Secondary or Cyclical Bull Market? Part II

From Investment Postcards from Cape Town, some related analysis to the Ned Davis article I posted earlier on whether we are in a cyclical or secular bull market:

Ever since Richard Russell (Dow Theory Letters) called a “Dow Theory bull signal” last Thursday, the debate has been rekindled as to whether the US stock markets are experiencing a primary (secular) bull market or a rally within a primary bear market, i.e. a secondary or so-called cyclical bull phase.

As mentioned previously, Russell views the March 9 low as a secondary low, saying: “We are now in a cyclical bull market as opposed to a secular or primary bull market. In effect, we’re in an extended bear market rally. The true bear market bottom lies somewhere ahead.”

Irrespective of terminology, 64% of the readers of the Investment Postcards blog see the current phase as one characterized by “irrational exuberance”, as gleaned from a quick poll a few days ago.

As always, there are various signals pointing in different directions. The 200-day moving average of the S&P 500 Index just three days ago turned up for the first time since January 2008, after having been breached upwards by the Index in early June. The 200-day line is generally seen as a key indicator distinguishing between a primary bull and bear market.

Also, when considering monthly data, three momentum-type oscillators (school:glossary_r#relativestrengthindexrsi">RSI, school:glossary_m#macdmovingaverageconvergencedivergence">MACD and school:glossary_r#rateofchangepercent">ROC) are reversing course for the first time since the sell signals of 2007 and now either indicate buy signals (or are getting close to a signal in the case of MACD).


Rosenberg: Employment Key to Asset Allocation

Some good points from David Rosenberg regarding how/when to allocate assets based on employment:

Let’s examine the historical record back to 1950:

The S&P 500 bottomed before employment bottomed 100% of the time. Let’s not bet against that. It is imperative, therefore, to have a forecast for a bottoming in employment in conjunction with a forecast for the stock market.
On average (median too), the S&P 500 bottomed six months before employment hit bottom. The range is between four and 11 months.
On average (again, the median too), the S&P 500 rallies 20% from the time it bottoms to the time that employment hits its trough.
Another way to look at it, in that six month interval between the bottom in the market and the trough in employment, 60% of the bear market is reversed on average; 45% in terms of the median. In periods when the bear market was during an asset and credit cycle as opposed to a manufacturing inventory cycle, the reversal was 35% of the prior bear phase.
On average, if you decide to wait until employment bottoms to go long equities, for a ‘confirmation’ that the lows have been turned in, you only missed 20% of the total bull market; there was still 80% left to go. Missing that first 20% isn’t the end of the world as long as you are putting cash to work prudently. For example, investment-grade corporate bonds typically generated a total return of nearly 10% (and 5% for Treasuries) during that interval between the equity market bottoming and employment finally doing likewise. Keep in mind that it is always nice to use perfect hindsight — there is more than one occurrence when the market thinks that employment is set to hit bottom … and gets it wrong. That is why it pays to wait just to make 100% sure that the employment backdrop does improve, at the cost of missing one-fifth of the bull market. What you get in return is a piece of mind that the rally has legs, and you still have 80% of the run left to go!

Let’s examine all the above in the current context:

The analysis would be consistent with the view that the March 2009 low will hold even upon retest, if employment manages to bottom this quarter (that is an important caveat).
The S&P 500 bottomed in March, which was 4 months ago. It would be unusual but not unprecedented to have employment go down beyond another two months from here. But if employment is not recovering by the fourth quarter, it would probably put the equity rally at great risk.
The S&P 500 has already rallied 45% from the lows, which is unprecedented in the context of sustained job loss, at least in the post-WWII era. The most the stock market ever rallied during a period of declining payrolls was 28%; so far, the rally has been double what is normal, even assuming that the jobs downturn is in its last stages (based on percent increases off the low, the S&P 500 would have hit a wall at 810 based on past performance — this shows how overextended the current rally has become).
Of course, from a bear market reversal standpoint, we have already hit the 35% mark so far this time around, which is the average of what is normal in asset and credit cycles. In other words, the market is already more than fully priced for the end of the employment downturn.
From our lens, it pays to wait for confirmation. The cost of being early and wrong as was the case in 2002 is too high, especially when corporate bonds offer better return potential for the risk and volatility involved. While Baa spreads have finally broken below the peak of the last recession (currently at 335bps), and while they are likely not going back to historical expansion norms of 150-200bps and may have just 50-75bps of spread narrowing left (ie, three-quarters of the spread compression or the “low hanging fruit” is over), the sector is still priced for flat-to-slightly-negative GDP growth and as such still has protection against any possible economic setbacks. At current valuation levels, however, the equity market, which is now operating on a massive momentum tailwind, offers no such insurance policy if the third quarter inventory bounce proves to be nothing more than a one-quarter wonder and the employment recovery is delayed into next year.

Ned Davis Research: Cyclical–not Secular–Bull Market

Compliments of The Big Picture via Mark Hulbert:

Mark Hulbert looks at the question of whether this is a once-in-a-generation stock market low (secular bull market) or a mere “cyclical” low.

To figure out which, he looks to Ned Davis of Ned Davis Research. NDR identified seven factors to determine if any given market low is a secular low, setting up the next lasting Bull Market.

The Seven Factors: There should be:

1. Money, cheap and amply available;
2. Debt structure that’s been deflated;
3. Large pent-up demand for goods and services;
4. Stocks that are clearly cheap;
5. Investors who are deeply pessimistic;
6. Major investor groups with below-average stock holdings;
7. Fully oversold, longer-term market conditions.

Looking at these elements, how does this cycle measure ?

1. Cheap Money? Neutral. You might think that this factor should be rated as “bullish,” given how accommodative the Federal Reserve is currently. But Davis notes that banks are also significantly tightening their lending standards. Given the heavy load of debt under which both consumers as well as corporations suffer (see next criterion), banks are finding it “increasingly hard to find ‘credit-worthy’ borrowers.”

2. Debt structure deflated? Bearish. This is the most negative of any of Davis’ seven dimensions, since by no means is the debt structure deflated. On the contrary, Davis calculates that the total credit-market debt load right now is nearly four times the size of gross domestic product, and that it takes more than $6 of new debt for our country to produce just $1 of GDP growth. That’s almost double the amount of debt required in the 1990s.

3. Pent-up demand? Bearish. Davis acknowledges that there has been improvement along this dimension from where things stood at the beginning of the bear market. But he is particularly worried by the ratio of total Personal Consumption Expenditures to Non-Residential Fixed Investment, which currently stands at a record high. At the secular bear market low in 1982, in contrast, this ratio was at a record low.

4. Cheap Stocks? Neutral. Though the stock market “got undervalued at the March lows,” it never became “dirt cheap.”

5. Sentiment? Bullish. Davis says that past secular market lows were accompanied by an extreme amount of pessimism, and his indicators show a similar extreme existed earlier this year.

6. Stock vs cash reserves? Neutral. While foreign investors have record-low stock holdings, according to Davis, household holdings — while low — are not nearly as low as they were at prior secular bear market lows. And institutional investors’ stock holdings “are only down to an average weighting historically.”

7. Oversold longer-term market condition? Neutral. Davis believes that, though many of the excesses of the real-estate bubble have been worked off, some still exist. That’s particularly a problem, he says, given that the stock market bubble of the late 1990s never completely deflated either. “As we saw in Japan after 1990, a double-bubble in stocks and real estate leaves it difficult to put ‘humpty dumpty’ together again.”

According to Davis, there is but one of the seven foundations of a major secular bull market in place. Three are neutral, three are bearish.

Conclusion: This is a Cyclical Bull market . . .

Rosenberg: March 6th May Not Have Been the Low (!?)

Yes, David Rosenberg thinks March 6th may not have been the low. The growing consensus is that it was. Here’s what he has to say:

Were the March 6th lows the real lows? We want to keep an open mind but after
a 45% runup one would think we would see some sort of corrective pullback —
or at least a retest. It seems so unlikely that March 6th was the fundamental low
because the market was trading at 2x book, with a 13x multiple on forward
earnings and 18x on trailing, and a 3% dividend yield. Those valuation metrics
do not exactly smack of a true market low.

From our lens, the market seems to be complacent and there are three major
risks looming:

1. A possible Chinese bubble bursting again
2. The tension between Israel and Iran (not to mention the White House)
3. The possibility of a spread of the H1N1 pandemic just in time for back-toschool

All this, at a time when the contraction of credit is ongoing.

Diagnosing SPY

I wrote a couple of days ago about how the market (S&P 500) was reaching–and has exceeded– some level of ‘fair’ value. However, price momentum is still strong, leaving an investor to wonder whether the fundamentals or technicals will be first to catch up (down) to the other.

Using Fibonacci retracements on a weekly chart of SPY, the significant 50% retracement level exists at a price of $112.31. In addition, as highlighted by the oval, a gap exists in the $107-110 range. Technicians generally believe that gaps tend to fill. The question with SPY is at what point this gap will fill and near the 50% retracement level. An investor could be ‘correct’ and still have to wait months or years for vindication.

One additional tool an investor can use to get a better sense of when to buy/sell is to use moving averages. On the weekly chart, we see that the 40 week moving average, a good long term indicator, has finally begun to go up. In addition, SPY is now trading above the 40 week average, a bullish sign for investors (it is also trading above the 40 week exponential average, not shown). In addition, the 20 week average is now trading above the 40 week average and SPY is trading above both averages which indicates a bullish trend. I previously featured the history of this strategy here.

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I am skeptical about the fundamentals underlying this recent rally. It feels ‘too fast’, and I sense that is the consensus from the investments commentators. This could tell us something in itself. If the consensus was always right, we’d all be rich.

The ultimate question for the common investor is what to do. Using SPY as an example, we get conflicting signals. The fundamentals are not very exciting but the technicals are very encouraging. One course of action would be to diversify your strategies. Have a small portion of your portfolio dedicated to buy and hold, which will give you constant exposure. Use a moving average strategy to catch major trend movements and avoid many of the major declines and also consider a momentum strategy to capture momentum and shorter term trends.

Managing these systems can be time consuming, so for free monthly updates and other commentary please visit Scott’s Investments.

You can also use the free tools at to help get trend analysis of SPY or any stock/market emailed to you at the click of the button, Here

New Strategy Link Added to the Right Hand Side

I added a new link under ‘ETF & Timing Portfolios’ on the right hand side. It is a link from with daily updates on the 10 and 12 month moving average buy/sell signal on the S&P 500 and 5 ETFs, DBC, VNQ, IEF, VEU, and VTI (inspired by The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets). Check his site out, he does great (free) work!

Just as an aside, any time you see a link to a book on this blog and click on it you will be directed to Amazon. The price of the book is the same, but if you buy the book after getting to it from this blog, Amazon will buy me a cup of coffee. So if you have any intention on buying Faber’s book, please follow the link above!

Rosenberg: Cautious on Commodities

David Rosenberg, while still bullish on commodities, is getting somewhat cautious:

We have been and remain long-term commodity bulls, but over the near-term, caution may be the watchword. The reason for this is because China is the key demand-driver for the group and Steve Roach pens a fascinating but disturbing assessment on page 22 of the FT after years of being rather bullish (see I’ve Been an Optimist on China. But I’m Starting to Worry). Basically, what it boils down to is short-term-ism in the fiscal stimulus package, which has re-engineered a credit bubble (bank loan growth is running at a record pace over the past six months and is three times the pace of a year ago) and the public sector capex drive has accounted for 88% of Chinese GDP growth so far this year (double the contribution over the past decade) — this is clearly unsustainable. According to Mr. Roach, China accounted for an amazing two percentage points of global GDP growth in the second quarter, which helps explain the export bounce in the rest of the continent. Unless private sector investment and personal consumption begin to take over, the prospect of a reversal is not trivial.

If you agree with Rosenberg, one way to play this would be to short (or sell, if long) commodity ETFs such as DBC. Otherwise, keep an eye on the China market as a whole with ETFs such as FXI or GXC. I’m not one to get in the way of a trend and China has been hot this year, so if you’re looking to short China or commodities wait for confirmation, such as a drop below a long term moving average like the 200 day and for the love of God, use stops! You can also use FREE trend analysis, emailed to you daily, to help make any buy/sell calls (I personally use this service). Just click here.

S&P Trading Above Fair Value, Now What?

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Jeremy Grantham proposes that we are now trading above fair value on the S&P, which in his July quarterly update he states is 880. Some supporting evidence can also be found in the following chart courtesy of, which uses the P/E10 which divdes the price by the 10-year averages of earnings. According to dshort the historical average is 16.3. Historically I doubt we have seen the amount of deleveraging we have and will continue to experience for the coming months, if not years, thus it is a bit worrisome that we have already moved into ‘slightly’ overvalued territory :

From David Rosenberg
(pdf), we see some analysis of the current fundamentals. Certainly not the only opinion available, but it does offer a summary of the earnings/revenue differences in this quarter’s earnings calls and calls into question the amount of earnings growth currently being priced into the market:

Much is being made of the fact that over 70% of U.S. companies are beating their low-balled earnings estimates, but the majority are still missing their revenue targets (as per Verizon and Honeywell in yesterday’s reports — top-lines down 6.7% and 22% respectively). Even so, a momentum-driven market will always be driven by just that — momentum; and there’s no doubt that investor risk appetite is being whetted. But after paying for the end of the recession in May, the market is now pricing in 40-50% earnings growth for next year, and while costs have aggressively been taken out of the system, this sort of unprecedented profits revival can only occur in the context of a V-shaped recovery, which we give 1-in-50 odds of occurring.

Where does all this leave the average investor? It is certainly possible that the momentum currently in the markets may lead to overvalued levels and could do so for some time. However, momentum could also change quickly and without notice.

Perhaps the best strategy for the average investor is twofold (well, threefold if I include turning off CNBC, but I digress): Diversify your positions and diversify your strategies. Holding some core positions in diversified markets both as a buy and hold strategy and also using alternative strategies, such as a moving average or momentum strategy, that capitalizes on the momentum of the market while setting clear exit rules when the market turns. For some ideas on core buy and hold portfolios, please visit a previous post, which featured ETF portfolios that held, among others, VTI, VEU, BND, VNQ, and DBC. Please also remember that additional free trend analysis for these stocks and more can be found Here

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Positive Technical Analysis

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Some good technical analysis from Kevin Lane, compliments of Investment Postcards From Cape Town, which puts some positive light on the light volume rally. At one point will the technicals and the fundamentals sync?

The comments below were provided by Kevin Lane of Fusion IQ.

As can be seen from the weekly S&P 500 chart, the Index finally closed above resistance (green line) and its intermediate-term downtrend line (red line). The significance of this is that on numerous occasions prices were repelled at these levels, suggesting there was still some overhead supply. However the ability of the S&P 500 to move above these levels now suggests that large overhead supply is no longer present and prices could rise as buying demand outstrips supply.

The only negative associated with the rally thus far is the declining volume (participation); however, we attribute a good portion of the decline to the typical seasonal summer slowdown in trading activity. With the current rally breaking out to new post-low highs, sentiment is surprisingly cautious and anecdotally every market newsletter author and person with an opinion are looking for a reason why prices have to correct as opposed to continue higher. As we have all seen, the market rewards the minority and confounds the majority, and currently majority opinion is still sceptical and not embracing this advance.

That said, we do recognise it is summer and historically the odds would suggest softer prices not higher ones; however, breadth has been good and the tape has good upside momentum behind it.

To balance the need for respecting the historically weak seasonal trends of the summer and still being on the right side of the tape, we suggest making sure your downside risk plan is in place in case seasonal trends do prevail against tape strength.


Source: Kevin Lane, Fusion IQ, July 27, 2009.