Weekly Short Course: 1/19-1/25

I update my market models weekly and monitor the trends in their allocation numbers. While I do not follow every market, I follow many important markets via their representative ETFs. There is a list of the current ETFs I am tracking in the sidebar.

 Here is a run through of this weeks observations:

The Basic Model

One of my models is a simple allocation program between the total stock market, VTI, and long term government bonds, TLT. These two ETFs are a great pair to follow since they have almost the same average volatility. Thus, they can be compared based on pure relative strength with about equal expectations for each holdings appreciation or depreciation capability.

The current allocation for this program is Conservative (<40% stocks). This week saw a slight shift back towards stocks and a reduction of cash.

It remains to be seen what is in store for US equities in the first half of 2015. We are finally making it back to positive territory for the year, but the risks are still high. It will take more time for markets to digest European QE. Looking at the data, I cannot draw any other conclusion than my holdings are in traditionally defensive areas of the market. Does this mean we are heading for meaningful weakingness in global equities? Remains to be seen. The markets are always churning, and sometimes holdings in uptrends just need a rest.

We need more time for US equities to tip their hand. Meanwhile, there are plenty of other places to have capital that are not in such ambiguous positions.

Keep an Eye on Emerging Markets

Above is a weekly chart of EEM, an ETF that comprises equities from emerging market economies like China, India, Brazil, Taiwan, and South Korea. As you can see, when EEM has broken out on a weekly basis in the past, EEM has tended to be strong for many weeks afterwards. We are in the midst of another break out. It will be a good idea to keep EEM and other ETFs like FXI (China), EPI (India), Brazil (EWZ), etc on your shopping lists as they may continue to perform well in the coming weeks.

Hedging Out Currency Risk

Interested in investing in Europe now that QE is confirmed? Be careful which funds you buy! As a US investor with assets, and, thus, capital, priced in US dollars, you cannot simply purchase foreign assets thinking they will move in the same manner as US stocks. Because foreign assets are priced in their home currencies, their value to a US investor is not only what price they will fetch on the foreign market, but also how their respective currency is changing relative to the US dollar.

Look at the charts below which show EWG, the Germany Fund, and DXGE, the Germany Currency-Hedged Equity Fund for the SAME time period. There is a substantial difference in price appreciation for both holdings:

As the Euro weakens towards the dollar, this makes all assets priced in Euros worth "less" to American investors dealing in US dollars. Both EWG and DXGE have exposure to the German stock market, but only DXGE outperforms when the Euro is weak and EWG outperforms when the Euro is strong.  

It is good to do your homework on the financial instruments available and tailor your portfolio to current conditions. Wisdomtree, for instance, has a a lineup of currency-hedged funds, including DXGE (Germany), DXJ (Japan), and HEDJ (Total International). DBEU is a Europe hedged fund if you are looking for a VGK alternative.

Overall

Deflationary assets (bonds, dollar, inverse commodites, gold, defensive stock sectors) continue to lead and black clouds remain over the US stock market. Eurozone easing may be providing a ray of light, however.

Emerging markets may be experiencing a short-term breakout. Check out gold too (not mentioned above)!

See you all next week!

Weekly Short Course: 1/12-1/18

I update my market models weekly and monitor the trends in their allocation numbers. While I do not follow every market, I follow many important markets via their representative ETFs. There is a list of the current ETFs I am tracking in the sidebar.

 Here is a run through of this weeks observations:

The Basic Model

One of my models is a simple allocation program between the total stock market, VTI, and long term government bonds, TLT. These two ETFs are a great pair to follow since they have almost the same average volatility. Thus, they can be compared based on pure relative strength with about equal expectations for each holdings appreciation or depreciation capability.

The current allocation for this program IS NOW Conservative (about <40% stocks). This week saw another shift towards bonds with the stagnation in stocks.

Last week, I said I would be worried about US stocks if my models started to raise cash against US holdings. As you can see, the basic model has begun to do just that. However, this is a basic model for a reason. I trust it in the long term to allocate correctly. Thus, I would like to see a week or two more sustained at these allocations to assume a more bearish outlook for US stocks.

A potential bullish outcome of these numbers is that the October 2014 low also coincided with these sorts of allocations before stocks rallied into the year's end. Thus, it may be time for US stocks to flex some relative strength (not necessarily absolute strength) muscle this coming week. Regardless, US stocks have been weak relative to other assets the past few weeks.

What's up with the POS? Is it stuck?

If you have been following my POS market index, you have noticed that it has stayed at 4, caution, for almost two weeks.

I have looked into this and there is actually good reason why my model has not gone full bearish where others like Dr. Wish have their GMIs on a sell.  Take a look at the $NYSE for the time the POS has been at a 4:

During the last few days, the stock market has gone sideways, stuck in a horizontal channel. While this is not ideal, it is certainly not a reason to panic. Moreover, the S&P 500 has not pulled back more than 5% from its recent high during the current weakness. Remember, 10% is the marker for a correction.

Thus, the POS is actually doing exactly as I hoped. Let's visit my explanation of the POS scores (under POS Scores Explained) for a "4": 3-4 & Down-tick: Caution, markets are indecisive, do not open any new longs, tighten stops and look to exit. This is exactly what I would want in the back of my mind for current conditions. Do not look to go long, and tighten stops, but don't run for the hills yet, until further weakness occurs. 

Stocks could launch from here to new highs. They could also drop, but if you are working with proper risk management, sometimes it pays a lot more to stay in, at least partially, during sideways moves. For instance, my experimental trading strategy for the POS has 1/2 a position on the current market. It has taken money off the table sure, but it will benefit if stocks resume an uptrend from here as the position is anchored back into December 22, when the POS revved up to a 7.

Discipline: Strap Me to the Mast!

Any good trading or investing strategy is designed to give us an advantage. That's why strategies exist. They are rules to make us a profit in the long run. The problem, however, is our psychology is not good at following long term strategies. We crave the short term payoffs and despise any short term pain. The problem comes when we abandon good strategy to appease our emotions. It is at that moment when we throw our well-designed and thought-through advantage to the wind and expose ourselves to the perils of pure gambling and sentiment.

Strategies that catch the high flyers are particularly prone to human weakness as something that is making new highs inevitably will correct or reverse trend eventually. For instance, there are a lot of holdings heading to the moon like Long Term bonds, the US dollar, and inverse commodities. The more weeks that these holdings march forward, the more weary our minds get of the coming pullback. We know it cannot last forever.

I have seen many technical articles about the coming reversal in US bonds or the dollar, for example, and I can't help but agree with their arguments. However, if I were to abandon my strategy before this inevitable weakness showed up, I'd be throwing away the very system that allowed me to profit from them in the first place. I can't both profit from these trends and also completely avoid the first stages of those trend reversals (under my principles). Thus, no matter what I have to stay committed to the rules. The rules may allow for short term weakness, but they are designed for long term gain. And, as good as short term gain FEELS, long term gain is all that matters in the end.

It can be tough, but as long as your system is designed to be self-correcting or risk managing, it will carry you through the rough patches. Don't give up. Your greatest financial enemy is often yourself.....and most definitely the financial media.... Also, make sure your strategy rests on sound principles, it could just be bad....

Overall

Deflationary assets (bonds, dollar, inverse commodites, defensive stock sectors) continue to lead and black clouds remain over the US stock market. However, there has been much buzz over EU QE this week, which may coincide with a shift to a new set of leaders as 2015 continues. It will be interesting to watch. Also, have you seen the big moves in both the Swiss (franc) and Chinese ($SSEC) markets due to big surprises this last week? A lot of money is moving in these shocks.

For the coming weeks, I will navigate whatever comes even if I have to strap myself to the mast.  Can you say that for your strategy?

See you all next week!

Weekly Short Course: 1/5-1/9

I update my market models weekly and monitor the trends in their allocation numbers. While I do not follow every market, I follow many important markets via their representative ETFs. There is a list of the current ETFs I am tracking in the sidebar.

 Here is a run through of this weeks observations:

The Basic Model

One of my models is a simple allocation program between the total stock market, VTI, and long term government bonds, TLT. These two ETFs are a great pair to follow since they have almost the same average volatility. Thus, they can be compared based on pure relative strength with about equal expectations for each holdings appreciation or depreciation capability.

The current allocation for this program is Balanced (about 1:1 stocks:bonds). This week saw another shift towards bonds with the stagnation in stocks.

Storm Clouds on the Horizon? 

As a technical analyst, I am as much a bull or a bear as the market allows at anyone time. Any reasons I could appeal to beyond observations of changes in price are speculation and almost worthless in my book. Thus, with many major indexes near all-time highs, I am more a bull than a bear on US stocks. Also, anytime weakness occurs in the course of a trend, it is probabilistically just a temporary pullback and not a trend change. The markets do trend- they get as many pullbacks as maintains the overall trend and only one trend change in in each trend's lifespan. Thus, you are playing a low-odds of success Russian roulette at best and are fearmongering at worst to call a top at any one pullback (I am looking at you financial media!).  

There are a few ETFs I track that are negatively correlated with stock market at times of high stress in the global markets, the five horseman of the US stock apocalypse, so to speak. The five are Long Term Government Bonds (TLT), the US dollar (UUP), the Japenese Yen (FXY), Gold (GLD), and Short-term VIX futures (VXX).

There are fundamental reasons why each of these holdings tends to do well in times of stock stress, although I prefer the simpler observations of the their price performance during times of stress to explain their inclusion in the list. Look at their progress during the 2008 recession, for instance. Nonetheless, I will speculate on fundamental reasons why these are defensive assets, if it is helpful for your own interests. In short: TLT is seen as a conservative investment in the safety of the US government; UUP tends to outperform in the depths of fear as investors go to cash fast, specifically the world-reserve currency, the US dollar as demand for commodities plummet; FXY tends to outperform when Japanese investors, some of the most conservative in the world, ditch stocks and risky assets as well; GLD is seen as a store of value in the face of both inflation and loss of attractiveness of traditionally risky assets; and finally VXX tracks the VIX, an index tracking investor usage of options to buy either upwards or downwards protection for their holdings. The VIX increases when investors buy more puts (downside protection) so positivity in VXX means investors are buying more insurance against potential future losses.

With this background in mind, below is the chart that shows some small concern. In the last three weeks, the NYSE has failed to make new highs (red lines), while the five horseman all show short term positivity (green lines):

Now, there are obviously other reasons why some of these holdings are performing as they are other than solely due to investor risk aversion. TLT and UUP, for instance, are in long term uptrends already.  However, if the positivity in at least four of these areas continues, it may mean new lows for stocks due to the historical correlations that exist in the pricing of these different holdings.

That being said, the bullish outcome for US stocks is that the short term postivity in FXY, GLD, and VXX are just more countertrend rallies that have occured before. If these ETFs breakdown lower, stocks are headed higher, breaking out yet again from a countertrend rally of their own. At the least, it will be interesting to watch in the coming weeks.

Finally, neither the US stock market nor the five horseman "cause" performance in each other. So, it is wrong to see strength in any one asset class as causing another asset class to do such and such. Rather, it is more correct to say that they move together in a specific manner (this is the basic meaning of correlation).

Overall

I personally will not be too "concerned" about US stocks until my models start raising cash against my US stock holdings, or US stocks otherwise become unusually small positions amongst my overall holdings. Has not happened yet.

On a "sunnier" note, last week was excellent for TLT, short oil, short euro, and long China. What is good or bad is all about perspective and what positions you hold. My holdings have continued to gain with the negativity in US stocks to start the year.

 The POS is on a 4, a cautionary zone that means prices are currently treading water and will resolve in one direction or another soon.

Last Words

Keep an eye on the Nasdaq too, this classic growth index has not been doing so hot the last few weeks. It failed to make a new high with the other indexes at the end of December. A sick Nasdaq is another black cloud over the market right now.

Speculating, like gambling, is fun! My observations above, so far as they could be construed to be predicting future downside in the stock market, is speculation. However, I do not trade on speculation and neither should you. Stay in step with the market and you will be rewarded in the long-term. This, in my opinion, is the true reason why Warren Buffet does not believe you can time the market. Timing, done incorrectly, leads too many to try and predict rather than follow trend changes. As I mentioned above, trend changes are very rare compared to temporary pullbacks.

See you next week!

Weekly Short Course 12/29-1/2

I update my market models weekly and monitor the trends in their allocation numbers. While I do not follow every market, I follow many important markets via their representative ETFs. There is a list of the current ETFs I am tracking in the sidebar.

Here is a run through of this weeks observations. While I analyze the markets using measures of absolute momentum, I include performance charts here for a quick and dirty illustration of performance. Where I wish to specifically show momentum, I use MACD charts.

My basic model: One of my models is a simple allocation program between the total stock market, VTI, and long term government bonds, TLT. These two ETFs are a great pair to follow since they have almost the same average volatility. Thus, they can be compared based on pure relative strength with about equal expectations for each holdings appreciation or depreciation capability. I've decided to share my weekly numbers for this program since it is so simple:

 The current allocation for this program is Balanced (about 1:1 stocks:bonds). This week saw a shift towards bonds.

The Dollar is King- The US dollar continues its streak upwards into 2015. UUP is en ETF that represents the value of the US dollar versus other major currencies, especially the Euro and Yen.  The chart below shows how other currencies' pain is the dollar's gain:

Overall- This week saw a step away from US stocks and into Treasuries, the Chinese stock market, and the Dollar.

The POS is on an 8, but any substantial weakness this week will turn it negative. The markets have stagnated to a decision point.  We should know the next major direction by the end of the week.

See you next week!