Expect volatility, and opportunity

The Bear-o-meter is a compilation of technical, seasonal and value indicators that I have been using for many years. It helps determine the risk/reward opportunities (or lack thereof) on the US markets. It measures various metrics against the SPX and Dow indices. Do a search on Bear-o-meter in the SmartBounce search engine if you wish to learn more about this compilation.

The compilation scores 0-8, which is then divided into 3 segments as “Higher risk”, “Neutral” or “Lower risk”. As always–a higher risk reading does not imply a market that will crash, and a lower risk does not imply a risk free environment. I liken the 3 segments to crossing the street. If you walk across the road in your subdivision or a quiet country road, its not likely you will get hit by a car. But–somebody could still come screaming around the corner and hit you. Similarly, a higher risk rating is like trying to run across a major interstate with 4 lanes on each side. You could make it alive, but the odds are greater that you won’t.

 

The diagram below illustrates the three zones of the Bear-o-meter. Last month, the Bear-o-meter read “3”, which is considered right on the line between higher risk and neutral. The market did sell off in September, then bounced back a bit near month-end. The level of 3 can imply volatility, and that’s what we got. Currently, the rating remains at “3”. This might suggest more volatility ahead.

Changes to the indicators

Most of the indicators remained the same from last month, however there were a couple of changes – one positive, one negative. These readings canceled each other out, keeping the meter at last months low-neutral ranking.

The positive change was the cumulative Advance / Decline line, which remained flat despite a declining SPX. That’s a positive sign of market health. It vindicates what I have been pounding the table about all summer – that the broader market has been losing money while a select few have done all the lifting.  That relationship had to change as valuations and parabolic chart formations on the favored-few grew to astronomical heights. The A/D line’s strength tells us that value is catching up. My message this summer was to overweight value & certain commodities in your portfolio – given the insane speculation on the stay-at-home and tech stocks.

The A/D line is just one indication that the market is beginning to pay more attention to the undervalued majority, and sell the overvalued FAANGs, Tesla, etc. This move was also evident in our ValueTrend Equity Platform. We underperformed over the summer, given our refusal to overweight the dozen or so favored stocks. September was a different story, as we saw a positive return in the ValueTrend Equity Platform against negative returns for the US and Canadian indices. Here is the performance page for that strategy. Below is the A/D line chart, where you can see the relatively flat performance vs a declining S&P 500.

The negative factor influencing the meter was the SPX’s move below its 50 day SMA. Note that the meter does not assign a negative rating should the market move below that average. Instead, it assigns a positive reading if the market is above the 50 day SMA, and a neutral reading on a move below it. The market was above the 50-day line last month, but moved below that line in September.  This caused the 50-day SMA indicator category to move from +1 to 0.

Conclusion

My thoughts are that the market will find reasons to fall, and reasons to rally over the coming month. Electoral patterns back that prediction, and the Bear-o-meter suggests a slightly worse than normal risk/reward potential. The strategy that we at ValueTrend continue to follow is to hold cash (now at just under 20%, having bought a little more gold and metals per this blog’s observations) and hold value plus inflation protection stocks. Opportunity will arise as market find reason to fret. Patience will pay off.

 

 

4 Comments

  • Hi Keith,

    The SPX move yesterday did quite a nice job on the chart. I’ll stick my head out and say that I doubt the market drops below this level of 3400 more than 1 day. It seems that many are hoping for it, yet, we’re now at 3400 with futures stable, and, a price above the neckline of an inverse head and shoulders. Will it get above 3550 I have no idea, but if I was a robot, I would go all-in with my cash, and, if I’m wrong, would trim if I’m wrong and we drop back under the 50 ma (closing price).

    Can’t wait to see what happens.

    Reply
    • Good points Matt
      Yes, the Bear-o-meter suggests up/down volatility like September, not bearishness. So lots of wiggle methinks.
      We are buying on the dips–had 25% cash coming into September, now down to under 20%. To us, this volatility is opportunistic. Post election patterns have been positive in months following election. Things can change, but I’ll follow the odds, which favor being invested fully by early November.

      Reply

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