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Turbo Signal
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Turbo Model Returns (Long & Short Strategy)
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Nasdaq 100
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Russell 2000
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S&P 500
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Classic Signal
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Classic Model Returns (Long & Short Strategy)
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World
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Nasdaq 100
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Russell 2000
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S&P 500
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Investors came into the week looking to turn around almost seven straight weeks of losses and build on holding support at a key technical level. Optimism over the next phase of the Greek debt bailout was key and drove markets throughout the week. Markets wandered around with little direction Monday ending the day with fractional gains. Tuesday saw accelerated gains on predictions of a favorable vote of confidence in the latest Greek bailout plan. This optimism broke open a short-covering rally which pushed the Nasdaq 100
and Russell 2000
up 2%. The vote came and went as planned leading stocks to initially find their footing Wednesday. Ben Bernanke's afternoon comments reminded investors that the domestic economy is soft and the Fed is stepping back. Fractional early gains gave way to losses for the major indexes with the Dow giving up 100 points in the last hour or so of trade. Thursday's trade opened with a bang on the announcement that the Strategic Petroleum Reserve taps would be opened to increase the short-term supply of oil. Oil prices skidded 5%+ at their worst dragging stocks down sharply at the open. The benefits of lower oil and gas prices eventually tickled investors who staged a sharp reversal especially in large-cap tech stocks to bring the Nasdaq 100 positive by almost a full 1% on the day while the S&P 500
recovered to a small loss. Friday brought more Euro-woe with Moody's looking to downgrade the debt rating of a number of Italy's banks for their Greek debt exposure. Separately, Oracle's earnings report failed to delight putting pressure on tech stocks and dropping the Nasdaq 100 and S&P 500 by over 1%.
The Nasdaq 100 (QQQ)
broke its seven week swoon to post a 1.10% gain for this week. The Russell 2000 (IWM)
was a relative outperformer rising 2.19%, while the S&P 500 (SPY)
ended the week down a touch with a 0.19% dip. All three indexes found support at their 200-day moving averages this week, ending the week just above that reference line but below their 50-day EMAs, a line they've sat under all month of June.
Our World portfolio continued to reflect weakness in international markets, giving up 0.89% this week as the Euro concerns bolster the U.S. dollar. Since we have an active Classic Model Cash signal, the World approach calls for staying in cash if you follow the "Long Only" or "Long and Short" strategy. Only if you follow the "Buy and Rebalance" strategy should you remain invested in the top 5 ETFs from our world ranking. Please go to the Classic Model "Description" page for details.
Our Classic Model Cash signal remains in force while our Turbo Model issues a Buy signal as of this evening.
How
we beat the market
The past few days have offered picture-perfect correction behavior
along the lines of our article a couple of weeks ago. After a sharp
downward move through the first couple of weeks of May/June, we
got oversold on a short-term basis (this time heralded by an unusual
seven consecutive week swoon). Then came the expected short-covering
rally that pushed stocks back up about 2% on weak volume (per usual).
The rally stalled at the first sign of overhead resistance (about
1300 on the S&P 500). Now, it's turned tail and running back
down again. The playbook would presume we retest the prior lows
near the 200-day moving average, if not push lower along the lines
of last summer's correction. Eventually, stocks will reach a value
point that brings the bigger long-term investors back into the market
(read: mutual funds, hedge funds, et al). Notionally, there are
a few of these folks looking to recommit money to stocks at around
1240-1260 on the S&P 500, in effect buying into the market when
it falls below the 200-day moving average and weaker players throw
in the towel. Doesn't mean we get to those levels, as big money
buyers will step in with more vigor when the market reverses higher
and firms, regardless of whether the market has dropped all the
way to their target entry price.
The false optimism about Greek debt restructuring has washed out
to sea leaving exposed the dangerous rocks that have given rise
to this correction. The other macro factors behind this correction
are also the same as a year ago - namely fears of what happens when
the Federal Reserve takes their heavy hand off interest rates, a
Chinese-led slowdown in the global economy coupled with soft U.S.
and Europe recoveries. In short, this is classic secular bear market
behavior weighing down the third (and final?) year of this cyclical
bull rally. P/E ratios are stagnant at below-average levels as corporate
earnings soar in the face of halting stock price gains. The secular
bear market playbook suggests we will ultimately get another 1-2
year bear market before the cleansing process is complete. Recall
that secular market cycles are 15-20 year cycles driven by investor
attitude as much as anything else. A secular bear market being dictated
by waves of increasing investor disgust for investing in stocks.
That negativity toward stocks manifests itself in a general long-term
downtrend in P/E ratios until they reach sub-10 levels (when using
smoothed 10-year average earnings to mitigate the ups and downs
of the economic cycle).
Not surprisingly, we cannot imagine investing in this type of market
environment without some sort of strategy that has the recognition
and ability to view market opportunities both long and short. In
other words, a recognition that markets will cycle up and down rather
than mostly straight up (as they did in the 1980s and 90s). This
recognition drives an investment strategy that seeks to take advantage
of both up markets as well as down markets, in part because the
broader stock market is offering virtually nothing on a buy-and-hold
basis. To address this, we offer our intermediate trend Model, Classic,
and shorter-term trading Model, Turbo.
One aspect of this type of investing is the importance of the short
trade on our returns. If you are buying and holding a stock market
index like the S&P 500, you get 1% in return for every 1% increase
in the index. You buy the SPY
and ride it up and down ending the
year with essentially the same return as the S&P 500. To do
better than the S&P, you obviously have to find a better investment.
Given that almost all stocks rise and fall, to a large degree, with
the market, your goal is to find investments that rise stronger
than the market when it's going up and/or fall less than the market
when it's dropping. By finding these "better than market"
stocks, you maybe get a 1.5% rise for every 1% rise in the broad
market while only suffering a 0.5% decline for every 1% drop in
the broad market. At the end of the year, you've made a little more
money when the market was rising, lost a little less when it was
falling, and beat the market index. Of course, finding such investments
is very difficult and what is working changes on a regular basis.
Thus, comes our long-short index strategy into play. Ideally, we
want to participate in the bulk of the rising periods in the market.
When the market rallies as it did from September 2010 through February
2011, we want to be on board that train for as much of that rally
as we can discern. Our Turbo Model rode that train for all it was
worth piling up gains essentially in line with the index, as planned.
The key point comes in how we BEAT the market, and that occurs when
the market is falling. We do not have to be perfect when the market
is falling to win. We just have to miss a little bit of the drop
because we are receiving a 2-for-1 benefit every time we are short
when the market is falling. Here's why:
Assume
the stock market falls 1% but we hold a short (inverse) ETF that
goes UP by 1%. We have just beaten the market by 2%. Consequently,
if we are short for only a portion of a market's decline, we are
piling up outperformance hand-over-fist at a 2-for-1 rate. (If we
were using our Long Only strategy, we would be in cash instead of
short and would be gaining 1-for-1 for each 1% drop in the stock
market index).
This brings us to our friend Turbo. He missed the first leg of this
correction falling along with the market. By doing so, however,
Turbo didn't fall behind the S&P 500 market index; he just didn't
get ahead of it. Turbo matched the market's performance. Now, Turbo
played the bounce and exited the market, going short. The first
day Turbo was short, the market fell about 0.6%. So, Turbo picked
up 1.2% on the market. In this way, Turbo can very quickly pass
the S&P 500 performance.
Thus, being on a Buy signal matches the market; being on a Sell
signal is the key to outperforming the market.
That's why Turbo is absolutely blistering in a bear market; with
90-100% gains common during those bad years for stocks. Turbo piles
up 2-for-1 gains all the time. As this cyclical bull rally gets
longer in the tooth, we can take comfort that the next cyclical
bear market is nothing to fear. Rather, it's a veritable land of
opportunity for us long-short investors.
Question:
What is a "follow-through"?
As trend investors, we are ever on the lookout for changes in market
trend. Coming out of a correction or pullback phase, the market
typically delivers a very strong one-day short-covering rally. A
short-covering rally occurs when investors who have taken positions
profiting from a falling market recognize that their bets are going
against them and quickly exit their short positions. To exit a short
position, the investor must BUY stock. This fuels a sharp rise in
the market until the shorts have cleared out their positions. This
short-covering creates dramatic one-day rallies along the lines
of the recent 2% rise in the Nasdaq 100. Trend watchers then look
for what's called a "follow-through day." This is a day
where investors bring new money to the market believing that a new
uptrend is beginning. This new money fuels another positive market
day to build on the sharp short-covering rally day. Thus, the market
follows through on its potential new rally. This follow-through
day can be even more powerful if it occurs a few days after the
short-covering rally day. That's because it signals a more reliable
change in investor mindset, rather than a continuation of the brief
sugar-high of the short-covering rally. Thus, these follow-through
days become significant market events for investors seeking a bottom
and end to a market pullback or correction.
The same concept holds when the market is reaching a top. There
are sharp one-day drops typically referred to as "profit-taking"
days where investors bank some of their recent gains. The question
then becomes whether they will go beyond banking profits to actually
cut back their core position. To do that requires a change in outlook
on the part of investors. So, we count days when the market takes
a hit and keep score. If an abundance of these days piles up, we
know that investors have collectively changed their mind and the
trend is changing. We know that changes in trend start with sharp
moves in price. We know that markets fall a whole lot faster than
they rise. As a result, it's never easy to identify the change in
trend (except in hindsight!). But we keep trying and hope to be
right more than we're wrong. If so, we likely win the investing
game, beat the market, and build our wealth in the process.
Warm wishes and until next week.
The TimingCube
Staff
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Turbo Model
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Classic Model
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