Saturday, January 29, 2011

Technical Breadth Indicator turns BEARISH...

Technical Indicators turn Bearish:   
To All readers of the Socially Responsible Investing website:

While I advocate always being invested in the market (see Background Information below), duly note that my Technical Indicators are now saying we're in a Above-average Risk environment.  The indicators turned Bearish on January 21, 2011.

Though, as I'm writing this capital markets of all shapes and sizes (from stocks to commodities) were being agitated by the implications of the Tunisian Turmoil.  As many of you already aware, peoples' demands for freedom have now reached Egypt.  This time the establishment is refusing to "cave in" so easily.  Going forward, Monday's markets may bounce, but the contagion may reach other countries, particularly Saudi Arabia (which has publicly stated its support of Mubarak).  Obviously, that would be a shock to the oil markets, (Strait of Hormuz, etc). Further, the Euro-Crisis remains an unresolved issue.

Behind the Indicators:
The Technical Indicators measure how the average stock is performing compared to the major market indices. For example, if the Dow Jones is performing well but there are more stocks declining than advancing, the indicators would turn Bearish.  A Bearish reading is approximately -3% or lower.

Conclusion: Investors are not being compensated for all the risk they're taking on (witness the low corporate Bond spreads).  By the very least, I would expect higher market volatility. At worst, a correction will ensue.  I do not expect a Bear Market as economic fundamentals are improving (see below).

Note on Economic Growth:  The headline news was that GDP for the fourth quarter 2010 was below expectations (up 3.2% vs 3.5% expectations).  Actually, it was one of the best I've seen in years, looking behind the numbers.  Consumer Spending was good and Final Sales were great, rising 7.1%, and the best since 1984  (this is GDP adjusted for the affects of inventories.).

As a long-term investor, I believe the time for Socially Responsible Investing is now…right NOW.  Long-term investors are not concerned over the current level of the stock market and whether the Market’s going to rise or fall the next day.

I propose investors be “fully invested” in equities most of the time.  Being “fully-invested” is different for different people depending on age, risk tolerance, etc.  As a Heuristic, I suggest being 75% long equities as a “base-case” level.  The remainder would be invested in bonds, real-estate, hard assets, and alternative/exotic investments (e.g., natural gas, platinum, rare-earth anyone?).

With that being said, there are certain times that are better to invest in the market.  Rather than choosing tops and bottoms based on certain fundamental criteria (e.g. price to earnings ratio), I have developed two Market Timing Indicators.  These indicators help me maintain objectivity with regards to my investment positions, as I have no influence on them.  They were designed during late 1992 and have been updated weekly since.

The two major indicators are:

1.    Sentiment:  based on human behavior, and supported by theories backed by Behavioral Finance. 

2.    Technical:  which measures market breadth, or underlying strength in the broad market.  This indicator was Neutral-Slightly Negative early Jan'11, but turned Bearish on 1/21/11.

These indicators are used to obtain my Portfolio's Investment Position.  Note, they do not know, or represent market levels.  They are measures of perceived risk, especially the Sentiment Indicators.  I have often taken mental notes of how everyone seems to clamor to buy things when their expected rate of returns are minimal compared to their inherent risks. 

This website will include three simple colored (traffic) signals.  Green for “Buy” (i.e, low-risk levels) which means allocate your portfolio to a fully-invested equity position.  For me, that’s about 75-80% invested, but it could be lower for a more-risk adverse, or retired individual.  Yellow, means caution, risk levels rising.  Red means “High-Risk”; investors should reduce their investment positions to conservative levels perhaps 30-40% equity.  The remainder could be in treasuries, gold, high-grade corporate bonds, etc.

Feel free to contact me for additional clarity or to answer other questions.

Helios and Matheson: I’ve seen this movie before, and it ends badly !

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