Archive for November, 2011

History Rhymes

As we pointed out in a previous post, the action on the S&P 500 reminds us of a similar period in May 2008. Investors tried to rally the market above its 200 day moving average (see faint red circle) and failed…leading eventually to a 40% drop.

S&P 500 in 2008

S&P500 in 2008

Source: Bloomberg

This year, we are faced with a similar pattern. There is good news in the S&P 500 (75% of the companies have exceeded expectations in 3Q numbers) and the US economy is still growing (albeit at a sluggish 2-3% pace). When this pattern appeared in 2008, the US economy was already in recession (started from December 2007, declared on December 1st 2008).

This time around, while there is a significant risk that the US economy is already tipping into recession (ECRI declared one in September), the two big issues dominating the market continue to be the European Sovereign Debt Crisis and the Political Gridlock in the US.

The Euro Crisis impacts the largest economic area in the world on a combined basis. Unfortunately, the central design flaw of the Euro (monetary union without fiscal union) has been exposed. There is too much sovereign debt in Europe and too much of it is owned by European banks which in turn have too little capital to absorb any losses. Germany is the only player with the economic and political clout to resolve the problem and it has yet to decide on which expensive resolution to adopt.

The US continues to struggle with political gridlock which in normal economic circumstances might not be such a problem. However, with such tepid consumer demand growth and a corporate sector keener to horde cash than invest in new projects and employees, the issue of the federal budget is causing deep anxiety amongst investors. For the middle of the road voter, who will once again swing the election next year, the choices are stark and surprisingly well understood. The Republican plan emphasizes spending cuts and will translate into an immediate reduction in GDP. The Democratic preference for stimulus spending financed with higher taxes will lead to a more gradual reduction in GDP but runs the risk of blowing out the deficit and attracting the negative attention of the bond market.

Neither outcome is particularly good for corporate profits and stock market performance. This is why we are seeing the October rally start to fade.

S&P 500…last six months.

S&P500 Today

Source: Bloomberg

What should investors do?

The System continues to favor short ETFs, short term US government paper and Gold. In other words, there is no underlying momentum in risk assets that should give one confidence at this time. The fate of the macro-economic foundations of half the globe’s GDP is in the hands of politicians who are faced with no easy choices and one of the leading forecasters of business cycles has called for a recession in the US.

We have often observed that the Bull Market slogans of the 80’s and 90’s (Buy and Hold…Buy the Dips) have served investors poorly since the dawn of the new millennium. At this juncture, we would remind investors of that observation continue to maintain a cautious investment stance.

The Phoney War

Between the Invasion of Poland in September 1939 and the Battle of France in May 1940, the British, French and Germans declared war on each other but did not initially engage in any serious battles. The six month period was dubbed the “Phoney War”.

Investors in global equity markets must feel very much like poor French farmers in Eastern France in the beginning of 1940. The Bulls and Bears have both lined up impressive resources, politicians and central bankers are playing a high stakes game of chicken in Europe and twitchy investors (hedge funds, perhaps?) are jumping back and forth between “risk on” and “risk off” trades to attempt to eke out enough performance to hang onto some of their funds at the year end redemption sweepstakes.

For the week ahead, there doesn’t appear to be anything too dangerous on the economic front and with Italy and Greece poised for new, technocrat governments, the political side might not yield any surprises for a few days.

That said, the S&P 500 is having a difficult time cracking rhrough to the positive side of the 200 day moving average.

The Fund King System is still suggesting a cautious outlook with low positive ratings on US government bonds, gold and Japanese Yen. The rest of the field is still rating in negative numbers, suggesting that discretion is still the better part of valor as we approach the holiday season.

New Developments

We will soon be releasing our app for the Android system as soon as we have worked out all the kinks. An iPhone/iPad app is on the to do list as well.

The improvements in the code will also be retrofitted into the systems that we use on the website.

MF, Netflix, Sino-Forest Blow-ups – Nowhere to Hide, Right?

Assumed wisdom in the markets is that you cannot avoid blow ups such as occurred with MF Global (bankruptcy), Netflix (down 75% in 3 months) or Sino-Forest (fraud investigation leading to suspension of trading at $0.00). Diversification and limited position sizing are the risk management methods that work best with a buy-and-hold portfolio. Fund King would not recommend any other strategy if the investment mandate is to be fully invested at all times.
However, if one uses the Fund King method to manage a portfolio that includes these securities – MF, NFLX and SNOFF – along with a range of other diversified ETFs such as TLT, SPY, MDY, EEM, EFA, etc., then you would have a diversified portfolio of choices in which to invest. Using the Fund King ranking system, you would get clear “SELL” signals for these blow up names. Three months ago NFLX was the #2 ranked security in this portfolio, and subsequently lost 67%, and yet this model portfolio keeps sailing.

What does this imply? It implies that trouble in a company is broadcast by its stock price. One does not need to mud wrestle with the financial statements, interview senior management, listen to fund managers and Wall Street analysts. All of that hot air means nothing if investors do not act on it. And in the stock market the only action that matters is clicking on either the “BUY” or “SELL” button. So what the Fund King system can measure is the action at the margins, which has the most material influence on prices. If more investors act on these changes, they tend to become self-fulfilling, creating a recursive feedback loop, and the company share price declines.

Don’t take my word for it. Try it yourself!