Interview With Jay Kaeppel: 5 Things To Look For To Confirm A New Bull Market

January 31, 2023No Comments

We have a very special guest today. Our guest is Jay Kaeppel, and he is a very well respected technical analyst. I’ve known about Jay for many, many years, and because I’m a longtime subscriber to Sentiment Trader Research, I was very pleased to see that a number of years ago Jay joined that crew and has added his own research to their group. Before we get started I will just say that Jay has a very well-constructed presentation that I came across through Sentiment Traders Newsletters and I actually contacted Jay and asked him if he would do this presentation for us. So I’m going to let him do the presentation, but just as a brief intro, some of you may not be quite as aware of the guru status that I assign Jay so I’ll just quickly provide his bio and I won’t provide the whole thing because Jay has a bio that’s as long as my arm.

He is a senior research analyst with Sundial, which is the leading company for Sentiment Trader and many of you that read my research have seen me quote Sentiment Trader on occasion. He’s got a long history of being a money manager and a commodity trading advisor. He has also got quite a level of expertise in options. I think this is a very interesting part of his personality. In fact, he’s been a writer for Stocks and Commodities Magazine, which is a magazine. This is an old one. I think this is from 1990 something or whatever.

Quite some time.

But I following the magazine and Jay’s been writing for some time. Jay is going to talk about the five things he would like to see to confirm what and if the market may break into a bull in 2023.

Very good. There’s a lot of things that we follow at Sentiment Trader, and the one benefit that I think we have is we’re not investment advisors. We don’t have to sell anybody to buy something or sell something at any given point in time. Our only job is to do objective research and say, here is what we see in the market. Usually those reports that we do highlight something that’s happening in the market or is about to happen, times that has happened in the past, and then how the market has reacted. We look at stocks and bonds and commodities and everything we can get data for. But we’re going focus on the stock market today and as you can see on the screen, there’s lots of factors.

For any investor, the real question is which ones do you emphasize? So basically, I’m not going to tell you which ones to emphasize. I’m going show you basically the status of a lot of these factors, and then people can weigh them accordingly. Right now, the big picture indicators are still net bearish. There’s been some improvement and you’ll see that as we go. But overall still unfavorable. However, a lot of the things that we’d look for to tell us when the market is turning or has turned or is about to turn, we’ve seen a lot of bullish action in those indicators. So it’s kind of an interesting trade off right now. We’re just going to start right in with valuation and talk about PE ratios. Here’s what you need to know. Valuation is not a timing tool.

PE ratios don’t tell you when to buy and sell. It tells you when the market is overvalued or undervalued, and I’ll show you how to use that. Th Schiller PE ratio is the S&P 500 divided by however Schiller calculates earnings. This goes back to the 1800’s and you can see sometimes it’s really high, sometimes it’s really low and as I said, people try to use it as a timing indicator. So you will see a red line and a green line. In the past, I’ve seen people say, well, if it’s over the red line, the market’s overvalued. Well that’s fine, except one problem with that type of analysis is technically stocks have been mostly overvalued since about 1995. How’s the market done since 1995? Well, we had some harrowing bear markets, no question about it. But overall, if you had sold when you thought stocks were “overvalued” you would’ve been very disappointed.

So, as I said, it’s a perspective tool. The only times that I worry about valuation are in an economic recession and/or when prices are in a down trend. A lot of times those two go hand in hand. But basically those two times when you have high valuation and one or both of these factors playing out, that is when the huge losses, the devastating generational wealth destruction losses occur. This is just a random opinion, and again, I don’t give advice and I don’t make forecasts, but I’m going to say this anyway. If your strategy is buying and holding the S&P 500 index, and that’s it, my opinion is the next decade may prove challenging? Now, is that a prediction? Not really. That’s basically just looking at history. So take a look at this now.

You see certain peaks in the Schiller PE ratio, 1929, 1966, 2000, and again in 2021. Now let’s see how the S&P did in the following 10 years. So if you had bought at the peak in 1929, 10 years later, you would’ve been 65% in the hole. In 1966, 10 years later, you would’ve been up 9% and in the year 2000, if you had bought at just the wrong time, 10 years later you’re down 22%. Then of course, we have a question mark at 2021 because we don’t know, but history suggests that the next 10 years may be a struggle. It doesn’t mean you can’t make money in the market. It means you’re going to have to do something besides just buy and hold an index. So I’m going to give it to you this way in terms of recession, it’s a little crude, but basically recession is the economic equivalent of jumping out the window, okay?

Valuation tells you what floor you’re on when that happens. So if you’re on a low floor, maybe it’s not so bad, but if you’re on a high floor, we go back to the Schiller PE. In 1929, we had a devastating decline. In 1966, you had 16 years of a sideways market and 2000 to 2012 the market was flat. We’re on a high floor, so what’s key is to watch for a recession, and I’ll talk more about that in a minute with one of our indicators, and also just to pay close attention to price action. So let’s do that. Let’s look at price action. We have the four major US index, Dow, S&P, Russell 2000, small cap, and then the NASDAQ 100. What we noticed, the red line is the 200-day moving average and theoretically, when the indexes are below those averages, we call that a downtrend.

When they’re above, it’s an uptrend. Now what we see happening right now is these indexes are making an effort to turn higher. In fact, all four of these as of yesterday, are now back above. So does that mean happy days are here again? Well, not necessarily. If you look closely at these charts, you can see situations where it popped up above and then flipped back below. But basically, keeping a close eye on these indexes is how we’ll know if price action is favorable or unfavorable. And sort of to augment that, I also follow four other indexes. The semiconductor index, which tends to lead the market, transports, utilities, and then an unweighted index value line. Three of these are above and utilities are the holdout right now. So keeping a close eye. You know, it’s an oxymoron. They say the most bullish thing the stock market can do is go up.


Well, that’s true but it’s important to pay attention to price. If the market is doing the right thing, regardless of what you’re reading or hearing about in the financial news, it’s really important to follow that trend. Trend following can go a long way. The next factor is inflation and that’s obviously been the big news in the last year. A lot of people get confused how to think about inflation, so let me show you. Here is the 12 months change, the consumer price index going back to 1914, and you can see where we are. We’re at a high level, but it’s in a downtrend. So what do people make of that? The rate is falling but it’s still high? Well, I’d mentioned before, we try to be as objective as possible. We did a study and here’s what we found. Between plus 4% and minus 3%.

In other words, if the 12-month change in inflation is between those two, we call that moderate inflation and the stock market loves moderate inflation because there’s less uncertainty. When it gets above 4% or below minus 3%, either too much inflation or too much deflation, that’s bad. How good, how bad? Well, this is an equity curve holding the Dow Jones Industrial average since about 1914. When we have moderate inflation, you can see an equity curve that goes from lower left to upper right, which is what investors look for. On the other hand, when it gets outside of that plus four to minus three range, you can see what happened. Over at the far left, you see basically the depression that was actually deflation. But then you go a little further and more towards the middle and you see the 1970s. We had high inflation and a lot of choppiness in the market.

The 2008 bear market actually encompassed a bout of inflation, which most people didn’t realize at the time because everybody was focused on housing. Then, of course, you see the last year it was down, down, down. So the cumulative return minus 68%. So for us inflation, it’s real simple. We want this number to get back below 4%. It’s trending that direction. I cannot predict when that will happen, but when the inflation rate gets back below 4%, in my opinion, it will lift a huge weight off the market’s shoulders. So that’s inflation.

Let’s move on to interest rates. I call it a quick and dirty guide to interest rates. We’ve all heard this. Falling interest rates are good for stocks and rising rates are bad for stocks. So here’s one way to follow that. Ticker TNX tracks the yield on 10-year treasury bonds and for some reason they multiplied by 10. So if you see 35.84 over on the right, that means 3.584% is the current interest rate. You also see a seven month exponential moving average and the question that I ask at the end of each month is, is TNX above or below that particular moving average? Below is good, that means interest rates are technically declining, and above is bad. How good, how bad? I don’t have the charts, but I have the number tested the Dow Jones Industrial average back to 1900.

If you bought to help the Dow only when interest rates were in a decline, as I just defined it, the Dow gained over 61000%. And how did it do when interest rates were rising? Well, the good news is it made money. The bad news is that in 123 years it made a grand total of 12%. So this is another indicator that is not necessarily an automatic buy or sell, but it’s a very important factor clearly from these numbers. So where are we now? Well, at the moment, if you look at the far right, the current interest rate is just above the seven month exponential average. That can change between now and the end of the month so we’ll have to keep a close eye on this one. That’s one way to track interest rates on whether or not it’s favorable or unfavorable for stocks.

Then let’s talk about the economy. So at Sentiment Trader, we have our own model called the Macro Index Model. At the top you see the S&P 500 index. At the bottom you see the model itself. Over on the left you see some of the things that into it. I’m not going to go through these, but housing, employment, etcetera. And again, we try to keep it as simple as possible. So in this case, a reading above 0.7, we call good and a reading below 0.7, we call bad both for stocks and the economy and here’s why. This chart goes back to 1968. This is a growth of a dollar invested in the S&P 500 index only when this particular model is above 0.7. Again, that’s the kind of equity curve we look for, lower left to upper right, and when it gets below 0.7, well it’s kind of a mess.

As you can see, it’s very choppy. Every major bear market that has occurred in the last 50 plus years has occurred when this model is negative. Now, one thing to note if you take a close look is very often the bounces off the bottom are pretty market so we’re hoping for one of those right now. But at the moment, this one is rated as unfavorable because it is down at 0.24. Now, another way to interpret that, since this is kind of an economic indicator, if we multiply it by a hundred and flip it on its head, it essentially implies a 76% probability of recession in the next 12 months. Will that happen? Well, there’s no way to know, but it’s saying right now there’s a high possibility. So we tie that together with valuation means we have to keep a close eye on the downside risk.

In the meantime, what we’re looking for, hoping for, is for this model to get back above 0.7. That may take some time based on the indicators. So right now, at this point, it’s been all pretty bad. Inflation, interest rates, the economy, even valuation are all unfavorable. Price action is trying to turn favorable. It doesn’t look too good. However, let’s look at some of the other factors that we use to follow or to try to identify turning points in the market and these are actually looking very good. So the first one is our own indicator. It’s based on a Citi Corp indicator that’s in Barron’s, but we did our own work on it called a Panic Euphoria Model that measures the mood of investors. So once again, you see the S&P 500 index on the top and at the bottom you see the blue line.

That’s the raw index, the Panic Euphoria Model. Higher readings obviously mean people are bullish and vice versa. The one thing that never ever changes in the market is human nature. When the market starts going down, people get more bearish the further it goes. Exactly the opposite of what we should be doing. As the market is really falling hard and way down, we should be saying, wow, we should be looking to buy. But as you can see here, that’s obviously not the way it works. That’s the bad news. The good news is we just got a signal recently. So the red dots indicate a signal where it got down to a particular level that is of significance, meaning the market has gotten so oversold and investors have become so gloomy that it tends to show good results. So if you look at the lower left, you see that we got a signal on December 23rd.

If you look at the upper right, you see a summary. Essentially this is a report from Sentiment Trader and you can see one year after those red dots, 91% of the time the S&P 500 was higher with an average gain of 25%. If you go right down the right hand side, you can see the gains. Most of us would be pretty happy if we get something like that in the next 12 months. So again, this is an objective way to look at sentiment and right now it has given a bullish signal. Now let’s look at breadth. This one was one of the ones I was looking for. It is now one of the ones that has taken place. The 100-day average of the NASDAQ high low ratio. Every day take the NASDAQ new highs divided by the new lows and take a hundred day moving average.

So at the top, the black line is the NASDAQ 100 index itself. The green line at the bottom is the 100-day moving average and you can see how it works. When the market’s going down, the green line falls. Some people will try to look for an oversold level. Some people will try to use this as trend following. The way that we look at it, sort of unique, is we wait for it to get to a certain low level and then reverse. The reason is we’re looking for this to tell us when the worst may be over. So again, if you look at the red dots, you see signals where this model, this indicator rose back above 0.29. As you can see at the far right, we just got a signal on this one.

Here’s the summary. In the lower left, you can see the signal was on January 24th. In the upper right, this is using the NASDAQ 100 index, you can see 100% of those red dots have been followed by higher prices 12 months later. That does not guarantee that this signal will be profitable. It’s one thing that’s very important to remember with any indicator is that indicators just give signals. From there, it’s up to the investor to decide whether to use the signal, how much capital to allocate, and most importantly, what to do if this particular signal does not work out, whether it’s a stop loss or something like that. But again, just taking this indicator as a standalone, you can see the results have been very favorable and this is another one now that we add to the bullish side of the ledger.

The next one, seasonality. The tendency of the market to move in a particular direction during a particular timeframe. This one is near and dear to my heart because I wrote a book number of years ago on the topic, and one of my favorite seasonal trends is what I call the best 10 months of the election cycle. So that’s here in the US and that goes from presidential election to presidential election. That’s a four year cycle and the best 10 months start October 1st of the midterm year, which was 2022, and it goes through July 31st of the pre-election year, which is this year. So we are in that period right now. And how’s it going? Well, so far so good. But first, let’s show you the big picture. This goes back to the 1930s. If you had bought and held the S&P 500 index only during this 10 months out of every four years, this would’ve been the equity curve.

That’s about as good looking of an equity curve as you’re going to find. In fact, the last 20 periods have showed a gain every time since 1938 to 39. If you look at the far right and the upper right, you can see we’re off to a pretty good start this time around. In fact, here is the S&P 500 index going back to last year and here I’ve marked September 30th, and it’s kind of like somebody flipped a switch. The market was getting beat up pretty bad, and then all of a sudden this favorable seasonal period began and just like that, since that time, the S&P is up 13% in about three months. So it doesn’t guarantee that it will continue through July but that’s kind of the way that I’m playing it. Another factor that we look at, corporate insiders. Nobody knows their companies better than executives and presidents and board members and so on and so forth.

So when they act heavily to buy or sell or some combination thereof, it very often gives important information. This is, what we call, the corporate insider buy sell ratio. What you see is that when it gets to a high level, the red dots, that means insiders are doing a lot of buying relative to the amount of selling that they’re doing and that tells us that they’re looking at something that’s telling them to do that. What you can see is when we get a cluster of red signals, it tends to be a good time to get into the market. Now this is like a lot of these, it’s not necessarily a precision timing tool, but it basically tells you what they’re looking at and what I have found is that insiders, when they act decisively in concert, are rarely wrong over a one to three year period.

Again, we look at the numbers as objectively as possible. So this printout is from Sentiment Trader, and you can see one year after those red dots that you saw in the last chart the market was always higher. Again, doesn’t mean that will happen this time but it’s a very good sign. So that’s corporate insiders. Five things to look for, it’s actually down to four now, but we’ll, we’ll get to that. The most important thing to watch is price action. Whatever you read, whatever you hear, if the market starts making higher highs and higher lows and breaking out and more stocks are going up, it’s telling you that it’s time to be in the market. So it’s very important to keep an eye on this. And, of course, like I said earlier, if they all flop right back down below the moving averages, that’s telling you something also.

The other thing that I pointed out is inflation. If it drops back below 4%, and that is here in the US, the Consumer Price Index 12 month rate of change, if that gets below 4%, that will be a very good sign for the market. Our macro index model. The big thing overhanging the market right now is everybody’s concerned about a recession and with inverted yield curves and a poor housing market, et cetera, it’s a very real concern. So we are looking for this to move higher to tell us that maybe it’s not going to be as bad. I wrote an article a while back, somebody can look this one up online, about three all clear signals through watch for. The first one has already happened and I showed you this one a couple moments ago, the NASDAQ high low ratio. Just a quick review.

In the lower right, you see that red dot is telling us that this indicator is suggesting that the worst is over and the market may be headed higher. If we combine that with seasonality, I would say, well, maybe between now and July we’ll see the market head higher. Then the last one is the American Association of Individual Investors poll their members. Are you bullish? Are you bearish? And they keep track. What we do is we keep a 20-week average, and it’s a lot like any other sentiment indicator. The more the market goes down, the more bearish investors get. What we’re looking for is a reversal from a low, kind of like the last indicator. So what we want to see is this green line cross back above 48% and it’s got a ways to go right now so this one may take a while. But again, if you take a close look at the red dots, those are bullish indications.

Here we are looking at a summary of the results with the NASDAQ 100 index. And again, this is another one that has a hundred percent success rate so far, and I have to emphasize that so far part, with some really terrific returns on average. So we’re keeping close eye on this one and hopefully this one will hit and confirm. Here’s kind of a summary. The very top line, the S&P 500, another trend following indicator that I did not in in include but a real simple one is if it gets back above and closes a month above its 10-month moving average that’s typically a good trend following indicator, and then you see the others below and that’s what I see.

Well, that’s great. Jay, thank you for that. I actually have one question for you. So like most technical people, I’m a longtime subscriber to Sentiment Trader as well as a couple other quant services and I have two models to try to determine what the market might be doing.

Most of the viewers of this video and readers of my blog are quite familiar with my model. So one’s a trend following model and one’s a risk assessment model.


And that risk assessment model uses some of the sentiment indicators that you guys post. But I also incorporate into that model breadth and you mentioned the new high new low, which is actually one of the indicators I use. This is a question that’s come up actually from a reader recently and it is a good question. So when I look at trend, like you were posting the S&P 500, the Russell 2000, the NASDAQ, and the Dow industrials, and you said, Hey, we’re looking for new highs and obviously the Dow is breaking out. The other ones are above their 200-day moving averages, but questionably if they’re taking out the last peak.

But as one of my readers pointed out, like I often talk about the S&P 500 and the S&P 500, as we know, is a cap weighted index. It’s overload with some of the tech names versus if we look at the New York Stock Exchange composite, which is not a cap weighted, it has broken out. On a weekly chart, it’s got a higher than the last peak, it’s higher than the last peak. So the question that this person asked me based on my system, which is to look at the same stuff you’re looking at, the mostly calculated stuff, is that wouldn’t you rather pay attention to the New York Stock Exchange composite to make that new high and say now is a breakout versus the S&P, which hasn’t broken the 4,100, which was the price as you know.

And my answer was, and I just want to find out your opinion on this, my answer was both are important and true. The New York composite says that breadth is pretty good, but let’s face it, where the money has been, not necessarily where it is going right now, and the reason their high cap weighted stocks is because that’s where the money went. So we have to pay attention to the S&P as a cap weighted and wait for that breakout to happen. So give me your input on that because maybe there’s rotation now into materials and whatnot, and the day of the growth and tech stocks is over. How would you address that with the higher high, higher low stuff.

Well, one thing I found is in terms of trend following, there is no one best trend following indicator, unfortunately, so that’s why I follow a lot of indexes. I do think that unweighted is important to look at, and I do think it can be a leading indicator and I’m hoping that it is in this case. One thing to keep in mind though is that the action of the S&P 500 affects a lot of people’s actions and thinking. When the S&P 500 index actually confirms a move that means a lot of new money is going to be coming into the market, because all the people who say, well, I’m going to be out if I think the trend is down and in if the trend is up, they’re looking at the major indexes. So that’s why those are important.

But weighted versus unweighted is a very important thing. On a related thing, one other indicator I follow is consumer discretionary compared to consumer staples. Typically in a bull market you see the discretionary outperforming and vice versa. That’s what we’ve seen in the last year. The staples, the stodgy, the slow growth stocks have done much better and that’s starting to turn. There’s also an unweighted version of that. I believe the tickers are RCD and RHS and that is showing a much more bullish chart than what would be XLY and XLP which is the weighted indexes. So I think that’s telling us something. Recency bias is another problem that people have to fight. From really after 2008 through the top of 2021, large cap stocks were where it was at. The large cap momentum stocks were what everybody was piling into.

So a lot of those cap weight indexes with Amazon and Apple, they rely so heavily on those. That’s not going to last forever. No market, no stock, no sector index ever has a permanent advantage. One place you can see that now is value versus growth. in the last year or so value, which was very poor performer relative to growth for about 10 to 13 years, it’s now reversed. That doesn’t guarantee it’s going to continue But, personally, that’s kind of the way I’m looking. I’m looking more at value than growth right now. Another related area is international versus US. Again, recency bias is a tricky thing because a lot of people here in the US, they don’t want to look outside the US because it’s done so well compared to the rest of the world, but I’ve seen the history and that won’t last forever. There are signs of that changing recently where the internationals have been outperforming so keep a close eye on that. Hopefully that answers your question.

No, that’s great Jay and actually I’m going to say great minds think a like. We’ve been rotating out of staples and actually we’ve been moving in a big way internationally, particularly emerging markets. I guess we’re all technicians and we have to follow the same rotations. So that’s what’s been happening. I just want to say thank you.

This was great information. I know my readers will be very, very happy with the information that you provided and I think it’s going to give a lot of people some insights that they didn’t have before.

Oh, I hope so. That’s great. Thank you, again.

Okay, Jay, thank you very much.



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