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.


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.