse back down again until it eventually began to tease the August 24th lows. Instead what we have (especially in combination with the charts I’ve already showed you above), is a potential set-up for a “W-Bottom.” No explanation needed here. Like a V-Bottom, a W-bottom simply looks like a “W” on the chart.
Again, we don’t know what the right side of the chart looks like, so said another way, we don’t know where the market is going to go from here… but as long as the current pull-back stays above the November 24th low, we’re in pretty good shape and likely poised for a great 4th quarter in the U.S. Stock market.
With that all said, I can show you all the technical, statistical, and historical charts in this article, but the market is going to do whatever it wants to do. Our job is to quickly react to it so as to lose as little as possible when it’s trending down, and make as much as possible when it’s trending up. I say this all the time, so I’ll say it again: We never, ever buy at the bottom and sell at the top. This would insinuate some sort of clairvoyance or suggest I have a crystal ball at my office (well, I do – a client gave me one as a gift years ago, but trust me, it doesn’t work)!
Instead, we aim to buy on the way up the hill when markets are advancing, and we sell on the way down the hill, taking profits off the table and heading for safety when markets are declining. I do all of this while focusing on the strongest investment categories in the market. Said another way, I shy away from full-blown “diversification.” A diversified investor would’ve had exposure to oil, gasoline, gold, and silver, which have all lost a lot of money this past year, in spectacular fashion. I have largely avoided those areas of the market completely, focusing instead on the top-ranked investment categories while avoiding those with a low rank.
Let me briefly explain this concept in an analogy. I know that not everyone watches football or the NFL, but if I were to ask all of you who the best teams in the NFL were and who you thought were going to head to the Super Bowl this year, I’m guessing I’d hear a lot of the same team names (Patriots, Seahawks, or the Broncos maybe)? If I were to ask you who the best players were, I’d likely hear names like Peyton Manning or Tom Brady. What if I asked you who you thought the worst teams were in the NFL? Would you tell me that my Cleveland Browns are at the bottom? Probably.
Now, what if I told you that managing money in a portfolio was a lot like picking teams to win the Super Bowl. Would you pick the Browns or the Broncos to win it all? What if you could pick multiple teams – would the Browns even be on the list?! Sadly, they’re probably already the laughing scapegoat of this analogy.
Anyway, when you “bet” on teams to win, that bet is final. You can’t change it. The money is lost unless they win. However, when you’re investing money in the markets (whether it’s the stock market, bond market, commodity market, currency market, or international marketplace), you can change your bet at any time! So as our investments winning percentage (trend) changes, and as different investment categories strengthen and weaken, we can avoid the Cleveland Browns of the investment world and focus more on the Broncos and Seahawks instead.
The market experiences, on average, three -5% “pull-backs” each year. Most people don’t notice them because they’re “only” -5% moves to the downside. On the same hand, the market also experiences a -10% (or more) “correction” once a year, on average, going all the way back to The Great Depression. In light of everything else I’ve taught you today, what that statistic should tell you is that this temporary loss is just that – temporary. While seeing a drop of -10% is the norm, this fall represents the first time we’ve seen an official correction in four years! No wonder it FEELS so bad!
Still, while bonds, currencies, commodities, and stocks both here and overseas are down this year thus far, U.S. stocks are still, in my opinion, “the best of the losers” in 2015, despite this market correction we’ve just experienced. So sit tight, try to relax, turn off CNBC and Bloomberg, and as always, feel free to contact us if you have any questions at all. We’ve built a great culture of people at our office and we all love what we do. We’re happy to help and you don’t have to be a client to ask a question!
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Till next time,
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Disclosures: All data above sourced via Yahoo! Finance. The proxy used for international investments is the ACWX (all country world index ex-US). The proxy used for commodities is the DBC (PowerShares commodities index). Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.
The opinions mentioned in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Past performance is not guarantee of future results. Economic forecasts set forth may not develop as predicted. The views and opinions expressed in this commentary are those of Adam Koos and do not necessarily represent the views of TD Ameritrade and its affiliates. Investing involves risk including loss of principal.Categories: Adam Koos, CFP®, CMT®, Market Commentary