Sunday, September 25, 2016

The Risk Of Dismissing The Data: The TED Spread And Baltic Dry Index

No single variable or statistic provides clear insight into the future direction of the economy or stock market. When a data point does not fit ones narrative though, justification to eliminate it seems to be gaining among some strategists. Recently, the market has seen a fairly significant spike in LIBOR and a resultant increase in the TED Spread, i.e., 3-month LIBOR minus 3-month Treasury.

Thursday, September 22, 2016

Sentiment: Investors Not Believing The Rally

This morning the American Association of Individual Investors released their Sentiment Survey showing a 3.1 percentage point decline in bullish sentiment to 24.8%. The bullish sentiment reading reported by individual investors remains below the -1 standard deviation level of the sentiment measure which is 28.3%.The 8-period moving average of the bullish reading declined as well to 29.6%. 

A vast majority of the decline in bullish sentiment showed up in bearish sentiment (+2.4 percentage point increase) with a net impact of widening the bull/bear spread to -13.5. This is the widest the bull/bear spread has been since late May when the spread was -14.8. Since that point in May the S&P 500 Index is up 5.6% on a price only basis. As individual investors continue to doubt the markets this year, they continue to move higher nonetheless.

Monday, September 19, 2016

Heightened Market Volatility Would Favor Low Volatility Strategy, But It Looks Expensive

A little more than a year ago we wrote about the outperformance of the low volatility strategy versus a more risk on/high beta strategy. At that time it was noted low volatility could persist; however, if the broader market reached new highs, the high beta strategy would likely outperform low volatility. This has essentially played out and as the calendar turned to 2016 the early year market pullback saw the high beta strategy succumb to significant selling pressure and was down 20% into the February low, almost twice the broader market's beginning of year decline. Once the market began recovering from the February low though, high beta has outperformed the low volatility strategy, 25% versus 9%, respectively.

Sunday, September 11, 2016

The Dogs Of The Dow And The Risk With Exchange Traded Notes

Three quarters through the year, the Dogs of the Dow strategy continues to be a winning one, outpacing the Dow Jones Industrial Average and the S&P 500 Index by nearly three times. The average return of the 2016 Dogs of the Dow equals 16% versus the Dow Index return of 5.7% as of Friday's close. As noted in earlier posts, the Dogs of the Dow strategy is one where investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Index (DJIA) after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year.

With the popularity of indexing, some investors have pursued the Dow Dogs strategy via an exchange traded note, the ELEMENTS "Dogs of the Dow" Linked Note (DOD). The return of this note has varied greatly from the performance of the Dogs of the Dow themselves. There are peculiarities with these types of exchange traded products investors should be aware of. More detail on the risk of exchange traded notes can be read here. Two important ones are the fact these investments are essentially bonds of the sponsor of the exchange traded note. In the case of DOD, the issuer is Deutsche Bank AG and an investor in DOD has unsecured credit exposure to Deutsche Bank AG. Secondly, the return on these notes are 'based' on some underlying index or basket of investments. In the case of DOD the ETN's return is based on the Dow Jones Select 10 Total Return Index. Because the issuer is not required to issue more shares of the ETN, the price of the ETN can diverge from the value of the underlying Index and in some cases the divergence is significant. This has occurred with DOD as can be seen in the below chart.

Year to date through early June DOD was up nearly 60% while the underlying Dow Jones Select 10 Index was up only 11.3%. As is typically the case, the large premium at which DOD traded quickly narrowed to the actual return of the underlying index.

Lastly, in this low interest rate environment, investors have a heightened focus on income generating equities. From a total return perspective though, the Dogs of the Dow strategy has had mixed results from year to year.

Friday, September 09, 2016

Transports Leading Industrials A Bullish Market Signal

As early as about six weeks ago, some technical strategists were projecting a near trigger of the Dow Theory sell signal. In short, when the Dow Industrials and the Dow Transport Indexes are in an uptrend together, i.e. higher highs and higher lows, the market is in a bull market uptrend. Conversely, when both indexes are making lower highs and lower lows, a bear market trend is in place or developing. If one sees divergence in the indices, this can be a signal of a change in direction of the market and this was occurring in July of this year when the transports were weakening.

As of the close yesterday though, the year to date return of the transport index return now surpasses that of the Dow index return as can be seen on the below chart. The transport index weakness in late July has been quickly reversed in August and early part of September.

Additionally, positive chart setups have triggered which portend potentially higher prices ahead for both indexes. For the transports an inverted head and shoulders pattern has triggered with an upside target price of about $162 and cup and handle trigger with a lower target than the inverted H&S trigger of $150. Additionally, in spite of the near sideways trading action in the Dow Industrials Index, bull flag formations are in play and are suggestive of potentially higher prices as well.

The industrial and transport segments of the market seem to be indicating an improvement in the operating environment over the next 6-12 months. If earnings prospects continue to improve, as we have discussed in earlier posts, the odds of higher equity prices over the course of the next year seem likely.

Friday, September 02, 2016

Another Month Of Equity Outflows

Individual investor sentiment continues to show a low level of bullishness and this has translated to continued outflows in equity mutual funds and exchange traded funds. Almost a month ago I noted the strong outflow from equity funds and ETFs that occurred in July and this selling trend continued in the month of August.

The outflows have caused assets in equity mutual funds to decline while equity ETF assets have increased on a year over year basis as of the end of July. The increase in ETF assets is largely due to the strong equity market returns from a year ago, for example, the S&P 500 Index is up over 12%.