Posts Tagged 'SPY'

Why I’m Getting Ready to ‘Go Away in May”

The attached article was published at on 5/2/2013. While the market continues to show technical strength, key economic data is deteriorating. While we remain fully invested, we are rotating portfolios to lower risk holdings.

The data looked good until the last half of April. Now the five factors needed for a continued rally have taken a decided downturn, prompting one advisor to move into a low-beta strategy and collect dividends over the summer. His advice? Watch SPLV and JNK very closely.

Recently we’ve seen a turn in economic data that may be showing a soft patch ahead for our economy. But with a plethora of data to choose from, which data really matters?

In the past I’ve used a study by Citi equity strategist Robert Buckland that suggests that after a significant increase in the market, there are five factors that determine whether an existing rally can continue.

But before we look at that data, let’s first take a quick technical look at where we are according to three indicators: SPY (SPDR’s S&P 500 Index tracking ETF), SPLV (PowerShare’s S&P Low Volatility Index tracking ETF), and SPHB (PowerShare’s S&P 500 High Beta Index tracking ETF).

Below is a year-to-date candlestick chart of SPY, with the 200-day simple moving average (SMA) in yellow. SPY is clearly trading well within its uptrend—as indicated by the white lines—which started in November of 2012.

Despite the media’s Chicken Little reaction on every down day, the candle chart provides a quick visualization showing that volatility also appears to be well within a “normal” range. And, finally, SPY is trading well above its 200 SMA, a common indicator of the strength and future direction of the market, as long as the 200 SMA also continues to show an upward trend.

Figure 1:SPY 12 Months

Horsesmouth: Why I'm Getting Ready to 'Go Away in May'


In Figure 2, below, I’ve added SPLV (yellow line) and SPHB (blue line) to the graph of SPY (green and red line). I’ve also changed the time frame to a year-to-date view. The white trend line shows that SPHB has turned negative since about mid-March, while SPLV has continued to show gains.

The result has been a relatively flat SPY. This shows a definite rotation from riskier high-beta stocks to lower-risk, lower-volatility stocks. While this is a “risk-averse” move, it is significant that SPLV is still showing a positive trend. Investors to do not appear to be concerned about a broad market sell-off but are apparently (and logically) looking for the lowest-risk securities—probably as an alternative to near-zero-interest-rate bonds. More dividend-paying securities will be in the SPLV index than the SPHB index.

Figure 2: SPY vs. SPHB vs. SPLV Year-to-Date

Horsesmouth: Why I'm Getting Ready to 'Go Away in May'


This is a graph I look at on a weekly, if not daily, basis. We moved out of SPHB and into SPLV for our Seasonal ETF strategy at the beginning of April. I will get very defensive if SPLV starts showing a downtrend along with a continuation of SPHB’s down trend.

Back to the fundamentals
While a rotation from SPHB to SPLV could just be an indication of investors looking for yield, it could also be an early warning sign of bad things to come. Do the fundamentals warrant a continued rally or a sell-off?

Let’s use Citi strategist Robert Buckland’s five criteria for a continued rally to help us determine whether this upturn might continue. We rank each criterion as a positive, negative, or neutral development:

  1. Lower-than-average starting valuations: Neutral. Reuters dropped 2013 earnings projections to $114.01. This gives the market a 13.9 forward P/E—a decidedly average number. I lean to a neutral position because historic low interest rates would normally account for a higher P/E.
  2. Double-digit EPS growth: Fail. Year-over-year earnings growth is now projected at a paltry 3.75%. estimates that top-line revenue growth will be flat for Q1 2013.
  3. Rising PMIs: Fail. Markit Flash PMI came in at a 52 reading on April 23. While still a positive number showing economic expansion, it is lower than the previous reading of 54.6.
  4. Higher U.S. government bond yields: Fail. The yield on the 10-year Treasury has dropped from about 1.88% to 1.7% in the month of April.
  5. Sustained flows into equities: Negative. According to, the week ending 4/24/2013 saw a negative flow from mutual funds of -7.3 billion. This was only partially offset by a positive flow into equity ETF’s of $1.1 billion

When I looked at this data in February, all five criteria were positive. Looking back at the economic report tables, I’d say this data has been fairly positive until just the last half of April.

And that’s the problem with economic forecasting. At inflection points, it is impossible to know whether or not a turn in data is an aberration, a temporary blip, or the beginning of a trend reversal. The one point that keeps me mildly optimistic is that virtually every forecaster predicted a soft first quarter for 2013. So this has not been a surprise.

Investment strategy
I follow the “sell in May” strategy supported by The Stock Trader’s Almanac and their research. However, we use a low beta strategy instead of cash for the “go away” period. As I noted earlier, we replaced SPHB with SPLV a month ago. I would expect that we will have completely rotated into our summer low-beta holdings by the end of the week.

For our dividend portfolios, we have already adopted a low P/E screen to our holdings. I hope that a relatively low valuation and high dividend yield combination will prove to be a solid defensive strategy as well as providing reasonable gains over the next several months.

What I’ll be watching
For our seasonal strategy, we simply will not get more aggressive until the October/November time frame. We’ll collect dividends over the summer. However, we can—and will—get more defensive if conditions warrant. At this point, I am watching SPLV very closely. If it establishes a negative trend along with SPY and SPHB, I will be very concerned. I would look at the equity fund flow data to confirm that interest in stocks has waned to dangerous levels. In our dividend strategies, I hold JNK (SPDR Barclays Capital High Yield Bond ETF) for a combination of yield and as a tactical position. JNK continues to provide a slow but steady appreciation in its NAV. However, I am very nervous when high-yield debt is only paying a 6.01% yield (JNK yield from as of 4/28/2013). If JNK stalls or turns negative, we will move this holding to cash very quickly.


Can The Market Rally Continue?

The following article first appeared at: on 2/14/2013.

Given the recent market highs, are we at the start of a new bull market or wrapping up an old one? We seem to be meeting the five critical conditions for continued gains, but that doesn’t rule out a 10% correction.

 Much has been said about the S&P 500 breaking through its former daily high set in 2007. The question seems to be whether this is the end of a bull market or the start of a new one?

First, let’s put this into perspective. Below is a chart of SPY, the SPDR’s S&P 500 Index tracking ETF, showing monthly returns since 1997. Many pundits like to point out that we have been in a four-year bull market, and therefore, this rally is extended and due to come to an end. This is simply false.

What we have been in for four years is a <i>bear market recovery</i>, as anyone who invested prior to 2008 can tell you. We have simply had a four-year long slog to recovery from the crisis-induced crash.

Figure 1: SPY Monthly Returns (1997 to Present)


 Source: [ Free Stock Charts]

 Second, from a longer-term secular reference, we have really been in a 13-year bear market and recovery cycle dating back to the 2000-2002 tech wreck market crash. Since the market peak in March of 2000, we have <i>not gone above, and stayed above</i> that level for 13 years now. This is the definition of a secular bear market.

The good news is that secular bear markets do end.

Know your P/Es

Below is a chart from Crestmont Research showing the history of secular markets in the U. S. since 1900. As you can see, the market’s history consists of long periods of rising markets (green bars) followed by relatively flat periods (red bars). However, “flat” describes the period from the beginning to the end of the period. Flat periods–or secular bear markets–can be filled with large declines and recoveries.

Figure 2: History of Secular Markets


Source: [ Crestmont Research]

 My point is not that we are at the beginning or end of a bull market. My point is simply that just because we may have re-attained prior market highs, it does not, in and of itself, mean much of anything as to which way this market goes from here. It is simply not that simple. But it makes for good headlines.

Positive trends

So what would give us an indication as to the market’s next move? Citi equity strategist Robert Buckland recently released a study in which he looked at prior 20% rallies that were then followed by double digit gains. This seems to be narrowing in a bit on our current situation, and may add some relevance to our current market high.

He found that to see continued gains, the markets must meet five conditions:

  1. Lower than average starting valuations
  2. Double digit EPS growth
  3. Rising PMIs
  4. Higher U.S. government bond yields and,
  5. Sustained flows into equities

Let’s take a quick look at where we stand relative to Mr. Buckland’s criteria.

  1. Lower than average starting valuations. According to Zacks, Q4 2012 earnings are coming in slightly better than expectations. More importantly guidance has been positive. Standard and Poors estimates Q4 earnings will be $23.83. If you annualize that number you have a P/E ratio of about 15.7 or pretty close to the long term average. While average is certainly not “low,” we have to give some accounting for “QEfinity” with historic low, albeit manipulated, interest rates. A 15.7 P/E is reasonable, but not where historic bull markets start. On the other hand, again considering interest rates, a bull market should be able to break through a 20 P/E quite easily if the other conditions exist.
  2. Double digit EPS growth. Standard and Poors is currently projecting a 17% year over year growth in S&P 500 earnings for 2013. While estimates have been coming down, they have a long way to go before dropping below a double digit estimate.
  3. Rising PMIs. Below is a chart of current and trend results for PMI and its components as reported by Markit, a London-based CDS specialist. PMI is growing “faster” based on a two-month trend. While I wouldn’t bet the ranch on a two-month trend, this does meet the criteria for a continued rally.

Figure 3: Manufacturing at a Glance (January 2013)


Source: [ Markit]

 Higher U.S. government bond yields. This would seem to be both the hardest hurdle and the most counterintuitive. With the Fed buying $85b of paper each month, they would seem to have the ammunition to keep yields low. And most pundits equate rising interest rates as one of the risks to a continued bull market. Below is a chart of the yield curve from Stock Charts.

The black line indicates the current yield curve. The lighter areas show the curve over the last 50 days — darker shaded areas being the most recent. Clearly we have seen a steepening of the yield curve resulting from rising rates.

Figure 4: Dynamic Yield Curve


Source: [ StockCharts]

 Sustained flows into equities. Figure 5 is a chart from Citi showing flows in bonds and stocks. There has been a clear flow of money to stocks since about mid December.

Figure 5: Weekly Bond v. Equity Fund Flows


 Here are some of the numbers from the third week of January:

  • Total equity inflows were $22.2 billion, the second-largest ever.
  • Inflows into long-only equity funds were $8.9 billion, the largest since March 2000 and the fourth-largest ever.
  • Excluding ETF flows, inflows into equity funds were the largest since May 2001, and the first over $5 billion since April 2003, according to Goldman Sachs.
  • Emerging market equity inflows were $7.4 billion, the largest in history.

The rally is on, but…

Current trends definitely support the case for a continued rally, based on Mr. Buckland’s research. The “but’s” would be that the current P/E is not historically low, some “trends” are really too short-lived to comfortably assert that they are in fact trends, and there still are some major macro events lurking on the horizon (will Europe ever be fixed?).

That said, in practice we remain cautiously optimistic. With one short term caveat: the market (SPY) does appear to be at the top of its short term trend line. A 10% correction could take place without violating the current intermediate uptrend as you can see in Figure 6 below.

Figure 6: SPY Trends


Source: [ Free Stock Charts]

Market in Perspective

You would think that the markets have been through the greatest rally of all time, and the biggest crash – all over the past 2 ½ months from the way the news has been reporting on the market. Of course heading into the home stretch of a fairly contentious Presidential election doesn’t do much too calm things either. Not to minimize the importance of global events, but the U.S. stock market is a reflection of the U.S. economy. We all already know about the fiscal cliff. Earnings expectations are low for the third quarter. Economic data has been “mixed” for months. So with all of this priced in, where exactly do the markets stand?

The chart below in Figure 1, was a bit of an eye opener to me. The graph shows the total return for each market rally – post a 30% or more market decline, since 1900. The “You Are Here” dot is in the bottom left. So on a long term horizon, the post-financial crisis rally has barely started. However, just to the right, is the “2002 blue dot.” Which shows that, by comparison, if this is another bear market rally the market could well be at an intermediate top.

Figure 1. Stock Market Rallies


For perspective I find it best to look out over the longer term and then narrow the time frame. One of my favorite charts of all time comes from In Figure 2 below, Crestmont does a wonderful job of breaking the market down into bull and bear cycles. Clearly the market moves up in spurts, (secular bull markets), and sideways (secular bear markets), for extended periods of time.

Figure 2. Secular Bull and Bear Markets


From this perspective the secular bear that started in 2000 is painfully obvious. It’s also hard to define the current market as in either a bull or bear phase. Yes, we’ve had a four year rally, but hardly to levels you could define as “high”. In terms of time, it would be prudent to start anticipating a return to a secular bull, but both the 1902 and 1965 Bear markets lasted longer – 18 years and 15 years respectively.

Zooming in on the past decade simply confirms Figure 1 and 2.

Figure 3. Spy 1996 – Present, Monthly


While the rally has been formidable, it is not unique. The pre-2000 rally was sharper and from lower levels. And we have not quite hit the 2007 peak. What is interesting for perspective, is that the last leg of the pre-financial crisis rally saw 13 out of 16 months posting positive gains. This past bounce of four consecutive positive months is by comparison hardly “extended.”

And finally let’s zoom in on a closer look. Figure 4 is a year to date look at SPY. While the current level seems “high,” again looking at Figures 1-3 all we can say is the market has had a decent recent run, but there is nothing here to say whether the market is “high” or the rally is getting overextended after just 3 months.

Figure 4. Spy Year to Date, Daily


Points that I’ve highlighted:

  • In April – May of this year you had a solid double top before the market gave way into the early summer. Double tops are one of those technical formations that do tend to be significant – if only because everyone expects them to be.
  • To the right I’ve highlighted the recent high with a horizontal line. The highlighted area also contains a continuation of the current trend line. Ideally the market breaks through the horizontal line, and peaks, no earlier than, the rising line around the point of the green arrow, before we start seeing a bit of a correction. This would indicate a significant break through resistance and avoiding the double top.
  • An alternative is that the market hits the horizontal line and falls. This will immediately bring warnings of a sell off from the media – citing the double top in April – May.
  • Looking at the channel formed by the rising lines, the market is in a definite bull trend. The fact that the last two bottoms were well above the bottom support line is very bullish. How it reacts to resistance at 147.50 will be interesting.
  • A drop should only be to 143.30, before a pause and re-assessment.
  • The 200 Day Moving Average is in Blue. The first sign that a sell off will be significant will typically be when the 200 SMA begins to slope down – that is a long way away; currently 136.38.
  • The last candle on the chart (Monday 10/1/2012, 2:30pm), is a negative formation. If the market doesn’t rally into the close, we could be testing support (bottom rising line) before we test resistance.
  • While October is historically volatile, the fourth quarter is historically strong in election years.

Despite what I would consider to be horrible news in the mid-East and Europe, reasonably bad news from China and Japan, and decidedly contradictory news in the U.S., this appears to be a market that really wants to go higher. Even the bears have to admit that with recent news and data, this market really could (or should) be much lower.

The fundamental positives seem to be that:

  • P/E ratio is stuck at “average”. While bull markets tend to originate from single digit P/E’s, Bear markets start at P/E’s closer to 20 than 10. According to the trailing S&P 500 P/E is 16.77 and forward P/E is 13.98. Considering the Fed has pledged a zero interest policy through 2013, or until unemployment is at “acceptable” levels, a P/E closer to 20 is justified using a discounted earnings calculation. Don’t discount the distortions caused by Fed intervention.
  •  Earnings expectations for the third quarter are low. Contraction across most sectors is expected. It’s easier to beat low expectations than high ones.

The negatives: virtually all things macro and political.

Portfolio Strategy
For our Growth strategies we have moved into out seasonally strong, higher beta portfolio. If October becomes too dicey I can sell our two most liquid ETF’s (IWO and IWP) and go short (SH) to hedge the portfolio. With two of ten holdings being GDX (Gold Miners Index) and UNG (Natural Gas Index), we’d then have a very low correlation to the market if I do need to hedge. But for now I’m in the bullish camp through the end of the year.

Ditto for our Dividend strategies, I’ve moved into more aggressive and higher yielding names. Again with selling of just two securities I can hedge the portfolio by buying SH. Even with 5% cash and 20% in non-yielding SH the portfolio will have a 4.5% dividend yield to coast through trouble. But if the market behaves itself in October, we should be set through the end of the year.

Bottom Line
Positioned for a continuation of the rally, but ready to hedge if fundamentals become too strong of a drag. I need evidence from the market before I get Bearish.

Market Outlook

A strong technical indicator looks to be approaching fast – the 200 day moving average as seen in the chart below. From a technical perspective, in a declining market the 200 SMA is seen as the last line in the sand. The bullish view is that the market will “bounce off” and start a new rally. The bears see a cross over, or drop below the 200 SMA as the start of a major correction – defined as a 20% drop. Of course there are two ways to play it. The Bulls will recognize that there is likely to be selling if SPY crosses under the 200 SMA and will see this as a significant buying opportunity. Bears will see this as the final line of support, and if it is crossed, they will accelerate their selling. Either way, I don’t see any reason to stand in the way; this is not a time to buy as an investor. Better to sit back for a week or two and see how this unfolds. • 937.434.1790

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Charles H. Dow Award Winner 2008. The papers honored with this award have represented the richness and depth of technical analysis.