The Bear-o-meter is a risk/reward measurement tool that I’ve been using since 2013. It’s a compilation of indicators falling under general classifications of:
- Breadth
- Value
- Trend
- Breadth momentum
- Sentiment
- Seasonality
As many of my regular readers know, the Bear-o-meter assigns risk on a scale of 0-8. A reading of 3 or under is generally a higher risk market. A reading of 3-5 is about “average” for a risk/reward tradeoff. Anything 5+ is considered lower than average risk. The illustration below shows us that a rating of 3, or 5, is kind of borderline. As I have noted in the past, this scale measures potential risk vs. potential reward. A low risk reading (above 5) doesn’t mean there is no market risk. A higher risk reading (below 3) doesn’t imply that doom is immanent. Both risk and reward are present on the market at all times. Its the relative degree of that risk that is important. We adjust our cash holdings and the beta of our securities with the risk displayed by the Bear-o-meter.
Last month, the Bear-o-meter read “3”. That’s a higher risk reading. To quote myself in the October Bear-o-meter blog: “This might suggest more volatility ahead.” Interestingly, the reading was also “3” in September, and that month was also volatile. These readings were useful in steering us towards holding a bit more cash. As such, we dampened a significant amount of the volatility over the past two months. I hope some of you find my monthly readings of this indicator helpful in your own investment strategy.
This month, the Bear-o-meter reads a very bullish “6”.
The 3 points that moved the needle from bearish to bullish were seasonality (which adds 2 points every November, then goes back to a “0” score from May to November) and a positive move by the VIX. The VIX chart below shows us that volatility reached a level where my research suggests the market has become overly pessimistic. Its a contrarian indicator, so high pessimism is a bullish factor. I noted on this blog that I traded the VIX in the ValueTrend Aggressive Growth Strategy -buying a VIX ETF when the VIX had declined in early October then selling it last week. Here’s the VIX chart.
Another positive for the markets comes out of the old Dow Theory tenant that looks for confirmation between the TRAN and INDU. I tend to look for trend divergences in my own twist on this concept. The chart below illustrates my historic annotations between these trends. Note that such divergences are pretty good at timing pullbacks when the TRAN (black) line divergences negatively against INDU (red line). I assign a negative point when that happens. Although it doesn’t add a positive point to the Bear-o-meter, I did note a positive divergence between the Dow Transports – which have seen a rising peak lately, vs the Industrials, which were more or less flat (actually, a slightly lower peak in October vs the summer). The chart below illustrates that this is rare. It happened in 2016. This spurred on a strong bull market in both indices in 2017. So the transports can be a leading indicator, and right now they suggest a positive move going forward.
The rest of the factors were identical from October. The smart/dumb money indicator remains in bearish territory, although I must point out that the indictor is moving higher towards a positive reading.
Conclusion
There may be some shake, rattle and roll over the next week or so as election jitters hit the markets. But its looking pretty bullish from a quantitative risk/reward perspective at this time. We bought a couple of stocks on Friday’s test of 3200 support – noted on this blog. We are still sitting on 26% cash in the Equity Platform at this time. My intention is to be fully invested in the coming week or two, assuming some sort of clarity concerning the US election. The stage is set for a bullish winter.
9 Comments
You like value; any particular names you fancy?
While I won’t give specific stock recommendations on this blog- I would suggest you do the following:
Go to the iShares US website and look at the holdings of JKF (the value ETF). Chart the names, pick your favorites
You will find a fair number of US banks, and energy there. We are light on oil, but will be buying into the sector as technical signals suggest a change in trend.
We bought an initial chunk of US banks, and will buy more going forward.
We do NOT like REIT’s. We do like grocery names here. Infrastructure too.
The best way to do things is to find value ETF’s and go thorough the charts. And pick an easy index like the TSX 60 and go through those charts one at a time. Look for stocks that fell, and have based and are showing signs of stability or, even better, progressively higher trend even if its slow.
Tomorrow (Wednesday Nov 4) I am doing a webinar for the MoneyShow at 2pm EST. I will present a few names on that seminar. I recommend you watch it.
Thank you Keith for your excellent article as always. You’ve mentioned oil as a contrarian play, what are your thoughts on cannabis? It seems to be basing at the moment. Are there any signals you would look for before legging into this sector?
Funny you should mention that Wanda. We bought a small position in a Canadian-focused cannabis ETF for our Aggressive Strategy. We feel that the Canadian stocks are overlooked vs. the USA counterparts –which have rallied on a potential Biden win.
Glad to see a positive Bear-O-Meter. And I’m glad to report I’ve had a very good year. I was in the midst of rebalancing last March when Covid 19 hit. I happened to be 25% cash at that point and was able to hold off purchasing till the turnaround, which I accomplished using some of your methodology. Thanks.
Re your reply to Vance, just for the fun of it, I looked up iShares Value vs. iShares Growth. Both use Dow Jones Canadian indexes. The Value ETF has an average annual 10 year performance of 3.92%. The Growth ETF 10 year performance is 5.68%. As a long term investor, I’d opt for the Growth fund every time.
Fred–thanks for bringing this up. Any overheated sector that has had parabolic short termed performance extrapolates that recent performance over its longer termed numbers. You could have done the same comparative of growth vs value in 1999 and found that growth had better long termed numbers. But – remember my comment on my last blog–regression to the mean brings average returns back to average returns!
Whatever the case, my point is: I view value as the better place to be now, simply because it is NOT overbought – which growth names generally are. That can and will change – but for now, growth looks way overdone.
One other thought – true, over the very, very long term, growth does outperform. But right now, there is little doubt that paying a PE ratio of 180 times forward earnings, while the stock is trading 40% above its 200 day moving average like, say TSLA, is rather risky. Hence, my call for better risk/reward on value over growth for the next few months. To me, this is about risk control. Growth could go higher, for sure. But risk is high in that trade.
That will change, and there will be great opportunities to own growth at a more reasonable level if these names trade sideways (they dont have to fall) for a period. But right now, my view is that buying stocks trading so parabolically makes no sense.
Hi Keith,
Every bad news in the world are on the screen now and the USA stock market going up and USA dollar going down. I am really confused what to do with my cash. I will do nothing for time being.
What do you think. Regards.
I can’t advise you, but I can say that I am stepping in a bit at a time, with a bit of focus on value plus inflation sensitive stocks
Enjoyed your response and thank you. As I have mentioned in the past, I have gone the long term investor route as I don’t seem to have the right stuff for market timing. My own portfolio is pretty well balanced over sectors and growth vs. value. But I kinda love watching the market and technical analysis nevertheless.