Not since 1995 has the S&P 500 not had at least a 10% pullback. Normally, you can count on a 10% pullback within an ongoing bull market to a great time to add funds or bring new accounts online. But 2013 is the year of the relentless rally where 2% pullbacks are new 5% pullback. Extreme bullish investor sentiment which is normally a good barometer of when to ease up on portfolio exposure has been pointless, as previous blog posts have demonstrated.
So, whats going on you ask? Why is this year different from the others and what does it mean going forward?
Markets are clearly being driven higher by the Federal Reserve current policy of Quantitative Easement and its by product of 0% short term interest rates.
Its no coincidence that when the Fed ended QE1 and QE2 markets fell apart with declines of -16% and -19% respectively in 2010 and 2011.
Its fashionable right now to analyze each economic tick (especially the recent positive employment data) to determine when the Fed will end QE3. But the truth is we really don’t have an accurate guess for when that will happen.
Three things we know for sure at the moment:
1. We are in the midst of the strong season for equities and that will last until March 2014.
2. The economy as measured by employment is improving. Contrary to politically biased media outlets job growth is not coming from part time employment. GDP growth in the 3rd quarter was stronger than expected. This is market friendly.
3. Bob Dieli’s Aggregate Spread and RecessionAlert.com are both at benign/miniscule odds of recession. Market friendly again.
My best guess of what will happen? Eventually the Fed must end QE3 and the markets may anticipate this ahead of time by churning nowhere or showing internal deterioration in strength. My thinking is that the Fed will do nothing till at least after congressional budget talks in January but by the time March comes around and temps here begin to melt some snow we should be decreasing our equity exposure in a meaningful way.
A quick update on our current status:
The major market indices are at or near major market highs which will likely be a difficult hurdle to surpass in the near term.
In addition, investor sentiment is extremely positive which has negative implications going forward in stock prices.
To our way of thinking the combination of negative investor sentiment with markets at historical highs implies either a sawtooth churning market with little or no gain or a moderate decline in prices in the near term. We don’t believe at this time that a major market top is playing itself out, we believe based on Ned Davis’s market cycle analysis that a major top is due in the Spring of 2014.
All recession indicators remain in positive territory.
So, we are essentially playing defense for our clients by selling off stocks falling in our ranking systems and raising cash rather than reinvesting on the long side. We have added a significant amount of inverse exchange traded funds that should aid in buffering downside volatility in client portfolios.
Should a decline emerge to the degree that overwhelming positive sentiment is reversed we will reverse our course and liquidate the inverse ETF’s and add new long stock positions for a potential new leg up in the indices that could last to March/April 2014.
Brad Pappas
Investors not satisfied enough with a +23% gain on the S&P 500 they want Ludicrous Speed!
All is not quite copacetic on my stock trading screens, there are two factors that are giving me some angst:
1. The small cap dominated Russell 2000 index is losing relative strength compared to the 100 largest stocks as comprised in the OEX index. For the past couple of weeks my trading screen is green for the Dow and the S&P 500 but negative for the Russell 2000, this is not a good sign. The Russell has been leading for a solid year and while our returns remain strong I’m seeing underlying erosion in the breadth of the market’s never ending advance.
As the chart below reveals the market for small cap stocks is rolling over and could likely be a precursor of a larger market pullback sometime soon. On a positive note: all of the economic timing systems we follow show continued economic growth with miniscule odds of a recession within the next 9 months. Its likely that any pullback, if it occurs will be modest and not the Bear Market variety.
2. Investor Sentiment: There have been very few times in recent memory where my ensemble of sentiment indicators are in the uniform opinion as they are at present. Too much euphoria and not enough fear.
Citi’s Tobias Levkovich in an 11/3 briefing: “The Panic/Euphoria Model is sending a clear warning sign of substantial complacency.”
Jason Goepfert at Sentimentrader.com has in my opinion the most reliable ensemble of investor sentiment measurements and the ones that matter the most are at an extreme.
“Smart Money is clearly becoming more defensive while the infamous “Dumb Money” continues to close their eyes and press the buy button.
On a shorter time scale Sentimentrader.com’s Intermediate term oscillator has shifted to ludicrous speed as well.
What to do now? Time to raise some cash and in certain instances modestly hedge our portfolios. We’re taking a hard look at our existing holdings and curtailing long purchases. We’re very fortunate to have few tax losses to take but we do have several holdings that have been lackluster and are candidates to sell.
We seldom use inverse exchanged traded funds, but in my judgement now is a good time for their consideration. While I may think this market is running on fumes, we only intend to use them in modest amounts since the underlying trend for stocks remains higher and no recession is imminent. Or, just enough to soften the pullback should it emerge.
If you’d like more detailed information please contact me directly.
Be careful out there
Brad Pappas
No positions mentioned
Its late July and the slow season for markets may be settling in but so far its been an astonishing year. The stock market this year reminds me of The Terminator it just never stops moving higher and all sell offs so far have been very minor representing a brief chance to add to positions. Eventually the rally will end but anyone’s guess is as good as mine as for when it will be.
The two websites that we use for determining our equity exposure:
recessionalert.com and nospinforcast.com are both in agreement that no recession is in site for at least nine months from now. So, with that information we remain fully invested in stocks. Expanding economies are generally a negative for bonds and that has been the case for Treasuries as well as for gold. It appears markets are moving back to their normal pre-2008 levels and investors who’ve been under a rock the whole time are putting money back to work again.
Trading for us has slowed down as well which I’m grateful for. Our models are now set in stone and other than very minor tweaks I don’t envision any changes to them as they have been astonishingly effective.
We do have a few recent buys:
American Electric Technologies AETI
Penford Corp PENX
National Technical Systems NTSC
all three score at the top of our ranking system
sold from portfolios are
Mutual First Financial MFSF
Netsol Technologies
Brad Pappas
RMHI is long all positions
Two weeks ago for the first time in a very long time small regional banks started to show up on our model selection list. It was refreshing to see them after a half dozen years in financial Siberia and one of them appears will have a very good short term payoff. Just as in the case of Sun Healthcare in June, we’ve only had a short time to build the position but the position is in place for most client portfolios.
Citizens Republic Bancorp is a small regional bank operating in Ohio, Michigan and Wisconsin.
Our client cost basis is in the $17 t0 $18 range which may not seem like much with the stock now trading at $19.17 up $1.53 on the day. Its the news that matters: CRBC announced it is hiring JP Morgan to seek a buyer for the bank.
Assuming JP Morgan can find a buyer the big question will be at what price. Here we have to dig into the financials of the bank:
CRBC Book Value: $26.53
Capital ratios are healthy and non-performing assets are improving.
Over the past three months insiders have purchased 11,200 shares.
Long CRBC
