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Watch Bonds For Clues To The Stock Market

  • Written by Syndicated Publisher 1 Comment1 Comment Comments
    February 18, 2014

    Treasury bonds have continued to move opposite to the stock market.

    After reaching a new low at the end of December, exactly as the stock market reached a new high, bonds rallied through January while the stock market declined.

    And now, bonds are pulling back as the stock market is bouncing back.

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    Bonds are approaching potential support at their 30-day m.a. as well as potentially forming a reverse head and shoulders bottom.

    As we have been saying for quite some time, we expect bonds can only rally if the stock market declines, when they have indicated they would act as a safe haven again.

    If bonds, pulling back from their short overbought condition, as the stock market is bouncing back from its short-term oversold condition, do find support at their 30-day m.a., and resume their rally, that would probably be a negative sign for the stock market.

    So keep an eye on bonds over coming days.

    A Change Is Coming In Our Strategies.

    We’ve been dissatisfied with the performance of our non-seasonal Market-Timing Strategy over the last several years. The strategy’s methodology worked very well in the 1990s, and through the two severe bear markets in the new century. It provided an impressive buy signal on March 10, 2009, for re-entry March 11, just two days after the 2007-2009 bear market ended, and the current bull market began.

    But it has not handled the bull market to our satisfaction for the last three years.

    The problem is that, as is, it is geared to the market’s normal driving forces, and not a market in which the main driving force is the Federal Reserve.

    For instance, it’s momentum and money flow reversal indicators do not work as well if a momentum reversal and market pullback results in the Fed rushing in with a new round of stimulus and promises, that halt the correction just as it breaks below key support levels.

    Yet we realize why the Fed had to do that. In this bull market, it is not so much that the economy is driving the market, but that the market is supporting the economy, providing consumers (70% of the economy) with a positive wealth effect, about the only thing that is, given the employment situation. So the Fed has had to target the market as well as the economy itself in its efforts to prevent the anemic economy from sliding back into recession.

    For instance, if the Fed had not interfered to halt the market corrections when the economy stumbled in the summers of 2010 and particularly 2011 (when the S&P 500 declined 19% in its nervousness), there is no doubt the plunge would have continued into another bear market. And that would have dragged business and consumer confidence down, and therefore the economy down into another recession.

    We have been reluctant to make a change in the strategy, expecting the Fed would soon be able to back away from manipulating the market. But it has become clear that the Fed is going to have to be involved for quite a few more years. That is not only due to the continuing stubborn weakness in the economy, but to such factors as at some point having to control markets as it unwinds the massive $4 trillion in assets it accumulated on its balance sheet as a result of the five years of stimulus.

    So in searching for ways to improve our non-seasonal strategy and overcome its weaknesses we have been going through the same type of research we went through in developing our very successful Seasonal Timing Strategy in 1998.

    And we have arrived at a significant new indicator to be used in our non-seasonal Market-Timing Strategy.

    Among the requirements we were looking for, it had to be mechanical in nature, with an easily understood rule governing its signals, intended to be independent of our normal work regarding valuation levels, overbought or oversold conditions, investor sentiment, economic conditions, and intermediate-term technical indicators.

    Most importantly, it has to work not only under normal market forces, but abnormal forces, such as recent years when the Fed was interfering with the normal market forces.

    Its purpose will be to help keep us in the market for much longer periods, while not interfering with our history of avoiding all serious market corrections and bear markets.

    We will still be providing our current timing for gold and bonds, as well as short-term and intermediate-term charting of what we expect for the stock market in the short-term and intermediate-term.

    But the additional component will be keeping us in the market during bull markets for longer periods, not as influenced by risk levels, focused more on what the market is actually doing regardless of what is causing its action.

    We will be introducing it to subscribers in a week or two, once we have worked out the details for a smooth transition with the current strategy. Unlike what we did with our Seasonal Timing Strategy, we will be keeping it proprietary for subscribers and will not be introducing it to the public.

    As a teaser we can provide the following chart of its signals since 1995, if it were used as a standalone strategy, which indicates the additional value it will provide to our strategies.

    In the first chart of 1995-2003, the indicator was in for the entire bull market from 1995 to the top in 2000 except for one brief almost zero-cost quick exit and re-entry at the mini-crash in 1998. Then out (or in downside positions) for the entire 2000-2003 bear market.

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    It was quickly back in for the 2003-2008 bull market (continued in the next chart), except for quick out and back in whipsaws that had only small drawdowns, almost no impact on performance in that bull market. It then was out for another entire severe bear market, the collapse of 2008-2009.

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    And it was then back in (although the re-entry was several months late) for almost all of the current bull market that began in 2009 to the end of 2013, except again for quick temporary exits and re-entries (drawdowns), when exit signals did not result in a bear market, (perhaps in 2010 and 2011 only due to the Fed’s interference). And it easily remained positive through the Fed induced volatility of last summer and fall.

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    The total performance of the indicator used alone over the entire 19 years not only almost doubled the performance of the S&P 500 (counting only long-side positions on the entry signals, not the potential of additional downside gains in the two bear markets), but it also had only very tiny periodic drawdowns, the largest 2.8%.

    That is very important in a strategy, because it is the huge drawdowns in bear markets for buy and hold investors that result in the majority bailing out in disgust at the lows after bear markets have decimated their portfolios. That experience leaves them too fearful to get back in until the next bull market has been underway for quite sometime, often several years. A strategy that avoids bear markets not only avoids those losses, but with only small drawdowns, eliminates that fear factor dramatically, in fact almost entirely, because investors don’t give back their bull market gains.

    We believe we have really got something here.

    It looks like we will probably also be able to use the indicator to further enhance our Seasonal Timing Strategy to reduce its risk even further. We would do that by allowing an exit signal from the new indicator, if it occurs during the market’s favorable season, to override the normal exit rule of the STS strategy.

    To read my weekend newspaper column click here:  Watch For A Taper Time-Out

    Images: Flickr (licence attribution)

    About The Author – Sy Harding, Street Smart Report

    Sy Harding publishes the financial website Street Smart Report Online and a free daily Internet blog at Sy’s Free Blog. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!

    It includes our research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s.

    It provides two model portfolios as guides. One is based on ourSeasonal Timing Strategy, one on our Market-Timing Strategy.

    In depth updates are provided every Wednesday, with interim ‘hotline’ updates every time we make a trade. An 8-page traditional newsletter Street Smart Report is provided on the website every 3 weeks, in pdf format for viewing or printing out.

    There is the Street Smart School of online technical analysis ‘seminars’,commentaries to keep you ‘street smart’ about Wall Street, and much more. 

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