Archive for November, 2016

Intermediate-Term Technical Condition of Domestic & Int’l Stocks and Bonds

Tuesday, November 29th, 2016

There is more to consider than technical condition of markets and securities, but combining technical condition information with fundamental and macro-economic information makes for better decisions.

Let’s look at the intermediate technical condition of US large-cap stocks; EAFE (DM ex US large-cap stocks) and EM stocks; as well as Aggregate US bonds, DM Dollar hedged investment grade bonds, and EM Dollar denominated sovereign bonds.

We used SPY, VEA, VWO, BND, BNDX and VWOB to represent those major categories in Figure 1.

FIGURE 1:

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The red/yellow/green color coded scales in Figure 1 rate each category as trending UP or DOWN or in Transition.  If the category is in Transition, a horizontal arrow shows the direction of the Transition from Up to Down, or from Down to Up.  If the price has crossed the primary trend line in a direction opposite of the trend direction, the rating is noted with an “X”.

Figure 2 presents the 4 essentially non-overlapping monthly factors in the QVM trend indicator, along with how they are scored and summed to an overall rating. The indicator is a price-only indicator, which does not consider distributions, which are part of total return.

FIGURE 2:

(click images to enlarge)

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There are 9 possible configurations of the 2-month leading edge of the Major Trend.  Figure 3 presents those 9 configurations graphically and how each is scored by the indicator.

FIGURE 3:

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We use a custom built program to plot a running rating for each security, which is shown in black in the top panel of Figure 4.

The middle panel in blue is ancillary information showing the distance of the price from the 12-month trailing high.

The main panel contains the 4 factors:  Major Trend in gold; Price in black, Buying Pressure in green; and Parabolic Pace in dotted red.

FIGURE 4:

 

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In a more compact way, and for easier comparison between charts, we also look at charts from StockCharts.com that contain essentially the same, but not exactly the same data (see Figure 5) — the difference being that dividend adjustments made by StockCharts sometimes cause ratings to differ somewhat when the technical condition is close to a change.  Most of the time, for practical purposes, the StockCharts plots are sufficient.  The StockCharts plots, however, cannot calculate or display the actual rating.

FIGURE 5:

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Figure 6 shows the tabular output of our software showing how each of the 4 factors is rated, along with the overall trend rating, with some additional information (Buying Pressure level, distance of the price from the 12-month trailing high, and the position of the price within the 1-year high-low range).

FIGURE 6:

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It is important to note that value and technical condition are not always aligned.

Figure 7 shows the Shiller price to 10-year average inflation adjusted GAAP earnings (“CAPE” for cyclically adjusted P/E), as it relates to the long-term median of that valuation multiple; and the expected 10-year return based on a potential decade-long mean reversion.

Bottom line, US large-cap stocks are in the best current trend condition, and are the most expensive, with the lowest return if valuation revert to the mean over the next 10 years.  Non-US DM stocks and EM stocks are in poor trend condition, and are significantly less expensive, with substantially higher next decade returns in the event of valuation mean reversion (see Figure 7).

Note that US large-cap stocks and DM stocks have similar expected volatility, whereas EM stocks have much higher expected volatility.

FIGURE 7:

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A more graphical way to look at the relative valuation of US large-cap stocks versus DM and EM stocks is in Figure 8, which shows the extremes of CAPE valuation, the range where the valuation is most of the time (in green), and the current valuation (black dot).  US large-caps are very expensive by this measure, and DM and EM stocks are inexpensive.

FIGURE 8:

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Figure 9 calculates the percentage price change that would be required today for a full mean reversion.  It is unlikely to make such a sudden full jump, but the percentages are another good way to see the disparities in valuation; and the theoretical price gain potential (before consideration of various political, macroeconomic and other factors).  It also shows the Morningstar provided 3-5 year earnings growth expectations, and our calculation of the PEG ratios using Morningstar data.

FIGURE 9:

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Figure 10 provides the current QVM 4 factor trend ratings for the 10 sectors of the S&P 500.

Figure 10:

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These data suggest that for those with a patient, long-term view, a little less US stock and a little more DM and EM stock should prove beneficial; BUT that requires accumulating assets that are in price decline, or maintaining an above average cash position to wait for DM and/or EM stocks to change to an intermediate up trend.  Even then EM stocks will provide a bumpy ride.

The cash holding to wait for a turn in DM or EM stocks is reasonable, because there is a distinct possibility (not necessarily probability) that US stocks could be in decline as DM and EM stock are ascending, in which case emotions may prevent the reallocation, or the gains and losses could substantially cancel each other.

All that is really being suggested here is rebalancing within the investment policy allocation range for each key asset type;, or using cash as in intermediary step between decumulation of one asset and accumulation of another based on trend evaluation.

Those near or in retirement need to make sure that in addition to any such long-term positioning, they maintain sufficient safe, liquid assets to be able to make withdrawals for a few years out of assets that do not fluctuate much in price, in the event of an extended or major market decline. The most vulnerable years are the 5 years leading to and 5 years after beginning to rely on the portfolio to support lifestyle.

In terms of sectors, the trend condition reports the obvious, which is that REITs, Consumer Staples, and Utilities are struggling with pending interest rate increases — and therefore should probably be kept at the minimum of the investment policy range for each portfolio until the trends recover.

The securities used in these trend evaluations were:

  • SPY – US large-cap
  • VEA – DM non-US stocks
  • VWO – EM stocks
  • BND – US aggregate inv. grade bonds
  • BNDX – DM Dollar hedged inv. grade bonds
  • VWOB – EM Dollar denominated sovereign bonds
  • XLB – basic materials
  • XLE – energy
  • XLF – financials
  • VNQ – REITs
  • XLI – industrials
  • XLK – information technology
  • XLP – consumer staples
  • XLU – utilities
  • XLV – health care
  • XLY – consumer discretionary

We will publish a similar review of country ETFs in a future article.