Thursday, December 29, 2011

2011 Year End Preview

Based on my year end preview my conclusion is that while there may be an opportunity to buy the All Ords well at current prices there is also a real,significant if improbable downside risk. By improbable I mean that based on past post 1984 performance most of my market indicators are at levels which have only subsisted or been worse about 10% of the time.

There is no buy signal on any of these major markets based on traditional Coppock 14, 11, 10 as at 28 December 2012. My Medium Term MACD 170, 150, 20 indicator shows either no action (line and signal overlaid) oscillation in the last month or continued decline. Please note that all my technical indicators are lagging and will miss the bottom and could lead to significant losses through whipsawing as in the 1998 to 2003 period.



My All Ordinaries Dashboard shows that the market is in a potential buy area (being well below most median periodic growths, oversold and well below previous highs in 2007 and April 2011), but, with the last close lower than all averages and all averages trending down there is a high risk the market could still be in a downtrend. There is, however a possibility it has commenced a very weak uptrend from the 26 September lows which had most characteristics of a median post-1984 low.

My Top or Bottom Analysis shows that the market is currently close to a median bottom as can be seen from the Dashboard, which is why I say we are in a potential buy area.

My Modified Turtle Buy/Sell indicator has been sold and there is no buy indicated or imminent, although this indicator caused whipsawing losses in the 1988 to 1993 volatile market.



My overall conclusion is that while you might like to increase holdings while the market is oversold there is still strong downside risk.

The historical post 1984 maximum loss from a situation like this was 22.3% from today's recovery to 134.7% of the 2009 bottom at day 712 after the 2009 bottom, to only 104.6% of the 1987 low at day 801 after the 1987 bottom. Those losses were fully recovered after day 951. So the 87 recovery was lower than 28 December 2011 close for 951 - 712 = 239 days or about 1 year and 1 month during the lead into and recovery from the 1991 low.

 On the BUY side, of the 5 recoveries since 1984, 4 out of 5 were only higher than the current level after day 712 right through to day 1200. Only 1987 went lower as it approached the 1991 bottom. 1987 was however the only other 50% loss market in our post 1984 data.

Fundamentals
On the fundamentals
1. US house prices are not in an uptrend and many mortgagors are under water, so household credit growth is subdued
2. there is widespread but not quite universal fear of recession in Europe
3. there is some fear of a slowdown in China because of its reliance on Europe and unsustainable capital works spending
4. there is some fear of a US slowdown or recession because of calls by ECRI and John Hussman, although these are largely discounted based on current monthly flows
5. in Australia there has been a marked reduction in building approvals 12 month average
6. in Australia employment growth has flatlined
7. Japan still has the tsunami damage and nuclear contamination to contend with
8. in Australia house prices have fallen widely over the past 12 months and by significant percentages in some markets.
9. there are likely to be ebbs and flows of sentiment in Europe over the sovereign debt crisis.

The fact that all of these are widely known may mean that it is a time when most are fearful and therefore a time to be a greedy contrarian, or maybe you would be better to await a clear upturn or at least only buy at the bottom of the current trading range at around 4100.







Monday, December 19, 2011

Coppock Bottom Picking Performance

Given that the market is again near a median bear bottom it is timely to look at the reliability and performance of the Coppock Indicator as a tool for picking a safe re-entry point. I have used the monthly data generously made available by Colin Nicholson of Building Wealth Through Shares.

In summary, market history since 1960 suggests the Coppock indicator is worthy of consideration as a way of determining a safe re-entry point to the market, but consider selling if the market has a deterioration of more than say 7.5 % or if there are two consecutive months each with lower performance (compared to percentage difference to the index value at the signal month end) compared to the prior month.

First a chart showing the results of all signals since 1960 shows that relying on the Coppock Indicator is generally potentially rewarding (partially depending on the timing of any sale) but not without risk.


Note the two false signals, one in August 1970, the other in April 1974. They would have been avoided by selling if the performance of the market went to -6% or worse at any month end after the signal was given. Two false signals from 15 is quite good performance. Thirteen of 15 signals provided the opportunity for profit.

We can also look at a table of the performance after the signal is given. I have chosen to look at the 24 months after the signal is given but note that 6 of the series considered ran on for over 4 years.



The number of months since the signal is shown in the left hand column, the average outcome (based on the number of continuing performances) is in the far right column. I have coloured some cells in the table. The two heavily pink series of results are the two very dangerous false signals from 1970 and 1974. The orange in the Average column shows that there are even months where the average outcome falls from the previous month. Yellow shows a month where the performance falls from the immediately preceeding month, but is better than for the month prior to that. It can be seen that a fall in performance measured at month end is not unusual, but that most of them pick up the following month. There were 65 such falls in performance. Of those, 27 were followed by a second fall in performance and I have coloured these pink and they could be considered as possible sell signals (although that is not part of the Coppock methodology). I have coloured the next rise in monthly performance green which could be considered as a possible buy signal, again not part of the Coppock methodology. None of this has been backtested other than by "eyeballing" the table.

(As an aside, after the transaction and whipsawing costs of timing systems the results seem likely to be broadly commensurate with the historical returns of a 50/50 portfolio of shares and long bonds and to more than halve the volatility and maximum drawdowns which frighten the life out of many self funded retirees.)

In considering when to sell if you are not buy and hold investor, always remember 1987 when the market was virtually at its bottom before most sell timing signals triggered, other than stop loss signals. From looking at various BEV charts I have done of recoveries from the bottom, there is great danger when the market falls more than about 7.5%. It rarely whipsaws immediately after a fall of 7.5%. After a  bottom the market spends 72% of its time before the next bottom at less than 5% below it's most recent high during the recovery. The risk of frequent whipsawing is very high if you sell the market on a fall since last high of less than 5%. Selling after a fall of 7.5% would have given you a chance to avoid the worst of the falls in 1987 and 2008.


The best summary might be that if you had purchased immediately after the Coppock buy signal was given since 1960 you would have earned on average 24% in the following 24 months, even taking into account two false signals which could have been avoided with a simple rule: sell if the month end performance is more than 6% below the month end on which the signal was given. (but be aware the next time it might reverse after a 7% fall! Whipsawing is everywhere!).

For interest, I also looked at the lead in to the Coppock signal being given.



While there is quite a variation between individual series, on a median basis compared to the month end on which the Coppock signal is given, the month end bottom was two months prior at 5.5% below the closing index value on the month end of the signal. On that basis it seems that a variation of the Coppock indicator which gave its signals a month earlier would, based on median results, have picked up an extra 4% of the upturn over the series reviewed. I am looking at Coppock 11,8,7 as a possible way to generate an earlier signal (but that might result in more false signals and so might not be as potentially profitable because of whipsawing).




Thursday, December 15, 2011

Mid Month Standard Coppock Review

While Colin Nicholson does a month end spreadsheet for the standard Coppock indicator (14,11,10) and, I assume relies only on Month end Signals, I have updated his speadsheet myself to see whether things seem to be improving or deteriorating with this signal. Purists might say that this is counterproductive as we shouldn't mix signals of different timings, but I wanted to see where we might be heading for month end.

See my previous post "Bottom? - MACD and Coppock Review" for historical graphs of the Coppock indicator.

The result is that all major markets covered by Colin's spreadsheet have deteriorated and if they held their current values at month end there would be NO Buy signal, so not a "safe to buy and hold for medium term" bottom in traditional Coppock terms yet. This does not mean that the bottom is not already in on 26 September 2011, or that now is not a lower/better market value than will be available in early January if the month end signal is a BUY.


This is not investment advice, merely educational commentary on general market conditions and indicators, as are all my posts. You pay your money and you take your chances. It's just that the race lasts longer than Randwick and historically you often win in nominal terms (but often not in real terms or in comparison to other common investments or other markets) if you just leave your money on the market.

Note: Australia is All Ordinaries, Shanghai is SSE 180 from http://www.sse.com.cn/sseportal/en_us/ps/home.shtml, not the one shown at http://au.finance.yahoo.com/intlindices?e=asia .


Wednesday, December 14, 2011

Bottom? - MACD and Coppock review

International stock markets have almost universally experienced a bear market over the last 3 to 9 months.

The question for most investors is now "Has it bottomed? Should I buy more shares?"

The Coppock Indicator was designed to answer that very question on a reasonably conservative basis, that is with few false readings. The MACD (Moving Average Convergence Divergence ) Indicator can also be used for bottom picking, but is more prone to being whipsawn or unclear. Links to the relevant Wikipedia pages for more explanation:
a) MACD
b) Coppock

I use non-traditional settings for both these indicators. I am not trying to pick the absolute bottom, just to ensure I buy comparatively cheaply. Using indicators like these always misses the bottom as they follow the price.

Coppock is usually monthly using 14,11,10. I use 11,8,7 as it gives a slightly faster signal. It was designed only for picking new uptrends after major bottoms, not for picking downtrends from major tops.

MACD is often daily 12,26,9 . For looking for major bottoms I use 170,150, 20 as it reduces whipsawing and provides rare signals that generally indicate major bottoms.

Using Incredible Charts I reviewed most major world markets and have prepared a very simple matrix looking at whether either MACD or Coppock are indicating that it is time to buy.

The answer is clearly that while a bottom might be forming and some markets are indicating a BUY on the basis of MACD, there are NO BUY indications from the Coppock Indicator. I have used Undecided where the MACD has barely crossed its signal line or they are running over one another or are horizontal and for Coppock where it is flat.



Colin Nicholson on his site Building Wealth Through Shares has a spreadsheet available with the Coppock indicator for 6 major markets.

Here are 3 charts derived from that data. The first is the Coppock indicator for the All Ordinaries since the early 1900's.



The second is a bar chart for the recent values so that it is clear when the indicator reverses direction from below the zero line.



The third chart shows the Percentiles of the Coppock for the All Ordinaries. It should be noted that other markets can show a much greater range and a very different distribution.


We are at a point in time where it should be well worth while to mnoitor the MACD and Coppock indicators to identify the point which will likely be the start of a major uptrend. This point could be in the next month or so as it appears a bottom is forming in some markets, or we could follow the 1987 to 1991 pattern in which case the bottom could be substantially lower and many months away.

Tuesday, December 13, 2011

Chart and Statistical Resources for Investors in the Australian Share Market

 The Reserve Bank of Australia publishes charts and statistical tables for Australia.

These would be of interest to investors in the Australian sharemarket, including through superannuation and managed funds.

To me the most interesting things are:
1. Commodity Prices for coal and iron ore (still very high)
2. Trade weighted index (still very high)
3. Housing Prices (very high but declining, generally slowly)
4. Household debt (high but some delveraging)
5. Household saving ratio (high, over 10% and stabilising at that level)
6. FX rates (generally near highs although not so much now against USD and JPY)
7. Export destinations (China is now quite important)
8. Unemployment (may have bottomed)
9. Retail sales (very low growth, reflecting household savings)
10. Interest rates (cash rate has had 2 cuts in consecutive months)
11. Stock market (volatile and way below the 2007 highs but better on USD basis because of AUD/USD rate changes, YTD is better than most developed countries in USD but US has been best of developed markets on MSCI indices.)
12. Federal government debt (very low on a net basis)
13. Bank dependency on foreign source wholesale funds (very high)

Chart pack is at:
www.rba.gov.au/chart-pack/index.html
These are very interesting and easy to browse.

Statistical material is at:
www.rba.gov.au/statistics/tables/index.html

My favourites from the ABS are Employment and Building Approvals, but I find that I have to adapt the information and chart it to really see the information I am looking for..


Comparative Yields as Timing Prompts

Timing the market to miss large falls but benefit from long bull markets is an investors dream, but moving average studies (eg by Doug Short) and of medium to long term returns of active managers show it is not easy to beat the market.

Recent significacnt changes in bond yields relative to earnings yields on shares on the one hand and between 3 month and 10 year bonds on the other hand have been significant and we may have just had a major prompt to watch for buy signals. In fact we have had two potential bottoms already, 8 August and 26 September, although the fear of recession induced by austerity in most major economies and European disruption could cause new lows. Volatiity induced whipsawing from following timing buy and sell signals is a real risk at present, however for those who have been out of the market until now it could still be a time to take on some risk.

Comparative yields between stocks and bonds and also between long and short dated government securities can be useful prompts, particularly where large changes take place relatively quickly. It is often said that the inversion of the yield curve has predicted 10 of the last 5 recessions, but rapid significant change is a useful prompt to be looked at with employment growth changes and the indicia of market tops and bottoms discussed in recent posts. I have previously done work on these issues based on Robert Shillers research of ├índ data for US markets and published on Seeking Alpha  I have now found data by Colin Nicholson which has enabled me to do a similar exercise for the Australian markets. The emphasis in each chart is on both the relativity and the significant changes in that relativity.

The two charts show comparative yields and rates of change in the ratios between the two yields being compared.

The first chart deals with 3 month and 10 year government bonds. The annotations to the chart tell the story, although I should emphasis that the change in direction from around or above 1.2 or from around or below 0.8 is really the start of the prompt. I understand from my reading that the futures markets are pricing in further rate cuts next year which if they come to fruition will likely bring the both the pink and blue lines above 1.2.



The second chart deals with the relativity between 10 year bond yields and the earnings (not dividend) yield of shares and with significant sharp changes in that relativity. Again, the annotations to the chart tell the story. Other than the depths of the GFC the ratio of bond yields to earnings yields have not been this high since before 1974. Only 1974, 1987 and 2008 have had such a dramatic relative increase in share yields over long bond yields. This is a reflection of extreme fear of recession, unemployment, falling earnings and/or stock market crash. Remember the dictum to "be greedy when others are fearful and fearful when others are greedy'? Well these relativities show others are fearful right now!


10 year bond yields in Australia are at around 4% and have not been at such low levels for a very long time, other than during the GFC. This could be a very bad time to buy bonds or we could be going Japanese. My suggestion is buy on your favourite timing buy signals but be prepared to be whipsawn because you may well get a sell signal within a few months given the situation in Europe and continuing austerity in many countries.



Employment Growth Already Stalled

Recessions and stock market downturns always have stalled or falling employment. Employment falls because demand has fallen, revenue is down, inventories are up so production/purchasing must fall. That means less employment.

I have previously written about falling building approvals and noted that "as go building approvals, so goes the economy" (generally speaking) and shown the fall in building approvals.

Employment growth has now stalled. The rate of growth in full time workers on a "change on same month last year" basis is effectively zero for November. Rarely does full time employment  stall without going negative. unemployment can be stable while growth in employment slows, but because of population growth and demographics, once it slows below the growth in the workforce, unemployment grows too.

My focus is on employment rather than unemployment because growth in the number of people working is the best indicator of likely growing GDP. This can be seen by looking at US growth in spite of still very high unemployment because employment has been growing for well over a year. Growing unemployment adds to the concern but you can have employment growth without falling unemployment because of workforce growth.

Two charts show the need to focus on the cycles of full time employment growth. (The pattern for total employed persons including part time workers is very similar). The first is persons employed full time. It shows a barely perceptible flattening over the last few months, partially obfuscated by monthly noise and seasonal changes.


The second shows growth from the same month last year which does away with seasonal noise and highlights the cycle more dramatically.


 The significant correlation of growth in employment slowing from around 3% or more and breaking down through the moving average and the commencement of significant stock market downturns is obvious. Upturns breaking through the moving average has also been a significant indicator of a major upturn in the stock market although a much shorter moving average would likely provide a more timely signal of upturns.

It may be that once employment growth falls through -0% you should be watching for buy signals (including very bad 2 month performance and a significantly oversold market) although with the risk of being whipsawn. In general purchases on a buy signal after a fall of more than 18% and then being "buy and hold" are more successful within 12 months than selling again, but of course there are some notable exceptions where the market has fallen 50%, but there have sometimes been multiple whipsaws costing say 20% of the fall. Most bear markets don't stay below 15% for very long.

My next post will look at changes in relative yields between stocks and 10 year bonds and also between 10 year and 3 month government securities. Looking at the signals from those relativities together with the employment signals will provide some very useful, but not perfect, timing signals. 1987 was unusual in that employment growth did not go negative although there was a very obvious trough. Mid 1999 and mid 2006 troughs were less significant.

These two posts could be read together with the post on market tops and bottoms for further indication of whether it is likely a good time to increase of decrease exposure to the stock market when clear price signals are given  eg moving average directions, moving average crosses, breach of trailing buys and sells (Turtle Trader" "style signals).

Both charts above are derived from Australian Bureau of Statistics (ABS) 6202.0 - Table 12. Labour force status by Sex - States and Territories.


Saturday, November 26, 2011

Building Approvals Foreshadow Recession

Australian building approvals foreshadow recession within about 6 months unless there are significant changes to policy settings in the next 3 months.


Note that the fall from the peak of monthly approvals figures in August 09 to September 2011 is almost 40%

The fall in the 12 month moving average from the peak in June 2010 to September 2011 is almost 15%, but most of this fall had taken place by January 2011. But allow for inflation of 3% pa and the fall in real value of 12 month average of approvals is probably 18% over the 15 months of the fall.

That must translate into lower construction and building supplies employment. Then there is the flow through into discretionary spending, retail employment, mortgage stress not fixable by interest rate cuts - all these lead towards recession and the lead time now might be as little as 3 months, given the timing of the majority of the fall in the average being already 9 months old.

Also note that 7 of the last 12 months were below the current average and 3 of the above average results included in calculating the average wash off over the next 3 months, suggesting the average will likely move lower over the next 3 months, meaning the inflation adjusted average fall at end December 2011 will likely be in the order of a 22% fall from the peak.

With a poor international outlook due mainly to Europe, tight credit parameters, high interest rates still (one cut isn't that much of a difference), and low confidence (ameliorated slightly by the change in easing stance), a greater than usual proportion of these approvals may not have translated into starts within the normal time frames and conditions are such that they may continue to be delayed further.

It is hard to see how these reduced approvals won't translate into a recession when unemployment increases among construction workers with consequent flow through the building supplies, retail discretionary spending, retail employment and possibly house prices through some increased rate of stressed sales.

The market still seems to be focussed on a resources construction boom, but:
1. isn't a proportion of that in the ABS approval data already
2. isn't some more than 12 months from approval, and
3. doesn't some of it require skills and relocations that may not be available in the domestic market?

Thursday, November 24, 2011

2011 Recovery (?) To Date (Day 44).

The 2011 bear market has so far bottomed at -22% on 26 September 2011.

While it feels like we have just had a failed bear market rally, it may be that we are still in a recovery from the 2011 bear market after 44 days.

Here is a chart of the first 100 days of recoveries from bottoms after falls of more than 20% since 1984, treating the bottom day as 0 and registering all recoveries in terms of percentage gains.

The chart shows that while we are at a point which is the lowest recovery at Day 44 we remain above the zero line and one recovery has been lower until Day 38 and another dipped lower for Days 58 to 63. in summary, we could still be in a recovery from the 2011 bottom, even though on fundamentals I am expecting otherwise.


While I am expecting to get triggered to sell within a few days if there are further falls, today's bounce has so far stopped me selling. I am very bearish, expect to sell based on timing strategies based mainly on moving averages and a modified "Turtle Trading" strategy and foresee a 1987/1991 market and economy double dip situation, we can't overlook the possibility that the recovery from the September 2011 bottom will continue and we should be buying the almost despair about Europe and mixed feelings about the US and China.

Tuesday, November 22, 2011

Bear Rally? From Recovery to Bear.

From earlier posts you have seen my graphics showing:
1. recoveries from prior bear market bottoms (http://thortsoninvesting.blogspot.com/2011/10/all-ords-below-average-recovery.html):
2. characteristics of market cycles (http://thortsoninvesting.blogspot.com/2011/10/market-cycles-in-australian-all.html) and
3. market bottoms in particular (http://thortsoninvesting.blogspot.com/2011/10/characteristics-of-market-bottoms-for.html).

The 1987 to 1991 Bottoms Bear's Eye View Chart

Today I am looking at how a market moves from one major bottom to another, irrespective of the length of time it takes and the shocks that take place on the way.  I have looked at each recovery individually using Mark Lundeen's "Bear's Eye View" where each new high is a zero score and each new level less than the last high is expressed as a percentage below that last high. As an example here is the BEV shart from 1987 to 1991. I chose this because my gut tells me that it could be very relevant in terms of the final bottom and it was the recovery from the last 50% fall before the 2007/8/9 fall of over 50%. It ends at the market bottom in January 1991after a fall of 30% from the last high achieved during that recovery. During the recovery from 1987 through to the bottom in 1991 the market never regained the high of 1987. We have already experienced this situation in 2009 to 2011 recovery as the market had a 20% fall from April to September 2011 without ever having reached the highs of 2007.

A couple of things you can see from the chart below:
1. There was a fall of about 12% very early in the recovery but the market reached new highs very quickly.
2. There was a period of about 8 months during which the market was down up to 14%, but again it reached new highs
3. The longer the Moving Average the less volatile and the more it follows the general trend of the market, but the more the market has moved by the time it changes direction.
4. During the major bear market leading to the bottom, there was a substantial bear market rally where using even a 90 day SMA as a timing indicator would have led to being whipsawn once, while a 10/30 cross of SMAs would have led to 4 round trip trades before the bottom, but the net result may have been better than trading the turning points of the 90 days SMA, depending on the buy/sell spread and transaction costs including stamp duties.



 The 30% fall took 16 months and brought the market back to 47% below its last all time high, almost to the level of 50% below its all time high. The level of the All Ords in January 1991 was within a few percent of the index in November 1987. Given the problems in Europe which could result in multiple sovereign defaults unless the ECB "prints" and supports sovereign bond issues, a repeat of 1987/91 for Australia is not out of the question. (Everything is linked directly or indirectly to Europe through trade, commodity prices or debt or affected by interest rates seeking yield and/or capital gain on long term bonds, it's just a question of how much the flow-on can be ameliorated by government and central bank interventions. My view is that it is far less likely to be offset by fiscal stimulus this time in many countries, and where it occurs is will have less dramatic impact than previously. It may ameliorate and slow the pace of recession but not prevent it.)

The Percentile Chart of the All Ords from Bottom to Bottom

I have also used a percentile chart based on each of these individual BEV From Bottom charts since 1987 to see what proportion of the time we have seen falls to particular levels like -20% and -50%. These percentiles are based on the market from the first new high after an absolute bottom of more than 20% (which is a zero on the BEV chart) to the next major bottom involving a fall of 20% or more (which in the recovery from the 1987 crash was a fall of 30% which some might consider as a reasonable proxy for the final outcome of the current bear market).

From the chart below we can see:
1. 50% of the observations have the market within 3.2% of the newest high since the recovery commenced.
2. The market is down 10% from the most recent high since the recovery commenced less than 20% of the time.
3. Four of the 7 market bottoms of more than 20% were between 20 and 22%, so diving in after a fall of 19% would have provided very good outcomes in those cases.
4. There are very few observations when the market is more than 25% below its most recent high even as it approaches a new bottom of more than 20%. The market has been more than 25% less than its most recent high during a recovery less than 3% of the time,

The big thing from this chart is that given we haven't had a rise of 20% since the September bottom, we might be in a bear market down 17.1% having just had a bear market rally and now falling away again, or the September bottom might be the final bottom and we are just down 5.3% from the latest new high in this recovery.  As there is no way to tell, you might decide to follow the price action based on eg the 10/30 SMA cross and sell.or go back to 50/50. My gut feel in the circumstances is that given US is at least stagnant and maybe entering recession and given the problems in Europe there is a real chance for a much larger fall, so following the price action at the risk of being whipsawn is my preferred course of action.




We see that only 5% of all observations are less than 20% of the most recent high. This is what leads to an investment approach of buying the market or certain sectors or stocks the moment the market is below say 19% or when it has a dramatically oversold position compare to some moving average or a dramatically negative 2 month or other short term performance. While the market may get much worse, historically you are highly likely to be in profit within 12 months unless the fall is eventually more than 40%. This problem has been avoided since 1984 if after a fall of 20% you wait for a medium length simple moving average of say between 50 and 90 days to turn up before buying or a cross of moving averages such as 10 crossing above 30. This is illustrated by looking at the BEV chart of the market from 1984 to now with a 90 day simple moving average.

One major qualification. The percentile would be quite different for Japan from 1990 or even '92 with far more common observations of falls greater than 10, 20, 30 40 and even 50%. The major risk is that most of the globe is in a balance sheet recession and that deficit hawks and bond vigilantes are driving austerity which leads to recession. It is this risk which drives me to be aware of reducing losses and not adopting the buy and hold strategy which has generally been so successful in Australia after a major fall in the markets.

Combining Percentiles, Bear's Eye View and Moving Averages



From observation (not backtesting which is beyond my time/computing resources/capacity) selling when the price falls more than 7.5% from its most recent high and then buying on an upturn of the say 90 day SMA would seem to insulate you from most loss during major bear markets but at the expense of occasionally having to sell and buy back with an opportunity loss (or even a real and realised loss) which would reduce your overall long term return.

But of course you could halve your volatility and maximum (hopefullly temporary,, other than if we are in a Japanese scenario) loss of value in your portfolio by having half in an index fund and half in bonds or being in a "balanced" fund, either of these at an average cost of only a few percent per annum in performance over the long term, and without having to constantly monitor your portfolio. The time that this wouldn't achieve a broadly similar result is in a situation like Japan 1990 to 2011.

You could also then switch to 100% equities after the 90 day SMA turned up after a fall of more than 20%, (which we know from our percentiles is only 5% of the observations from bottom to bottom) then switch back to balanced after the market went up say 15% and remain in balanced mode until the next fall of more than 20% and upturn in the 90 day SMA. This would reduce the losses incurred  from being whipsawn,   moderate the effect on you of "black swan" or "long tail" events (events which are a big deal but very rare and generally unforeseen.) and let you participate more in recoveries from major market bottoms.

Where are we now? The Dashboard is rolling over! Whipsawn by a Bear Rally?


Since my last Dashboard update the 10SMA has turned down (I average two lots of 3 days to reduce volatility), but the 10 day SMA is still above the 30 day SMA. I am also using a variation of the famous Turtle Trading System on a trial basis and my sell point on it is 4186. This system uses a series of trailing stops and leading buys that move with the market so that if the market falls more than a multiple of average daily volatility you sell and if it goes up more than a similar amount you buy. It is probably better suited to trading commodity futures, but can still result in significant cumulative realised losses.

I will sell if the All Ords closes below 4186 today and is below that level the following day at 2.30pm, or if the 10 SMA crosses below the 30 SMA whilever the 10SMA is trending down. My gut screams sell and I will have had a loss of a couple of percent from my August/Spetember purchases.

Could there be a Weekend Default/Withdrawal from the Euro?

I am thinking of selling on Friday no matter what as a surprise default and withdrawal from the Euro currency by Italy is probably in Italy's best interests now. If they leave it much longer the capital drain will have been very high. Would you have a deposit in an Italian bank now, given the sovereign is also in doubt? Not when I can deposit it in EURin a German bank in Germany instead or in Swiss Franks (CHF) in a Swiss Bank in Switzerland. Why would you take the default/devaluation/regulatory/tax risk?  I am likely being over-reactive in this, but the possibility is real. The worst result for Italy is two years of capital flight and recession inducing  austerity followed by a default and withdrawal anyway. Any default by one of the PIIGS or bank failure is likely to be on a weekend, so weekends are potentially dangerous times.

The TED/Libor Spreads and those compared to Germany of Spain and Italy are all elevated. The credit markets are likely becoming less liquid and some notable bond investors have reduced exposure to European sovereigns. When the banks are avoiding lending to one another it get's very dangerous. These TED and LIBOR spreads are nowhere near the highs of the Global Financial Crisis, but they are trending upwards very consistently.

Thursday, November 10, 2011

External Indebtedness - Australia in Bad Company

Australia has one of the worst Net International Investment Positions in the developed world at -61% of GDP in 2009 according to the Bank of Japan. (1)

Could we face action by "bond vigilantes" in the same way as Italy? 

Our position (2) is worse than:

Country Year % of GDP
 United Kingdom 2009 -13.1
 United States 2009 -17
 South Korea 2009 -17.8
 Sweden 2010 -22.2
 Italy 2010 -24.3
 Slovenia 2010 -35.1
 Mexico 2010 -36.5
 Brazil 2009 -37.5
 Kazakhstan 2009 -38.1
 Turkey 2009 -44.9

However we are in a better position than:

 Poland 2010 -63
 Slovakia 2010 -66.4  
 Estonia 2010 -71.8
 Greece 2009 -83.1
 New Zealand 2009 -90.1
 Spain 2009 -93.6
 Ireland 2009 -97.8
 Portugal 2009 -108.5

Is a position better than Poland and Slovakia but not as good as Kazakhstan and Turkey sustainable?

Is a position of 4 times as much net international investment as a percentage of GDP as the US and UK sustainable? And for how long? And can we allow our current position to deteriorate further? 

 In a world of "bond vigilantes" perhaps we need to examine our vulnerability. We have seen a number of myths exploded over the last few years:
1. House prices don't fall
2. Banks don't get bailed out,
3. Bank debt to foreigners doesn't matter of itself.
3. Western developed countries are immune to sovereign debt concerns.

While we have the benefit of being an issuer of our own currency (and can print and "quantitatively ease") to our heart's content, that doesn't help where our debt is denominated in foreign currencies, or we want to borrow more money from foreigners (remember the "Belgian dentist?).

We also have the benefit of low sovereign debt, but our states, while generally well rated, have large pension obligations under old defined benefits schemes many of which are indexed for inflation. The states can't issue currency and therefore need to fund these pensions over time as our demographics (dependency ratio) deteriorate.

The Federal Government has already had to guarantee some of our major banks borrowings from overseas which are needed because of the historically poor savings rate over the period from about 1995 to 2007.

Remember that European and US banks are likely to have to raise hundreds of billions of dollars in additional capital over the next say 5 years, or sell assets to reduce balance sheets. In those circumstances, will those banks increase lending to Australian Banks or to Australian governments wishing to fund welfare such as health, education, unemployment and retirement benefits?

Will international banks wishing to accept additional Australian exposure simply lend only to those major resource projects with undoubted export markets such as energy projects and not into general pools of funds in banks unless they are guaranteed by the Federal Government? Might foreign banks only fund their own major companies and their projects in Australia?

Could we face a foreign debt capital strike? Or increased yield requirements?

How can our policy makers address this position without causing a recession, higher unemployment, falling house prices and possibly a bank failure or two?

Footnote
1. See Table 5 on page 10 of http://www.boj.or.jp/en/research/brp/ron_2010/data/ron1009a.pdf
http://www.boj.or.jp/en/research/brp/ron_2010/data/ron1009a.pdf
2. See Wikipedia: Net international investment position
http://en.wikipedia.org/wiki/Net_international_investment_position

Saturday, October 29, 2011

All Ords - A Below Average Recovery

The Australian All Ords recovery since the 6 March 2009 bottom is below average, but in the recovery from the 1987 crash it got a lot worse from here.

See the bottom of the page for methodology and disclaimers.

Recent Position
As can be seen from the chart below, the current recovery from the 2009 bottom after the 2007 peak was the lowest percentage recovery of all since 1984 for a few days around mid September this year, 2011, or about days 645 to 648 on the graph which is about 2.5 years after the bottom. It was significantly below Average and below Average - 2003.

Currently (Friday 28 October 2011) after 671 trading days, or about 2.5 years since the 2009 bottom, we are at a 41.6% recovery, compared to an average of 54.9% or an average not including 2003 of 52.3%.

This does not mean that the recovery will automatically revert to the mean/average or that any reversion that does occur will be before any further significant falls. I am not pretending to forecast the market close at some point in the future.

In the chart below, which only covers trading days 471 to 810 since the bottoms, bold bright blue is the current recovery, the average is the orange line around the middle of the chart and 1987 is the pink line dipping towards trading day 800. 

 

Interpretations/Explanations
There are several possible explanations for this position.
1. The European debt crisis caused a secondary crash - the fall from the April highs to September lows was a median major fall of the Australian All Ords.
2. Austerity to reduce government debt resulting from stimulus and bank bailouts is reducing GDP/GDP growth whereas there was no Western debt crisis other than for highly geared corporates in most previous recoveries.
3. The imbalances that grew during the artificially induced "Great Moderation" of 2003 to 2007 and the size of the 2007/8/9 crash were of such magnitude that they will continue to work through the global economy for some years, much as was the case after the 1987 crash and so 1987 is as likely a guide to the future as the average of past recoveries.

The Megaphone of Likely Possible Futures
 We can think of the chart from Day 671 forward as a megaphone (or sideways cone if you like) of  likely future possibilities - it might not be correct, there could be worse outcomes eg Japan from 1990 to 2011, or maybe even better outcomes than the recovery from 2003, although personally I don't give that a snowballs chance in hell. I regard these latter outcomes as very remote, highly unlikely possibilities.

Our Attitude And Approach From Here - Invested but respecting the possibility of 1987/1991.
While we might hope for reversion to the mean and possibly above from time to time, we should not lose sight of the 1987 possibility (I heavily discount a Japanese possibility because of the resource demand from China and India and our better demographics), which is that we could fall from being a 41.5% recovery now to being only a 4.6% recovery over the next say 130 trading days, just like what happened to the recovery from the 1987 crash in 1991.

So while we might be heavily invested now after the September bottom, we should set our stop loss limits now (one off  "risk off" disinvestment or staggered risk/investment reductions to avoid the possibility of being totally whips sawn). Personally I will reconsider what will, after this Monday, be my almost fully invested position if there is a drop of 5% from my buy price on Monday.

Methodology and Disclaimers
I keep a number of charts of recoveries, all with the bottom as zero and measuring the percent improvement since the bottom for all crashes from 1987. I follow each recovery for 1100 trading days which allows us to see how this recovery compares to others. That period of time normally includes at least 1 other fall of more than 20%, but not in the case of 2003 to 2007. I include 2 averages, one of all recoveries and one of all recoveries other than from 2003 given it seems unlikely to be repeated any time soon given the various private, public, foreign and foreign currency debt crises that still exist.

As always this is not financial advice or a forecast and the past does not foretell the future. Ask any Japanese stock market investor about time in the market and the possibility of markets being lower even after 20 years after a bubble peak. Read widely and make your own decision after getting whatever specific advice you might need.

Tuesday, October 25, 2011

Market Cycles in the Australian All Ordinaries

What have the market cycles in the Australian All Ordinaries looked like in the modern era (post 1984)?

While I have previously posted on market Tops and Bottoms as separate entities, this post shows the cycles of tops and bottoms in one table in chronological order.

Explanation of the use of the lengths of cycles and rates of growth over different time periods have been given in the last post about the Characteristics of Market Bottoms and very similar principles apply to market tops.

The only additional word of caution is regarding the possibility that we are in a long term secular bear market and so falls might be longer lasting and bigger and bull rallies shorter and lesser, but this is just a caution about a real possibility, not a prediction.

The last line is today's results and it will not be a major turning point (famous last words?) unless Europe falls apart over the next few days.

The greens and blues are buys, the pink, yellow and orange are sells. you will see from the last two columns that tops are all large rises (because we are adding together the growth for 2 or 3 periods) and the bottoms are all large falls (for the same reason).

You will see that all bottoms have falls for 2 months and 1 year and generally for 2 years also, while almost all tops have positive growth for all periodicities with only a few exceptions, including in April 2011. Only 2 tops out of 7 have any negative growth period. It is uncommon to see a top without all periodicities showing positive growth.

The median lengths of complete cycles, rises and falls are at the bottom of the table as are the median results of adding each of :
a) 2 month and 1 year, and
b) 2 months and 1 and 2 years growth
for tops and separately for bottoms.

Median cycle is 3.2 years, median rise is 2.1 years, median fall is 1.0 years.

In about 1974 Austin Donnelly's book on Charting for Profit indicated that cycles averaged about 4 years, so things haven't changed that much, particularly if my 2 sub 20% fall bottoms were excluded, as most people would do in an article on market cycles.

Because of the occasional fast dramatic fall like 1987's 50% in 50 days with some trend indicating strategies failing to initiate a SELL until most of the loss was over, you may wish to have a stop loss at say 7 to 8% fall from the current bull market high. A tighter loss will result in more whipsawing and resultant losses over the round trip (Sell/Buy)

 When looking at market bottoms, you may also like to consider the likely maximum fall in terms of the previous 1 or two rises. The largest falls often occur after the most extraordinary rises like the 1987 and 2007 tops.

Should I "pick the bottom"?
You may choose to to invest at a time when the market:
a) is grossly oversold compared to eg its 200 SMA,
b) has had a fall of say 9% over the last 2 months (all bottoms except 1995 met this criteria), and
c) has fallen more than say 114%
on the basis that you will lose recovery of say 10% of the value at the top when the market turns up while you await the emergence of an apparently sustainable uptrend and so will get in closer to the bottom with this bottom picking strategy than by waiting for the uptrend to establish. You would likely be more cautious and adjust the above parameters if the preceding bull market was longer than usual, had a higher percentage rise than most bull markets and a higher rise in percent per annum terms.

For those interested in avoiding major falls but participating in major rises, this information should be helpful.

I add my usual cautions about the Japanese possibility which would change all these things and also of the dangers and costs of being whipsawn.


Characteristics of Market Bottoms for Aussie All Ords

Since 1984 (based on the free data from Yahoo Finance), the Australian All Ordinaries has experienced 9 major market bottoms of 14% or more, 7 of which were 20% or more and 2 were 50% and 54%. So while no one rings a bell at a market bottom, we ought be able to observe some characteristics of market bottoms that may help inform decision making now and in the future.

The table below summarises some of the indicators I believe are relevant to determining whether a market bottom is likely to have occurred. This should be read in conjunction with market trends so that you don't pick a bottom while the market is still trending down. In the case of very large sudden falls you might try bottom picking on the basis that if you are a bit early it is likely not worse than you would have been being a bit late while you waited to be sure a sustained upswing was emerging.

The main indicators are growth/fall rates over various time periods, and the length of a rise and fall. From past major bottoms and these indicators are derived Average, Median, Maximum and Minimum of each indicator.

From the table below
Please note that the last normal row is as at today which can't be a major bottom, but including it lets us see it is not too dissimilar to 2 previous major bottoms so could still be good buying.

If it is more than 1.5 years since a prior bottom you are getting into the range where one has occurred previously. The range however extends out from 1.5 to 6 years so this measure alone is not sufficient.

Falls can be surprisingly rapid - 1987 was 50% in 50 days, so you may want to sell after a fall of 7 to 8% no matter how quick the fall. A smaller fall is unlikely to be part of a major fall and if you sell after a fall of 3 or 4 % you will be whipsawn frequently, much to your detriment.

Assuming the fall is at least 8% already, the bottom could be in at as little as 14% total fall but the median is 22% and the average is 28%. As a guesstimate, if you buy in after a 20% fall you may still do as well as if you waited for a 30% actual bottom and then a 12 to 15% recovery while you waited to be sure that any emerging uptrend was likely to be sustained.  If you buy at 20% down and the actual bottom is at 25% down you might have done better buying in at the 20% as it might recover to being only down 15% before you otherwise are convinced to buy. The chances of picking an absolute bottom are virtually nil.

Major bottoms have only occurred when there has been a fall over both 2 months and over 1 year. It is also not uncommon for there to have been falls over longer periods, but rarely for there to have been a fall over 5 years except in the very worst of falls. The very worst of falls normally occur after the very best of rises!

As in the last few columns on the right of the table, you can look at cumulative falls from the 2 or 3 shortest periods of growth I monitor as a further indication and look at the Average, Median, Minimum and Maximum for them also.

While it would have been misleading in the Japanese market since 1990 and I assume in any other crash of a huge bubble you can look at the rate of growth since say 3 bottoms ago compared to the median to see whether the rate of growth seems to be about the rate of growth in the economy over that extended period. It is highly unlikely that there will have been exceptional growth compared to the economy as a whole over the term of 3 bottoms.

From this exercise we can see that there was an almost median bottom of a fall of 22% on 26 Sept 2011. This is not to say that the market can't fall further, possibly resulting in whipsawing losses if you buy back in/increase exposure and the market falls.

Note of Caution
"Time in the market" and "Buy and Hold" have been disastrous for the Japanese since 1990. Given the global debt crises (public, private, external and FX denominated) it is possible that we may be in a Japanese situation and that should be kept in mind. In the Japanese post 1990 bubble the market has shown a further loss (and negative return over the last 3 bottoms) at each new, lower bottom until now (assuming September was a major bottom). the percentile amount of time in loss approached 50% compared to 30% in the Australian market since 1984 to date. our percentiles in loss could increase given the long, high growth we had from 2002 to 2007.


All Ords Dashboard Update - 25 Oct 2011

(See earlier article for a detailed explanation of this Dashboard. Essentially the top section is about timing signals and the bottom section about whether it is a likely top  or bottom in the market)

From the Dashboard it appears that a possibly sustained up trend is emerging from an approximately median market bottom on 26 Sept 2011. (See recent post on characteristics of market tops and bottoms.)

While the market is up 9% from the low it is still 15% below the April 2011 high and a sustained up trend could be reasonably expected to have a total rise of 20 to 50% or more.

From the short term chart included in the Dashboard below you can see a possible trading range of 3900 to 4400 and a longer term chart shows strong resistance at 5100. (I use Incredible Charts free version and the free data since 1984 from Yahoo Finance.)

From the Dashboard
The market is presently above its 10, 30 and 50 day simple moving averages, but below the 100 and 200 SMA's.

The 10, 30 and 50 day SMA's (as I calculate them which uses two lots of 3 days with a 2 day delay) have all turned up, but the 100 and 200 are still trending down.

The 10 has crossed above the 30 and 50 but there are no other crosses (30/50, 30/100, 50/100 and 50/200).

The market is still heavily oversold against the 200 SMA being in the 13th worst percentile since 1984. The 2 month rate of growth is not at either extreme. The market remains extremely volatile based on my calculations, being in the 95th percentile of most volatile periods.

The 1, 2, 4 and 5 year growths are all in the bottom 20 percentiles. Over 80% of the time the market shows better growth for these periods than currently.

While Japan is a cautionary tale for many of these indicators, the market has since 1984 been closer to its then all time high 92 per cent of the days. I am not very persuaded by this as the 2007 top was quite and extreme and we could be in a secular bear market with another 10 or 15 years to run so medium term cycles might be more helpful indicators than relativity to the 2007 high.

Conclusion
My overall conclusion is that on a break above the 4400 mark or perhaps on earlier favourable crosses of moving averages I will increase exposure to stock markets, probably in Australia.


Macro Analysis
Uncertainty in Europe looks like being resolved, at least in the short to medium term, later this week. (In the absence of full union or individual currencies it is impossible to expect that trade and performance imbalances can be resolved - Europe is on a "gold like" standard which means all adjustments are internalised, not through a floating exchange rate and/or inflation.). Even temporary resolution will likely assist market confidence globally. A Euro breakdown would be a Lehman like event, while a time delay would be a likely negative.

The US has some indicators showing that the recession forecast by ECRI and John Hussman might be avoided, although others claim that the favourable indicators are lagging or their positive performance is statistically insignificant noise.

China continues to be of some concern and this is not positive for Australia, but falls in commodity prices and the mining sector may ease the AUD and assist local manufacturers and tourism operators and any interest rate cut would provide cash to most mortgaged households and could lead to increased spending and profits.

A fall in interest rates because of slowing construction approvals (12 month average), falling house prices in some mainly regional markets and core inflation probably moving back into target range is now regarded as quite possible/likely, particularly after recent IMF growth warnings.

Wednesday, September 21, 2011

All Ords Dashboard Update

The Dashboard says:
1. Should have been in 100% cash or 100% short by now (if you short), (but it may be too late to start selling now - see below).
2. There is no uptrend to buy into so don't buy now.
3. Various percentiles of growth and volatility are at about the types of levels for an average/median bottom (based on performance since 1987), so look for a change to an uptrend to buy into.
4. It could still get markedly worse as 2 month, 1 and 2 year percentiles are only at moderately, not extremely low levels.


The macro fundamentals remain negative as Greek interest rates indicate the market thinks default highly likely within 6 months.

The Japanese post bubble experience would treat the All Ord's current  negative growth levels as only around or slightly below median performance (other than for 3 month) and the expectation would be that a bottom was not really likely until negative growth was more extreme (say around 15th percentile) at at least 2 of  1, 2 and 3 years.



Given Zombie Consumers in US and Zombie Sovereigns and Banks in Europe it is quite possible our next ten years will be much more like the Japanese experience than our last 10 years.

David Murray, CEO of Australia's Future Fund is reported (21 Sept 2011- ABC On Line) as saying we likely have 20 years of deleveraging and low growth from major developed countries in front of us.

Monday, September 12, 2011

A Statistical Approach to the Australian All Ordinaries

Buy low, sell high - like motherhood and apple pie, but what is high and what is low?

The answer to this question can be narrowed down by taking a statistical approach to analysis of the recent history of the Australian All Ordinaries.

Excel has a function which allows you to create a percentile analysis of a series of data. This can be applied to a series like the results of calculation of the percentage difference between the All Ords today compared to say 2 months, 1 year and any other number of periods ago. It can also be applied to a series of the volatility, or degree of overbought/sold compared to a benchmark such as the 200 day simple moving average.

The results of that percentile function can then be graphed using Excel's built in graphing functions.

You can then read any piece of data against the chart to determine where in the historical context the point lies. What percentile does it fall within? What percentage of historical results were higher or lower?


Here is the result of percentile analysis of the All Ordinaries growth performance for various rolling periods using index data starting from 1984.


If we know the 1 year growth as at today we can compare to a chart to determine the percentile within which that level of1 year growth would lie. Excel will, for each point on the chart, tell you the percentile number and the level of 1 year growth. For 12 September 2011 the 1 year growth rate was determined from the my table of calculations to be negative 11.9%. From a similar chart to that above that was determined to be in the 13th percentile of 1 year growth. In other words, from 1984 to 2010 the 1 year growth rate was higher 88.1% of the time. But 11.9% of the time it was worse and that can mean a lot worse, but generally not lasting for more than a year.

From the chart above we can see that about 75% of the time there is positive growth in the stock market. Compare that to the chart near the bottom of the Japanese Nikkei over a similar period. It has had positive growth only about 35% of the time.

You can also look at the results for a day that was a historical high or low to determine whether the results for today look like previous highs or lows compared to medians and averages (two other Excel functions) of the available past results.

What do market bottoms look like?

Here is the result of my analysis of major falls in the market since 1984.


This chart is quite straight forward other than that I have assumed at present that we had a bottom on 9 August 2011. This is on the verge of being proven wrong as I write on 12 September.

The top section of the table shows the Average, Median, Minimum and Maximum of the results shown in the bottom half of the table.

The bottom half of the table shows the characteristics of a number of market bottoms. It can be seen that the market on 9 August 2011 was within the ranges of results that in the past have been a market bottom, but not at the extreme bottom of those ranges for the one and two year growth rates in particular.

Summarising the Outcomes.

The results of the various periods of growth (and moving averages) that I monitor can be summarised into a "dashboard" which shows both the percentages and the percentile of historical growth within which that percentage falls.



From the top half of the above Dashboard we can see that the market has virtually no evidence of an uptrend at present. All of the moving averages I monitor are pointing down (last 3 days total is less than previous 3 days total) and for all but 10/30 all moving average pairs/crosses indicate that the market is falling.

However from the middle of the dashboard we can see that the market is in the worst 20 percentiles of being:
1. Most oversold against 200 day sma
2 Having most negative growth in 2 months and
3. being most volatile (as it is during bear markets including around market bottoms).


Towards the bottom of the dashboard we can see the actual levels of growth over the periods I monitor, compare them to the median and see the percentiles within which todays results fall.





This analysis is subject to the usual caveat of the past not predicting the future. Also, given the size of the stock market boom to October 2007 and fall to March 2009 there is a chance that in future these curves will shift so that the types of negative growth now will be more common (ie in higher percentiles) as they are now in the Japanese market (which I have also analysed) because of the falls from the undoubted bubble top in 1990. Having said that, the odds of the market showing higher rates of growth in future would normally be regarded as quite strong, while the chances of significant further falls would be regarded as real but significantly less than the chances of rises.

If we look at a chart of 1 year growth from 1985 to 2010 we will see that more negative growth is quite rare and has not lasted all that long in the past.


Could this be a top?

We know that we are below April 2011 levels so it is not a top, but lets look at what markets tops look like in terms of growth. As you will see is that the current market does not look anything like any of our past market tops in terns of historical growth.


Since 1984 the market has never had a top without 2 Month and 1, 2 and 5 year growth being positive. Generally all periods show positive growth. At the present time, no period of growth is positive and all periods of growth are substantially below the median levels of past market tops. It doesn't look anything like a top.

What Strategy To Follow?

There is little point in buying when there is virtually no evidence of any sustained market upturn, even if the market is within a range often associated with market bottoms and with various growth periods being at relatively low percentiles.

My strategy is that now and lower provides a time of probable buying opportunity but there is no point buying a falling market. Work out what you will accept as signalling a likely/possible market uptrend and how to stage your commitment to that uptrend, but be prepared to cut positions in the case of any emerging uptrend being a bear market rally.

Two bits of folklore to remember in this regard are:
1. first loss is best loss
2. the (up)trend is your friend (until it ends).

This strategy is informed by the analysis and results of John Hussman. He was guided mainly by economic fundamentals and value compared to historical outcomes. This helped him identify the unsustainable high of the market in 2007. However he missed virtually all the 2009/early 2010 rally because he was unwilling to look at price trends and how low the growth percentiles were in historical terms.

A note about the Japanese experience.

Japan has three lessons for us. First, money can be made in a market post the bursting of a bubble if timing is good, which is why looking at the trends is important. Second, what appear to be lowish percentiles in a market characterised as a sustained bull market will be average percentiles in a post bubble market with tough demographics, which is why not getting too carried away based only on the percentiles is also important - wait for the emergence of a trend. Third, time in the market is not a guarantee of a positive return if you buy at an extreme market top, which October 2007 may have been.


We see from this chart both that the top growth percentiles are literally off the chart because of the extreme bubble of 1990 and that about 65% of the time each period of growth monitored had negative growth as a result of the protracted readjustment of the market from the 1990 bubble during which the Nikkei has fallen about 80% from its all time high.

Conclusion.

By looking at the percentiles resulting from a statistical analysis we can know whether we are buying near a possible top or bottom and tailor our risk management accordingly.

By looking at indicators of existing trends such as the direction or crosses/pairs of moving averages we can judge whether we would be buying/selling into an up/downtrend.

The goal of course is to buy near a bottom but only into what is likely to be an uptrend but to accept the possibility of whipsawing and losses through reversal of the trend.

We can reduce the risks of whipsawing by staging our commitment to a new up or down trend or, having bought near a very likely low based on our percentile analysis, we can choose to ride it out in the hope and with the likelihood that our losses will be smaller than most other investors and eliminated during the next uptrend.

Friday, September 2, 2011

Building Approvals Show the Coming Slow Down.

Building Approvals by Value are, obviously, a good indicator of likely levels of future construction activity.

New buildings leads to new furnishings, plant & equipment, and technology sales so provide opportunities in those other areas including retail. 

During the GFC the Federal Government supported the building industry and construction workers through the insulation and school building programmes. Most of those jobs are now finished or soon will be. So what does the future hold?

The Australian Bureau of Statistics (ABS) series 8731, table 39, Value of Building Approvals by State/Territory as of June shows that building approvals by value across Australia are in a major downtrend. That can be shown in both semi-logarithmic and linear axis charts. The semi-log chart allows a more meaningful evaluation of changes over time.



There are a number of noticeable events in this chart:
1. The slump before the 1974 stock market crash
2. The slump before the 1982 bear market
3. The major boom in approvals between 1987 and 1991, and the slump prior to the 1992/3 recession
4. The slump in approvals prior to the 1992 recession
5. The double dip now occurring, reflecting the pre GFC slowdown, government stimulus and the run-off of that stimulus.

By clicking on the chart to see the larger version the dimension of the slowdown in approvals compared to previous periods is quite evident (directly comparable in nominal terms as a result of the use of a semi-log scale). It is not as severe as the 1989/91 downturn, but is comparable to each other slump. If adjusted for inflation, it may well be more severe than many of the seemingly similar slumps that happened in times of higher inflation.

So what does the next 12 months hold?

There is a lag of, in the main, 3 to 12 months in building starts compared to approvals. The slump in approvals is a harbinger of substantially reduced activity and employment in the construction industry and those that benefit from the spending decisions correlated with construction and its completion.

While the NBN roll out may absorb some employment as the insulation program did, there will be reduced employment in the construction industry most of which will not be taken up in the resources industry.

Reduced employment will result in falling retail sales as consumers see an increased risk of personal unemployment and defer purchase of durables and forgo discretionary expenditure, initially by moving purchases down market and reducing frequency of things like restaurant meals. Construction and Retail were two of the major areas of reduced employment in the US as a result of the mortgage crisis, busting of the home building and value bubble and GFC, but the scale will likely be smaller in Australia.

The chances of a slump of the current magnitude not having an adverse effect on GDP and employment are very low.

The likely consequences are:
1. fall in profitability of retail, construction and discretionary services
2. increased unemployment
3. a lower stock market in Australia

The likely timing is 4 to 8 months based on the lag between current jobs finishing and the reduced activity from the reduced level of new jobs becoming more obvious to the general community.

Now is the time for government to plan the infrastructure renewal and its tendering, costing and execution (to avoid the problems of the insulation and school building programmes)  so as to be able to take advantage of the opportunities that arise and to ameliorate the downturn.

The nominal axis chart below provides a better view of thevolatility of the swings in approvals of the last 5 to 7 years.

Please note the trend lines and 12 month simle moving average are different between the two charts as a result of the different scales used for the vertical axis.




Friday, August 26, 2011

Paul's Dashboard and the Recovery So Far and Looking Forward

I do a lot of analysis in Excel using the data from Yahoo Finance since 1984, which covers the period of the rally to and crash from September 1987.

I use Excel functions to do charts from the data, to do calculations of performance and to calculate percentiles of performance so I can put current performance in a quantitative perspective.

I summarise the recent performance and the trends into a "Dashboard" which I colour to provide me with a quick overview of the market for buy/sell analysis.

One of the charts  I maintain compares the current recovery with past recoveries and 2 averages, one of all recoveries since 1987 and one not including the 2003 to 2007 bubble recovery.

Here then are the Dashboard and a Recoveries Chart.


The Dashboard shows that while on virtually all measures the All Ords is trending down, the 10 day SMA (using 6 days data) has turned up. It also shows that volatility, overbought/sold and recent growth are in the area where buying should be considered. It also shows that growth over all periods I monitor from 2 months to 5 years is well below median. Further we remain well below both the recent and the historical high. But do note that we are up substantially since the bottom. That brings us to the Recoveries Chart.




The Recoveries Chart shows that until the last 25 days this recovery was well above average - "too far, too fast". It is now a below average recovery and since 1987 only one recovery has been lower for any significant length of time looking forward, the 1987 recovery. The chart looking forward from today also shows us a "cone of possibilities" and on balance the previous patterns would indicate that there is a lot of historical precedent for the market being higher over the next year or so, but this is tempered by the knowledge that 1987 was also a >50% fall like 2007-9 and there are fundamentals that will provide a strong headwind. Based on an eyeball estimate the area within the "cone" (ie looking forward from today within the upper and lower bounds of previous recoveries) above the current recovery level is about twice as much as the area below the the current level - odd of 2 to 1 in favour of an upswing to higher levels over the next 10 months you could say.

Being armed with the information from the Dashboard and Recovery Chart will help in understanding the basis for my previous article.








Thursday, August 25, 2011

Five Questions Regarding the Australian Share Market for Australian Based Investors.

Five Questions Regarding the Australian Share Market for Australian Based Investors.

(This does not examine comparative investments in other markets, commodities or currencies)

1. Is there a possible buying opportunity?
2. Should I buy some now?
3. Can I lose by buying now?
4. Is my reliance on these indicators appropriate for the market we are in?
5. Is the 12 month macro environment/outlook positive or negative?

Is there a possible buying opportunity?

Yes!

Should I buy some shares now?

Yes! The 10 day simple moving average has turned up after a fall of 20% (using the intraday low).

Can I lose by buying now?

Yes! The 10 day SMA is volatile and gets whipsawn, but no market recovery starts without the 10 day SMA turning up. Based on the price pattern after the 1987 crash, you can expect to make a loss from whipsawing until there is a significant major uptrend. That major uptrend might start now in which case you will have no drawdown or there may be say 10 false signals, many involving a loss on the round trip trades, until a major uptrend starts. But, you will not be caught in a future major downtrend if you follow a moving average strategy. You may, however, not do as well as if you just bought in 100% now and held as long as possible.

Is my reliance on these indicators appropriate for the market we are in?

This depends on your age/recovery time, other assets, income outlook but if you are highly concerned about major losses (the Japanese scenario where their market is now down 78% from its all time high in 1990) but also want to participate in any upside, a moving average strategy will protect you from a Japanese scenario but at the likely cost of reduced returns in a sideways or uptrending market (This statement based on analysis by Doug Short: www.dshort.com).

Is the 12 month macro environment/outlook positive or negative?

My opinion is that it is negative. This is based on the unresolved PIIGS debt problems, the introduction of fiscal austerity in US, UK and Australia as well as in the PIIGS and the current trailing earnings in the US being at a never sustained multiple of the 10 year average real earnings. The abandonment of mark-to-market also causes concern. However, central banks are taking extraordinary measures to ensure financial stability and to destroy incentives to hold cash and short and even long term securities. The US 10 year rate is about 2.2% and the S&P 500 earnings yield is about 5%, a ratio rarely sustained for long since 1960, so stocks are quite attractive if earnings merely hold up at current levels. I follow the hypothesis of Richard Koo that this is a balance sheet recession and that to avoid GDP falls the government must take the savings of the private sector and spend them.

Detailed explanation.

I analyse the relative performance of the Australian All Ordinaries Index since 1984 including:
1. returns over 2 mnths and 1, 2, 3, 4 and 5 years
2. whether it is overbought/sold against its 200 day SMA
3. its position against its all time and most recent tops
4. the length and size of its most recent rise or fall against all rises and falls of more than 8% since 1984. (8% is a not quite arbitrary number to eliminate the noise of minor, short term fluctuations).
5. its volatility (persistent high volatility is correlated with major bear markets)
6. the comparative percentage recovery over time from major bottoms
7. the rises and falls between major tops and bottoms and between tops and bottom 3 years apart. (to smooth numbers and avoid comparison only to some extraordinary crash or bubble)
8. What gains/losses have been for 1,2,3,4 and 5 years since the previous tops and bottoms to assist in identifying whether based on past growth rates for those periods at prior tops and bottoms we are likely near a top or bottom (but this analysis will not assist in a long term secular downtrend like Japan as each cyclical top is often lower than the previous cyclical top).

Buy indicators
Present indicators of now being a likely buying opportunity include (based on prices since 1984):
1. The Australian market has only been below its highest point previously by the current 37% for 8% of the trading days since 1984, it has been closer to its previous all time high 92% of trading days since 1984 and has always reached new highs.
2. The length of the current fall to its recent bottom is above both average and median duration of all falls of greater than 8% since 1984
3. The size of the current fall to its recent bottom is above both average and median duration of all falls of greater than 8% since 1984
4. My measure of volatility is in the 96th percentile, so near all time highs
5. Growth over 2 months and 1, 2, 3, 4, and 5 years is at significantly lower than median points being in the bottom 10th, 18th, 18th, 10th, absolute bottom and 2nd percentiles.
6. The market has, since 1984, hit a new record high within 5.5 years, so we might expect to be at 6850 by April 2013, which would be a rise of 60% over the next 20 months (personally I doubt it very much, but the September 1987 high was exceeded in January 2004 in spite of the fall of over 50% which took place in September 1987.
7. The percentage recovery of 37.7% at trading day 625 since the bottom is below average and below all but the 1987 recovery at day 625. Until this recent fall the current recovery had never been below average since day 20. But the 1987 recovery had a sustained period of relapse lower than the current 37.7% recovery after day 625. The 1987 recovery went through a further major downturn and spent only 170 of the next 586 days (the limit of my analysis) above the present level. So there is risk of being whipsawn for a loss if you buy now and get a sell signal later.
8. After the recent falls the market is significantly below its linear trend line on a simple scale and its logarithmic trend line on a logarithmic scale so mean reversion would indicate a likely future uptrend, although timing is always uncertain.

Risk indicators

1. the 30, 50, 100 and 200 smas are all still trending down.
2. there have been no bullish crosses of the 10/30, 10/50, 30/50, 30/100, 50/100 or 50/200 moving averages, so there is a real possibility that you will get whipsawn for a loss if you buy now. It may be too early.
3. You can't totally rule out a Japanese style situation of cyclical losses for another 10 years.
4. The 1987 situation went to a lower level of recovery for about 76% of the next 586 days
5. Periods earlier than 1984 (particularly the post 1929 years) will likely have worse results but are not included in my analysis.

My record
As for my record of profit, I only became an active manager of my funds since the peak of 2007 and I got in too early after missing some parts of the fall and from the top in 2007 I am now slightly ahead of the market in nominal terms.Measurement is complicated by withdrawals to fund retirement. When I add back my cash withdrawals for living expensesI am down approximately 12% from October 2007 compared to the market being down 37%.

My future strategy
I will sell again if there are falls resulting in a downturn of the 10 day moving SMA but not necessarily on the day of the downturn. I will buy more if more trend lines turn up and there are bullish crosses of some of the trendlines I monitor. I have not yet decided exactly what my buy actions will be based on.

Disclosure
I have a significant exposure to the All Ords established within the last 2 weeks (before the 10 day sma turned up but based upon the size of the fall and the percentiles of volatility and growth), but less than 50% of my investment pool, so at present I am almost ambivalent about the direction of the market. I have locked in some outperformace against the All Ords but can take advantage of any major falls to buy in at lower prices, but will regret not having bought more if prices rise and my 10 day SMA remains in an uptrend.

My 10 day SMA is based on the sum of the last 3 days minus the sum of the previous 3 days