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"Speculators are obsessed with predicting: guessing the direction of stock prices.  Every morning on cable television, every afternoon on the stock market report, every weekend in Barron’s, every week in dozens of market newsletters, and whenever business people get together.  In reality, no one knows what the market will do; trying to predict it is a waste of time, and investing based upon that prediction is a purely speculative undertaking."

  —Seth Klarman, Margin of Safety

- Enjoy more of our favorite value-investing quotes


JUNE 28, 2015




In This Edition:




Where is the market headed? This is a question that many wish to have answered. However, as noted by value-investing billionaire Seth Klarman in the Quote of the Week at the top of this page, it is also a question for which there is no dearth of answers from an endless line of 'experts' on the TV business channels, market-oriented websites, business newspapers, and investing blogs.

However, IntelligentValue is not in the business of fatidic speculations.  I'm not going to tell you what I 'think' the market is going to do because I do not know. However, what we can do is identify some telltale signs of potential risks and opportunities, and take the appropriate action, as prescribed at the end of this article.

Based upon my 35+ years of experience in the market, it appears that we may have come to a critical juncture.  Value stocks have been in a flat-line consolidation for the last year.  Their underlying Support Line, at the 20-week Moving Average, has closed in on that overhead resistance, and there is no room left. I believe that this group of equities are going to break sharply in one direction or the other, and it will likely occur this coming week; the week of June 28. For details on why we believe this is the case, see our June 24 Value Alert newsletter regarding why value stocks have been struggling.

That breakout or breakdown in value stocks (and perhaps the market as a whole) could be fast and furious, depending on the direction. In this article, we will look at an important indicator that precedes big moves to see what it is currently telling us. We will check in on the nine primary sectors of the market to see what conclusions we can draw about the status of the business cycle. We will also look at a 'big picture,' 20-year monthly chart and examine how the market has reacted when it is been in this situation previously. In the course of this review, our goal is to determine whether we are about to begin a fresh leg up in a long-term, secular bull rally or on the brink of a selloff.


The S&P 500 large-cap stocks are up 213%, and the Russell 2000 small-cap stocks are up 271%
since the low in March 2009. These gains have come during what may be the best six-year investing period of our lifetimes. When markets gain as much as they have in the last six years, not letting your enthusiasm get the best of you and keeping your expectations in check are two of the most important things you can do. At this point in the market cycle, it is easy to extrapolate what has occurred in the past. In fact – believe it or not – that is what 95% of Wall Street analysts do (I know this from first-hand experience of being one several decades ago).


reports that there hasn't been a single day in 2015 with a move greater than 2% in the S&P 500. Market technician Ryan Detrick recently tweeted that the market's primary index has gone eight straight weeks without even a 1% move, a stretch of 20 years since the last time this happened:

8 Weeks without a 1% move
Click to enlarge



The chart below shows the S&P 500 index for the last 12 months with the Volatility Index ($VIX) in the bottom window. In the main window, we can see the S&P 500 is losing momentum and may be rolling over as 2015 progresses. The mid-June high was lower than the mid-May high, so we already have one lower-low. In the bottom window, the Volatility Index (which many pros use to hedge against a volatile market) has been steadily falling in price after a peak in October 2014.

Since the sharp rise in October 2014, the S&P 500 has been losing momentum and is at risk of rolling over.

It is quite difficult for investors to get ahead when stock prices are running in such a narrow range, without volatility.  In particular, value investing takes advantage of the sub-optimal behavior of investors when they oversell the stock of sound companies (usually a result of fear). Without any volatility to speak of, it's hard to get a foothold with fresh undervalued positions in this market environment.


In another measure of declining volatility, the Bollinger Bandwidth is an indicator that can be used with individual stocks or with indices such as the S&P 500 (shown below).

According to, "Bollinger Bandwidth is best known for identifying The Squeeze. The Squeeze occurs when volatility falls to a very low level, as evidenced by the narrowing bands. The upper and lower bands are based on the standard deviation, which is a measure of volatility. The bands narrow as price flattens or moves within a relatively narrow range. The theory is that periods of high volatility follows periods of low volatility. Relatively tight BandWidth (a.k.a. the Squeeze) can foreshadow a significant advance or decline. After a Squeeze, a price surge, and subsequent band break above the upper band signal the start of a new higher. A new decline originates with a Squeeze and subsequent break below the lower band."

 The chart below shows Bollinger Bands around the S&P 500 in the top window with the Bollinger Bandwidth in the lower indicator window. As the bands in the top window get narrower, the Bandwidth indicator in the lower window gets closer to zero. Notice that the Bollinger Bandwidth is currently only 2.4%, which is extraordinarily low. This indicator is practically screaming that a big move is coming! not just have thatThe SQUEEZE is on:

The Bollinger Bandwidth for the S&P 500 has gotten extremely narrow at just 2.42%. This is a set up for a major move higher or lower. But which?


So it appears that the market is set up for a very significant move, but the question is – which direction? Let us see if we can discern that from the way the market's sectors are performing...



The business cycle is typically defined in terms of expansion and contraction. During expansion, the economy is growing in inflation-adjusted terms, and increases in employment, production, sales, and income are the norm. In recessions, the economy is contracting with decreases in the indicators mentioned above.

According to the NBER, there been 11 business cycles in the post-World War II era. The average expansion lasts about 58 months (about five years) while the average contraction lasts about 11 months. The trough of the last recession occurred in the spring of 2009, so it has been more than six years since the last recession ended. However, we can't just assume that because this expansion is getting long in the tooth it is time to exit stocks and bury our heads in the sand. Let's take a closer look at exactly what the market is telling us.

The chart below shows two cycles, one of the market (shown in red) along with its nine distinct sectors as the market moves through each stage identified across the top, and one of the economy (shown in green) with four stages beginning on the far left, starting with Full Recession, Early Recovery, Full Recovery, and finally Early Recession. Take a moment to study this chart:

The market's 9 sectors (red) rotate in advance of the economic business cycle (green). Chart courtesy

The nine distinct sectors that make up the S&P 500 proceed from the left (across the top) when the market cycle is at a bottom (in red). The first sectors that begin to catch life following a bear market are Cyclicals (consumer discretionary) and Technology. As a bull market gets into swing, the Industrials and Basic Materials sectors start growing vigorously because consumers are buying, and businesses are growing and in need of supplies and raw materials.

At the top of the market, Energy is reaching a peak because of high demand as the economy is firing on all cylinders. Then, as the market cycle begins to top and head downward, Consumer Staples, then Healthcare, Utilities, and finally Financials are the sectors that precede a bear market because investors are looking for safety of principal and dividends. The market cycle (red) generally leads the economic cycle (green) by about six months.


So now that we know which sectors lead different segments of the market cycle, where are we now? That can best be determined by identifying which sectors are currently strongest and which are weakest.  Remember these nine sectors are (in order): Cyclicals, Technology, Industrials, Basic Materials, Energy, Staples, Healthcare, Utilities, and Financials. The market progresses in that general order of sectors as we move through a market cycle and business cycle.

 Where do things stand now? The chart below shows that Healthcare is the number one sector for the last two months, followed by Financials, Cyclicals, and Consumer Staples. As would be expected when a commodity sells off by half, Energy is at the bottom of the chart, followed by Utilities and Materials.

The nine sector ETFs are showing that defensive sectors are leading the market. Utilities and Cyclicals are the only out-of-order anomolies.



What conclusions can we draw about the market from this ordering of sector performance? Well, Energy is at the bottom, in the same vicinity as Materials and Industrials. Those are all sectors that thrive when the economy is still gaining ground and near the top. Therefore, it is likely that it will be quite some time before they rise to the top again (towards the peak of the next market cycle).

We see the Financial and Healthcare sectors near the top of the performance list, and these are two of the most defensive sectors that excel when the market is heading down. Can we conclude that the market is about to sell off and begin a bear-market period? Perhaps, and as value investors we would prefer that scenario since there is currently a distinct dearth of undervalued stocks from which to choose.

What does not fit in the current running order of sector performance is the fact that Cyclicals are coming in near the top while the Utility sector is near the bottom. Typically, the Cyclical sector kicks off a bull-market rally, accompanied by the Technology sector. However, we now find Cyclicals in third place on our two-month performance chart. However, Technology is all the way down in fifth place and is underperforming the S&P 500.

The other sector that is out of order is Utilities, down in next-to-last, just above Energy. One possibility to consider is that Utility prices peaked several years ago, when many were seeking income that they could no longer get from Treasuries. With many across the world expecting a Fed rate increase and rising interest rates in coming months, Utilities have gotten cast aside. Therefore, stocks in the Utility sector may be the best opportunity to create alpha should the selloff we anticipate gather steam.  

Also, ETF's are now making the movement of vast amounts of money by institutional investors as easy as a half-dozen mouse clicks. With $2.5 trillion invested in them now, ETF's can move the entire market and individual sectors, as well as individual stocks. Compared to 10 years ago, it is like the 'tail waging the dog.' It is not surprising to see a couple of sectors out of order in this analysis. Otherwise, they are staight down the line in the order they would be in preceding a bear market.


How could the market possibly be near a bear-market selloff if stocks are still hitting all-time highs? Actually, stocks are not still hitting all-time highs. While some segments (such as the Russell 2000 small-cap index) hit a fresh, all-time high last week, undervalued stocks, the NYSE, NASDAQ, Dow Industrials, the S&P 500 and many other indices are very close to rolling over.

If we step back and take a 'big-picture' look at the market, as represented by a 20-year monthly chart the S&P 500, we can see that cracks are forming. The chart below shows three ways to see when an index rolls over. As displayed by the red vertical lines, the market rolls over in the top window if it closes below its 10-month moving average. In the second window, the market rolls over when the MACD rolls over, and in the bottom window, if our Intelligent Market Risk Oscillator™ drops below the Bullish Zone.

In this case, the S&P 500 monthly chart has already rolled over as measured by the MACD (middle window). MACD is a well-known momentum and trend indicator. The S&P 500 is getting close to dropping below the Bullish Zone on our Intelligent Market Risk Oscillator™ (bottom window). In the top window, it doesn't appear close to closing below the 10-month moving average, but if you look back at prior occurrences, it can happen very quickly after momentum begins to wane.

The S&P 500 is very near to rolling over. It's only a question of when.




While PE ratios seem to be the most important measure of a stock by Wall Street, we don't play the game of the 'dark forces.' The bottom line of a company's Income Statement is too easily manipulated by the accounting department. For this reason, we track sales, gross income, operating cash flow, and operating income as some of our revenue-based gauges of the market and individual stocks.

What could cause the market to selloff? Have a look at this chart of the S&P 500 (top) and its Operating Income (bottom) for the last decade. Notice that S&P 500 Operating Income has already rolled over and is heading downward:


Operating income of S&P 500 companies are declining.



S&P 500 Operating Income, 2 years



We believe we are overdue for a business cycle contraction. However, the US Federal Reserve is still on an emergency level, zero-interest-rate policy (ZIRP). Other central banks around the world are still pumping money into their economies via QE (Eurozone and Japan, are prime examples) in an effort to stave off deflation. 

If the U.S. economy begins contracting now, having added trillions of dollars to its balance sheet through six years of quantitative easing and interest rates still at zero, the Fed is essentially out of bullets. Therefore, we will be entirely unknown territory, without the Fed having the ability to implement its historic recession stimulous: lowering interest rates in a recession to stimulate borrowing and expansion. However, we have been in unknown territory since this, the largest financial experiment in human history, began six years ago with QE.

As I was completing this article, I see that there is a new headline out of Greece: "Greece shuts down its banking system, ordering lenders to stay closed for six days starting Monday, and its central bank moved to impose controls to prevent money from flooding out of the country."

This one item, even though it has nothing to do with U.S. companies, will likely get the blame for the selloff we expect. However, it is not the cause of a selloff, it is just a convenient scapegoat for journalists. The reasons are established in the article above (and our Value Alert from June 24, "How to Think About Market Prices.")  Hopefully, we will see a significant selloff that will last for several months and will inevitably overshoot, forcing the stock prices of sound businesses to drop below the company's intrinsic value per share. It is in this way that great value-investing opportunities are born.


We have been holding significant amounts of cash for some time and will sell several stocks from our model portfolios on Monday (IV Members can see the Portfolio pages for details). We will not replace them at this time. We will also be putting closing-price stops on each of our remaining positions and will notify members by email this week if a stock should be sold at the open the next morning. (Note: we do not use trailing stops.)   When the market has completed the coming correction, our weekly Intelligent Market Risk Analysis™ system will tell us, and we will load up on fresh, undervalued stock for our DEEP VALUE and RELATIVE VALUE Portfolios.

We hope that we have thoroughly discussed the issues in this Value Alert, and you can implement these ideas to your benefit.  Our objective is to give you the best value-oriented investment information possible, with ease of use, timely identification of the issues that affect our portfolio positions, and a full understanding of our approach.  If you have any questions or comments, please contact us with a support ticket.

Best Wishes for Another Week of Intelligent Value Investing,



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Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Shareholders, employees, and writers associated with IntelligentValue, Inc. may hold positions in the securities that are discussed. If you are not sure if value investing or a particular investment is right for you, we urge you to consult with a Certified Financial Advisor. Neither, nor any of its employees or affiliates are responsible for losses you may incur.