Archive for September, 2015

S&P 500 Volatility-Based Price Probability Range

Wednesday, September 30th, 2015
  • Historical volatility projection suggests the range of probable S&P 500 prices from around 1750 to 2050 by year-end
  • Major trend indicators suggest high probability of prices ending in the lower half of the probability range
  • GAAP P/E and forward operating P/E ratios reverting to 5-year and 10-year averages suggest prices in the 1700’s
  • GAAP earnings have turned down and prices tend to follow
  • But GAAP earnings yield relative to current and near-term prospective 10-year Treasury yield is supportive of current index price

As you might imagine, the phone has been busy these past few days with nervous inquiries.

The prevailing questions are about direction of the US stock market and the magnitude of likely price change.

I have written to you before with a negative outlook, based on objective data mostly about breadth; simple price chart behavior and patterns; and recent declines in quarterly earnings — but tempered by the continued market supporting aspects of the Treasury yield curve.

Our 4 factor major trend reversal indicator is suggesting a major trend change to a downward direction.

None of that attempts to fathom events and conditions around the world, but merely examines the final result of all that is going as expressed in earnings, price changes and trading volume.

So, my conclusion is that the probabilities (not certainty) is for the Correction to continue into a Bear.

A Correction is a 10% price decline from the trialing 1-year high. A Bear is 20% price decline from the trailing 1-year high, which decline is sustained at that level or worse for at least 2 months.

Let’s look at that two ways:

  1. out 3 months based on historical volatility
  2. valuation level reverting to a “normal” valuation (not an overshoot) based on historical price GAAP and forward operating earnings estimates; and GAAP earnings yield relative to historically normal 10-year Treasury yields.

These are all projections, but based on reasonable and historically justified calculations.

Volatility-Based Price Probability Projections
This daily S&P 500 chart plots three horizontal cones projected three months into the future (to 12/28/2015) based on the 1-month, 3-month and 12-month historical volatility of the S&P 500 index, and using a 67% probability range.

That means prices would be expected to remain within the cone area with a 67% probability if the prices form a normal probability distribution (no “fat tails” and ignoring historical positive skew).

Such volatility projections are non-directional (they show price range potential equal on the upside and downside), but we believe the Direction is to the downside based on the other data we have evaluated in prior articles.

(click images to enlarge)


The trailing index high price is 2132. The current price is 1881. The 12/28/2015 end-points of the volatility cone range from 1784 to 1752.

The current price is below the trailing high by 11.8%
1784 is 16.3% below 2132
1752 is 17.8% below 2132

These are not posited as end points of a Bear, but just 3-month (year-end) values at the outer boundary of 67% probability.

Notice that the upper probability bound by year-end is for about a 60% retracement of the decline from the peaks in July to the trough in August

Let’s now look at the 90% probability range.


The trailing index high price is 2132. The current price is 1881. The 12/28/2015 end-points of the volatility cone range from 1720 to 1667.

The current price is below the trailing high by 11.8%
1720 is 19.3% below 2132
1667 is 21.8% below 2132

These are not posited as end points of a Bear, but just 3-month (year-end) values at the outer boundary of 90% probability.

Notice that the upper probability bound by year-end is for about a 100% retracement of the decline from the peaks in July to the trough in August

GAAP Earnings P/E Valuation Reversion to 5-Yr or 10-Yr Average
Valuation is about earnings. Trailing reported GAAP earnings are trending down as this FactSet Earnings Insight chart shows (the blue line) and stock prices are following (the green line).


The P/E on 12-month trailing reported GAAP earnings last Thursday was 17.1x compared to a 10-year average of 15.7x and a 5-year average of 15.3x. After yesterday’s (09/28) market action the trailing P/E was 16.6x (at index price 1882).

If the P/E reverted to the 5-year average, the index price would be about 1734 (18.7% below the trailing high index price of 2132). It would be 1790 at the 10-year average P/E (16% below the index high).

During the European debt crisis in 2011, the P/E went down to less than 12x. At 12x (not a projection, just a data point), the index would be priced at 1360 (36.6% below the index high – a severe Bear).


Forward Operating Earnings P/E Valuation Reversion to 5-Yr or 10-Yr Average
Forward operating earnings estimates were trending down, but have risen, and are not nearly flat as this FactSet Earnings Insight chart shows (the blue line) and stock prices are following (the green line).


The P/E on 12-month forward operating earnings last Thursday was 15.2x compared to a 10-year average of 14.1x and a 5-year average of 14.05x. After yesterday’s (09/28) market action the trailing P/E was 14.75x (at index price 1882).

If the P/E reverted to the 5-year average, the index price would be about 1740 (18.4% below the trailing high index price of 2132). It would be 1746 at the 10-year average P/E (18.2% below the index high).

During the European debt crisis in 2011, the P/E went down to less than 11x. At 11x (not a projection, just a data point), the index would be priced at 1404 (34.1% below the index high – a severe Bear).


Earnings Yield Relative to 10-Year Treasury Yield
The S&P 500 earnings yield (inverse or P/E – it is E/P) is 5.27%. The 10-year Treasury yield is 2.05%. The spread is 3.22%. The 20-year average spread is 0.30%. That is very supportive of current prices.

The 20-year average 10-year Treasury yield is 4.32%. If the 10-year Treasury yields were at is 4.32% average, today’s earnings yield would be 0.95% greater. That would still be more favorable to stocks that the historical averages.  A 4.32% 10-year Treasury is nowhere is sight.

It’s hard to make an argument that the current earnings yield (and thus the P/E) is unreasonable in the current interest rate environment if earnings were stable, or in the rate environment that is likely within the next year or so.

Unfortunately, earnings are not stable and are in decline. The uncertainty is whether those who expect earnings to decline in 2016 or those who think they will rise are correct.


Earnings Direction and Price Direction
Earnings have turned down, and stocks tend to follow – and if the turn down is significant, it can create enough downward momentum in stocks to create a Bear.

This chart shows how the index price varies with the direction and magnitude of change in earnings.


You can see that when earning make a significant downturn, the index changes trend from up to down.

The failure of the S&P 500 to make that change in the late 1990’s was due to the fact that most of the popular DotCom stocks that dominated the index then were not making money or expected to do in the near-term. Note, however, that the Russell 2000 small-cap index which was not dominated by DotCom stocks did respond to declining earnings, although not with a major trend change.

This chart gives a magnified view of the change in earnings over the last 3 years.

Clearly, profits have been down all of 2015 so far (and stocks are down for 2015 so far).


If earnings were stable and growing all would be well, but earnings are not stable, are not currently growing.

A sufficient number of experts are concerned that earnings may not do well in the near-term that caution is warranted.

The consensus street estimate for year-end S&P 500 price is in the 2100 to 2200 range.

Let’s hope that is true and that we are wrong, but until and unless that recent chart trend and earnings trend is reversed to the upside, the weight of evidence is for S&P 500 prices to reside in the lower half of the probability ranges shown in the cones at the top of this article (from around 1900 to the mid 1700’s).


A Bear Is Now More Likely Than Not

Monday, September 28th, 2015
  • A Bear market from this Correction is more likely than not
  • Yield Curve suggests Bull has further to go
  • Breadth measures suggest Bull is exhausted
  • Triple top and Head & Shoulders pattern suggests breakout to the downside
  • 4 Factor Technical indicator suggests Bear is around the corner

[the following is a copy of our letter to clients last night (Sunday Sept 27)]

20150927aThe stock market does stink right now.

How do I know?  Well, stocks are in a Correction and gyrating up and down by large percentages, with a massive trading and investment press opinion tug of war on whether we are OK to return to S&P 500 price growth, or heading for a significant Bear market.

I also know because last Friday, Jim Cramer said, “This market stinks!”  So there it is.

But let’s look at some data instead of headlines and 30 second interviews.  The evidence is split, but mounting on the side of more pain to come.

First, here is our table of market indicators that we have been updating for you over the last several weeks.  It has some positive items, but a lot more negative items, and the negatives are a bit more negative than before, while the positives are about the same magnitude.



The yield curve is still steep, more specifically the 10-year Treasury rate minus various shorter-term Treasury rates is still positive.  In prior letters to you, we have shown that virtually all recessions are preceded by the yield going flat and then inverting (the spread between the longer and shorter rates going to zero, and then the shorter rates rising above the longer rates) – the New York Federal Reserve confirms that with their research.

Stock markets tend to go into Bears before recessions (and after, or coincidentally with, the yield curve going flat or inverted).  The yield curve is still steep, and that is Bullish.

An argument could be made that in this artificially controlled interest rate market the yield spread is of little predictive value.  Recognizing that, we are prepared to say the 3-mo/10-year spread may have no current meaning.  However, the 2-year/10-year and the 5-yr/10-year is not Fed controlled (Fed influenced YES, but still in the domain of market forces, not just Fed decisions), so we think they have some predictive value.

The 2016 consensus earnings growth analyst forecast is nearly 10% higher than estimated 2015 operating earnings.  That is good, but analysts tend to modify their estimate regularly and it’s hard to know what they will think 3 months from now, or how energy earnings as a major wild card will change their estimates.

The Saint Louis Fed Financial Stress Index is on the low side of a +/- 1 standard deviation (“normal”) level.  That is positive, but the different parameters measured by the Cleveland Fed for their stress index are at the high side of normal.

Those are the good things in our regular data set that suggest the Bull will continue.


Breadth is down:

  • Cumulative net new highs are down
  • Cumulative net advancing issues are down
  • Cumulative net advancing volume is down
  • Equal weight indexes are underperforming market-cap indexes.

Price chart conditions are negative:

  • Prices are below moving trend line (200-day) moving averages
  • Trend line leading edges are moving down
  • Retracement from Aug low to July high is low.

Near-term earnings are down:

  • Reported GAAP earnings for trailing 4 quarters is lower than the 4 quarters before that
  • Operating earnings for 2015 over 2014 are down.


I am glad you asked, because there is more on the negative side.

Clearly, there are plenty of positive stock stories, and in the long-term it is not a good idea to bet against American industry or the stock market.

However, in the shorter-term, sometimes a year or two, earnings, valuations and stock prices can take a big hit, before resuming their historic rise.

Let’s look at some immediate stock market behavior that is concerning, and tilting very close to an outright Bear call – not totally yet, but it certainly starts to smell that way.

We look at four technical factors that, taken together, did a great job of calling the market tops in 2000 and 2007/2008, while at the same time they did not suggest jumping in and out of the market over common bumps in the road.

They were not as effective in the period 1980 through 1993, however, so maybe they have had their day.  On the other hand, what has worked recently is likely to work in the present.

We have written about those factors and provided back testing data from 1980-August 2015 on our blog.  When those 4 factors confirmed each other in 2000 and 2007, they did so at the market tops.

We look at monthly data to see:

  1. Whether the price is above or below the 12-month moving average (same length as the daily 200-day average)
  2. Whether the leading edge of the 12-month average is tilted up or down versus the prior month
  3. Whether the price is moving up at a reasonable pace (a time-based indicator called the parabolic stop & reverse)
  4. Whether the volume of trades is more at the upper end of daily price ranges or at the bottom end of daily price ranges (the money flow index).

The first two factors are necessary, but not sufficient, to trigger a major reversal alert – because alone they are prone to whipsaw.

The third and fourth factors measure different things than the first and second, and are necessary to confirm the alerts from the first and second to minimize whipsaw risk.

Here is a chart for the two most recent major market tops (our blog reviews all the trend reversals from 1980).


No method works all of the time, and this one has worked better since 1993 that before, but we think it still has utility.

You can see from this chart it did a great job at signaling reversals to the down side.  It did a pretty good job on alerting reversals to the upside, but that is not our concern today.  All eyes are on the lookout for a top, and one seems to be near.

Because the method is monthly, the data in the chart above is through August, and in three days we will have September.

In the meantime, let’s try to peak around the corner by running the same data through a weekly filter.  Weekly data is not as reliable as monthly data, and has lots of whipsaws, but that said, it forecasts a fully confirmed trend reversal come next Wednesday.


There is one more negative item, that deserves attention in this letter.  It concerns a specific (actually two specific) chart patterns that are each typically indicative of a trend reversal.

One is called a Triple Top, and the other is called a Head & Shoulders Top (we have a detailed article about them on our blog), but here are the key points. describes Triple Tops this way:

“The Triple Top Reversal is a bearish reversal pattern … There are three equal highs followed by a break below support. As major reversal patterns, these patterns usually form over a 3 to 6 month period

Here is a recent example of a Triple Top in Chevron – just to show you in isolation what one looks like:


(explanation of Renko charts)

This is what says about Head & Shoulders patterns:

“A Head and Shoulders reversal pattern forms after an uptrend, and its completion marks a trend reversal. The pattern contains three successive peaks with the middle peak (head) being the highest and the two outside peaks (shoulders) being low and roughly equal. The reaction lows of each peak can be connected to form support, or a neckline. … The head and shoulders pattern is one of the most common reversal formations. It is important to remember that it occurs after an uptrend and usually marks a major trend reversal when complete.”

And here is what a Head & Shoulders looks like, in hypothetical form:


Well, we think we see both patterns in this noise cancelled 3-year daily Renko chart of the S&P 500.



Once again, no chart analysis is perfect or consistently correct, but when you add all of the stuff above, including our major trend reversal indicator with this specific trend reversal chart pattern; it gets really hard to be warm to stocks at this time.

What you should know is that a major drawdown has a high probability of occurring, based on the evidence presented here.

What you should do depends on:

  • when and if you will rely on your portfolio to support your lifestyle
  • whether you have near-term capital expenditure commitments
  • how long you think you are willing and able to emotionally wait for a major market drawdown to fully recover
  • how you would feel if you experienced a major drawdown (even if you knew it would come back)
  • whether your money is in a tax deferred or exempt account (where there would be no tax cost for making changes vs a regular account where embedded gains might be taxed more than the market may take)
  • how you balance in your own mind the possibility of missing out on some capital appreciation if a Bear does not materialize versus the comfort that may come from getting out of the way
  • and other things.

Most of you are either near retirement or currently living out of your portfolio, and most of you have limited ability to sleep well if another Bear comes along.

I don’t believe in market timing, which I view as quite different from gauging major trend direction.

If it’s raining or snowing with lots of wind, I am willing to be outside or on the road; but if there are public safety announcements of an approaching tornado or hurricane, I stay inside, off the road, and out of the weather.  The same holds true, in my view, for investing.

Volatility comes and goes.  Corrections come and go.  It makes sense to stay fully invested for those, but for major trend reversals for those in or near retirement, without excess assets, and without an iron stomach; taking some money off the table makes sense to me.  There will probably be attractive re-entry points later.

With a few exceptions, most of you have 40% to 100% of your equity allocation in cash at this time.  That was accomplished over a period or weeks or months.  I personally have about 75% of my equity allocation in cash.

I could be wrong, but personally value the peace of mind and capital protection more than the opportunity cost if this is a whipsaw and I must re-enter at a higher price.

How do you balance capital protection and peace of mind versus potential opportunity cost in this situation?

If you feel differently, let me know so I can adjust your allocations.

If you agree, look over your other assets you manage yourself, or that you have with other advisors, to see how they are positioned for a Bear.

I am tending to keep the assets I control for you heavily in cash for now.

Please feel free to call and discuss.


Directly related funds are S&P 500 funds such as SPY, IVV, VOO and VFINX — but if we have a bear market, virtually all US equity funds and individual stocks are likely to be sucked in the whirlpool of declining prices.  Correlations approach 1.00 in the early stage of rapid decline in a Bear market.

4 Factor Trend Reversal Indicator Sees a Bear

Sunday, September 27th, 2015

Technical vs Marco and Fundamentals:

Macro analysis is helpful, but not able to determine turning points in markets. There are so many things an investor might consider that it is beyond human capacity to know which are most important and how they interact.

Fundamentals and valuation are better, but stocks can remain undervalued or overvalued for long periods of time.

To get closer to the actual event of a major market trend reversal, you need to use the calculator that rolls everything and everybody’s opinion into single factor.  That factor is the market itself.  The price and volume action of the stock market is the end-point resolution of all the facts, all the investors, and all of their money.

Sometimes the market acts so suddenly and dramatically that there is no warning (e.g. a flash crash), but most of the time there is a discernible build-up of evidence one way or the other that gives investors time to make adjustments if that is what they are inclined to do.

Unfortunately, what works shifts over time, so continued retesting of indicators is essential, but measurement of price and volume action is “where it’s at”.

Fundamentals are great for security selection, but not for gauging market trends.  Fundamentals and technical (chart) analysis are two separate but important parts of portfolio management.

Find a Method and Stick To It, But Adapt Method Over Time:

One key to using chart (“technical”) indicators is to find ones that work pretty well most of the time (none work all of the time), and to find ones that are not redundant to confirm one another.

Here is a method we are using at this time — noting that it didn’t work all that well in the 1980 through 1995 period as it has in the 1995 through 2014 period.  For 2015, we think a continuation of the utility of the 1995 through 2014 pattern of behavior is more likely than the 1980 through 1995 period.

The indicator we use is a combination of 4 factors:

  1. the price position above or below the 12-month moving average
  2. the up or down direction of the most recent month moving average versus the previous month
  3. the 3-month moving average of the 12-month money flow index above or below 50 (on its 0-100 scale)
  4. the price position above or below the slow parabolic stop & reverse indicator.

The first two factors (price position relative to moving average and moving average leading edge direction) are necessary conditions for confirmation  of a trend reversal.  The second two factors (money flow index and stop & reverse index are used to provide confirmation or non-confirmation of the first two indicators triggering an alert).

Importantly, money flow and stop & reverse are essentially non-overlapping among themselves, and non-overlapping with the first two indicators. That is critical to make multiple factors useful.

Money flow index provides a volume dimension to the data. Parabolic stop & reverse provides a time element to the data.

Back Testing:

When all 4 are negative a major top occurred in 2000 and in at the rough boundary of 2007-2008.

In 1981 and 1987, the indicator resulted in a late exit.  We can write-off 1987 to a flash crash type of event, but in 1981 it just did not work.

In a number of other periods, the absence of all four would have kept you in the market when a nervous belly might have resulted in exiting, and subsequently experiencing a whipsaw that left money on the table.

Our Own Failing:

We must admit that in the 2011 European debt crisis, we feared a repeat of 2008 and allowed our judgment about the macro scene attempt to front-run the indicators.  That turned out to be a mistake.  There was no Bear market, and we had opportunity loss (read that underperformance) by the time we re-entered.

Conditions Today:

Today we find ourselves in a Correction that may become a Bear.

Our 4 factor indicator is at 25 (0-100 scale) based on 3 of 4 factors negative.  Only money flow index is positive and it is weakening.

Breadth indicators are negative, but they yield curve is positive, and we think there is a triple top and head & shoulders pattern leaning toward the last leg probably falling into place for a Bear.

Our 4 factor indicator can show values of 0, 25, 50, 75 and 100.  It could be used as a purely binary 100 or 0 long/short, or enter/exit tool — or it could be used for some sort or staged entry or exit.

We have been guided by this (supported by breadth and some other factors) to partially phase out of stocks over recent periods.  As a result, we have not experienced the full impact of this correction on our stocks allocation, which is partially in cash.

Close-Up Of Past Periods:

Figure 1 plots the leading S&P 500 ETF (SPY) from 1980 through 1985, along with the data for our 4 factors.

It has a pink dot over each of the factors when they are negative, and a green dot over the factors when there are positive, when at least 2 of 4 are either flashing agreement as negative or positive. Our thinking is that when only 1 or 2 are either positive or negative, there is no consensus, but when 3 agree we must take strong note, and when 4 agree a trend reversal is confirmed.


spy tech 1a

It didn’t work that time. The exit was late, due to a precipitous price drop and the re-entry was late due to a more gradual recovery. The exit was around $7.50 and the re-entry was around$ 8.75.  Opportunity was lost, but there was an unquantifiable avoidance of a potential major loss.

If only the price position versus the average and the direction of the last month of the average were used re-entry would have been around $7.75

In 1984 there were 2 factors that went negative, but it didn’t go further — no trend change.

Figure 2 plots 1987 through 1992.

During the October 1987 one-day crash, all 4 factors were triggered, but there was no build-up time.  If an investor did follow the method then, they would have exited (or shorted) at $16+.  If they used the indicator for re-entry, they would have stayed out of the market for about 1.5 years and re-entered around $20+, leaving a lot on the table.

If they had used only the price position versus the moving average and the direction of the leading edge of the moving average, they would have been out 9-10 months and re-entered at around $17+.

In 1990, there was a market decline that triggered only 3 of 4 factors, which if followed, prevented an exit and avoided a whipsaw.


spy tech 2a

Figure 3 plots the period 1993 through 1998.  Because there were no instances of the moving average leading edge turning down, there were no trend direction change alerts.


spy tech 3a

Figure 4 plots the period 1999 through 2005.  Here the method did very well.  It alerted for an exit in late 2000 around $100, and alerted for re-entry in 2003 at around $76 — with more than 2 years of freedom from the stresses other experienced watching the broad indexes decline.


spy tech 4a

Figure 5 plots the period 2007 through 2010.  The method alerted for an exit at the end of 2007 at around $115.  It “prevented” participation (by virtue of no signal) in the head fake rally in early 2008.  It alerted for re-entry in late 2009 at around $99.

Clearly, some brave souls, with guts, luck or a good short-term system may have re-entered earlier in 2009, and made a pot-full more money, but they also risked a further catastrophic loss.  To each his own.

We prefer longer-term indicators when it comes to trends, because we think in terms of long-term trends, and don’t prefer to in and out a lot.


spy tech 5a

Figure 6 plots from 2010 through August 2015.  We are in a 3 of 4 alert as of the end of August. The money flow index is the missing factor, which is declining, but not yet below 50.

As you will see in Figure 8 below, the weekly indicator for money flow is now alerting to the downside, so we expect when we do the September monthly indicator, there will be a 4 of 4 exit alert.

We impatiently try to look ahead between monthly data, by tracking weekly data too.  That data is noisy however, and much more prone to whipsaw.

We have been phasing out based on a combination of monthly and weekly data.  While some of our clients for different reasons chose not to tactically allocate between stocks and cash, those who chose to do so are between 50% and 100% in cash within their normal stock allocating amount.  I am personally at the 75% level.


spy tech 6b

Figure 7 shows how we use binary alerts about each factor and the combined factors to avoid the tedium and visual judgements required to analyze the charts the way we did above for illustrative purposes.

Our signals actually look like this, where the 4 factors are binary zero or one; and the combined factors are rated zero to 100 in increments of 25; where 100 is a major trend reversal to UP alert, and 0 is major trend reversal to DOWN alert.

This monthly calculation shows the combined factors at 25 (almost a confirmed major trend reversal), with only the money flow index failing to confirm.



Like you might expect, when the monthly data gets close to a full confirmation (a 75 or a 25), we really want to try to look ahead, so we peak at the weekly data.

We are only 3 market days from the next monthly plot which we believe will be a confirmed major trend reversal to DOWN, based on the weekly data for the same factors shown in Figure 8.



S&P 500 Bear Risk Indicator: Head & Shoulders Top

Saturday, September 26th, 2015

The investment world is swirling with speculation and argument about whether the current S&P 500 correction will end with a return to gains, or descend into a Bear market.

As Jim Cramer said recently, “this market stinks”.

We have been reporting negative breadth measured by:

  • new highs and lows
  • advancing and declining issues
  • advancing and declining volume
  • equal weight to market-cap weighted indexes.

Our recent article about those factors is here.

We have been holding out on completely tossing in the towel because of the still supportive yield curve, which has almost always gone flat before a Bear market — although we have phased into substantial cash positions ranging from 50% to 100% for clients whose investment mandates call for such tactical actions.  I am personally 75% cash at this time.

We will be publishing another article this weekend about our monthly 4 factor market trend reversal indicator that is currently 75% confirmed of a trend reversal in formation. Our recent article using the indicator on sectors is here.

An important trend reversal pattern may be forming in the S&P 500 price chart — a Head & Shoulders pattern. describes Head & Shoulders this way:

“A Head and Shoulders reversal pattern forms after an uptrend, and its completion marks a trend reversal. The pattern contains three successive peaks with the middle peak (head) being the highest and the two outside peaks (shoulders) being low and roughly equal. The reaction lows of each peak can be connected to form support, or a neckline. … The head and shoulders pattern is one of the most common reversal formations. It is important to remember that it occurs after an uptrend and usually marks a major trend reversal when complete.”

Figure 1 is a stylized diagram of a Head & Shoulders pattern, including the implied downside target price.



The basic idea is that an uptrend becomes a downtrend with the price drops from the right shoulder and crosses below the neckline.  At that point, a long exit or short entry is indicated.

Head & Shoulders patterns occur in all time frames from tick-by-tick, to day-by-day, to week-by-week, to month-by-month, and perhaps year-by-year.

Traders focus and act upon the short period H&S patterns, while tactical investors may focus on intermediate period H&S patterns; and strategic investors may focus on longer term H&S patterns — Buy & Hold investors don’t care (I guess).

We focus mainly on monthly periods, but the daily periods H&S patterns seems to be confirming our monthly period data that suggests a major trend reversal is a distinct near-term probability.

Figure 2 is a simple daily line chart for the past three years, in which some of the attributes of an H&S pattern may be visible.



Figure 3 annotates Figure 2 to declare the left shoulder, head, right shoulder and neckline of the possible H&S pattern. It also roughly estimates the downside target price in the 1700+/- area.

Note that the current forward operating earnings P/E is around 15x, and at the downside target price it would be around 13x.  The current yield is 2.16% and would rise to about 2.45% at the downside target price.


SPX line hs 20150925

We must admit that the formation of the H&S pattern is not in any way crisp or clear.  What caught our attention was a Renko chart of the index (see description). That made both a triple top (maybe quadruple top) and an H&S pattern seem to pop out.  Triple tops and H&S patterns are both reversal patterns, and to have them simultaneously is even more concerning.

Figure 4 shows the Renko chart.



Figure 5 annotates the Renko chart to illuminate the H&S pattern.


SPX renko hs 20150925

The H&S is not fully formed and may be washed away like sand castles as the ocean high tide returns, but so far it is an intriguing possibility.

If the S&P 500 goes below about 1875, lookout for a possible 1700 (about 20% below the trailing 1-year high of 2132 — a 20% Bear market decline.)

Directly related funds are S&P 500 funds such as SPY, IVV, VOO and VINFX — but if we have a bear market, virtually all US equity funds and individual stocks are likely to be sucked in the whirlpool of declining prices.  Correlations approach 1.00 in the early stage of rapid decline in a Bear market.


Technical Rating of Sectors & Industries

Tuesday, September 22nd, 2015

In our prior post (Bear Market Watch 2015-09-20), we presented a monthly indicator that has done a pretty good job of identifying top of market exit points and post-bottom re-entry points for the S&P 500.

It combines 4 technical indicators into a single indicator that rates an index from zero (exit) to 100 (enter) in 25 unit stages.  It rates the S&P 500 at 25 as of the end of August — more about how it works in that prior post.

The 25 unit stage could be used to monitor the development of the situation toward an exit or entry; or possibly to guide a staged entry or exit.

Something that is at least interesting, and possibly helpful to some investors, is the time series aspect of plotting the rating system.  We present the time series in this blog from 2008.

The 4 indicators that are inside this indicator take these factors into consideration:

  • price position relative to moving average
  • direction of leading edge or moving average
  • time limits for price to make significant up or down movement
  • trading volume weighted tendency for closing price to be in the upper or lower part of daily price range

Important Note:  This indicator is technical only.  It does not include any fundamental factors.  It is backward looking in that it records what has happened to the security, and is only updated monthly.  It is forward looking to the extent that the price and volume action is the result of the forward looking opinions of investors in the aggregate.

Let’s see how sector and industry ETFs are rated using the same method. As you view the rating timeline, take note of how steady the ratings tend to be, how long they have been up, when they began a decline, and whether the decline is steep or gradual.

(click images to enlarge)

S&P 500 (SPY) rated 25


S&P 500 Basic Materials (XLB) rated 0


S&P 500 Energy (XLE) rated 0


S&P 500 Financials (XLF) rated 25


S&P 500 Industrials (XLI) rated 0


S&P 500 Tech & Telecom (XLK) rated 25

S&P 500 Consumer Staples (XLP) rated 25

S&P 500 Utilities (XLU) rated 25

S&P 500 Healthcare (XLV) rated 50

S&P 500 Consumer Cyclical (XLY) rated 50

MSCI USA Technology (VGT) rated 25


NASDAQ Biotech (IBB) rated 50

Dow Jones Aerospace & Defense (ITA) rated 25

S&P Homebuilders (XHB) rated 75

S&P Oil & Gas Exploration & Production (XOP) rated 0

MSCI Equity REITs (VNQ) rated 0


KBW Regional Banks (KRE) rated 50


S&P 100 Mega-Cap (OEF) rated 0

S&P 400 Mid-Cap (MDY) rated 0


S&P 600 Small-Cap (IJR) rated 25


Russell 2000 Small-Cap (IWM) rated 25


We have large cash allocations at this time (generally 50% or more) in most accounts (depending on client goals, preferences, retirement status and other circumstances), and are in a strong defensive position. We began increasing cash several months ago.

Among out long equity positions we have some SPY, KRE and VGT, but all positions are less than full allocations.

Bear Market Watch (2015-09-20)

Tuesday, September 22nd, 2015
  • S&P 500 is still in Correction, but multiple indicators are pointing to increasing possibility of a Bear
  • 4 component binary indicator effectively called last 2 major tops and bottoms — rings warning at this time
  • Significant cash positions are a prudent tactical allocation for retirees and others who cannot tolerate a potentially large drawdown
  • Accepting possible opportunity cost now may be better than risking large loss to pursue gain.

[this is our letter to clients 2015/09/21]

The S&P 500 continues to look very weak, even though it has recovered from its worst levels in the last several days.

We continue to hold large cash positions (and have done so for a few months now) either for retiree or near retiree accounts that cannot tolerate a potentially large draw down, or for accounts that prefer to make tactical allocation changes between cash and stocks in the face of infrequent but potentially large price declines in the S&P 500.

We sincerely hope we are in no more than a correction, but believe by virtue of rational indicators that more may be brewing.

We would rather be safe than sorry, and are prepared to incur certain opportunity cost in lieu of capital loss by holding significant cash positions – which we expect to reinvest when the same indicators suggest the dark skies have cleared.

In an end of August letter we discussed a variety of Bull/Bear indicators — which we subsequently published on our blog titled:
Correction Yes; Bear Probably Not Soon, But Possible — Key Indicators Discussed

The last two images in this letter update the summary tables for that discussion.

The following chart introduces you to a simple set of 4 binary indicators we have found collectively to be a pretty good indicator of major market trend changes, based on monthly data. Taken together those 4 binary indicators suggest we are 75% of the way to a clear market EXIT point. The Money Flow indicator (one of the 4 binary indicators) is the 25% that is still positive

We have annotated the chart with large semi-transparent red and green dots to show how the indicators identified key major trend changes over the last 20 years.

When the bold red line in Panel #5 is at the zero level, the major market trend is expected to be DOWN. When the bold red line in Panel #5 is at 100, the major market trend is expected to be UP.

(click images to enlarge)



Main Panel:

  • Prices (black vertical bars)
  • 10-month simple moving average – same as 200-day moving average (gold)
  • continuous 10% correction level from trailing 1-year high (dashed red)
  • continuous 20% bear level from trailing 1-year high (solid red)
  • parabolic stop & reverse indicator (dotted blue) [indicator description]
  • money flow index (black line – left scale) [indicator description]

Panel #1: binary indicator:
(Price position relative to moving average)

  • if price >10-month simple moving average, then 1, else 0 (where 1 = Long)

Panel #2: binary indicator:
(Direction of leading edge or moving average)

  • if leading edge of 10-month simple moving average UP, then 1, else 0 (where 1 = Long)

Panel #3: binary indicator:
(Time limits for a trending market to make significant up or down movement)

Panel #4: binary indicator:
(Trading volume weighted tendency for closing price to be in the upper or lower part of daily price range)

  • if money flow index >50, then 1, else 0 (where 1 = Long)

Panel #5: summation of values from Panels #1 – #4:

  • if sum = 4, then 100% Long (ENTER)
  • if sum = 3, then 75% Long (or observing development)
  • if sum = 2, then 50% Long (or observing development)
  • if sum = 1, then 25% Long (or observing development)
  • if sum = 0, then 0% Long (EXIT)

Here are the same binary indicators applied to monthly, weekly and daily data presented side-by-side. Do note that the frequency of whipsaws (false or highly transient indications) for weekly and daily periods are high. The method is best suited for monthly periods, but perhaps the weekly and daily data is useful to see how the current month is developing before it ends and can be added to the monthly chart.


The weekly data is solidly negative, but the daily data is trending to positive, consistent with the recent relief rally in the S&P 500.

This overall negative picture is consistent with the other market conditions dimensions we have discussed with you before (also published in our blog 08/30/2015), and which are summarized here in these two tables as of 09/18/2015:



We are in 50% or higher cash positions in accounts that do not have the capacity to withstand up to 3 years of negative stock returns. We are not predicting three years of negative returns, but for actively retired or near retirement clients, the deleterious impact of fixed amount withdrawals on a volatile portfolio in a negative return period can be severe – the “Risk of Ruin” (outliving your assets). Conservation takes precedence over growth in those situations.


Investment funds directly referenced or based on named indexes in this article:  SPY (S&P 500), IVV (S&P 500), VOO (S&P 500), VFINX (S&P 500), OEF (S&P 100), MDY (S&P 400), IVOO (S&P 400), IJR (S&P 600), VIOO (S&P 600).

More importantly, since the S&P 500 covers more than 80% of the US stocks market-cap, and with the S&P 400 and S&P 600 cover nearly all of the market-cap; this article is about the US stock market as a whole, and virtually all of the broad-based ETFs or mutual funds available.