February 28, 2016
HOLDING STEADY IN AN UPTURN
REMINDER OF CHANGE IN PORTFOLIO-MANAGEMENT POLICY
In last weekend's Value Alert newsletter, we stated that we were making a change to our approach. Instead of focusing on our newer subscribers and investors by trading in and out of positions to eliminate paper losses, we are going to direct our attention to our more experienced clients. The reason for this is that we discovered through analysis of our records that the majority of our subscribers have been with us for more than 10 years.
To focus more on these experienced investors, we will hold our positions longer and target major price trends rather than short-term swings. Instead of attempting to micromanage our portfolios by trading in and out of positions in an effort to eliminate temporary losses (which frighten newer investors into bailing out), we will be holding those equities through volatile daily and weekly price swings.
For our less experienced subscribers who do not have confidence in inverse ETF's or in IntelligentValue's proficiency in identifying market turnpoints, we advise you to stay in cash rather than using inverse ETF's during our 'Market Down' signals or at times when we are recommending inverse ETFs. Your subscription will still prove to be extremely valuable as we identify important changes in market direction and purchase the optimum equities to take advantage of bullish setups.
TEMORARILY HIGHER STOCK PRICES POSSIBLE
On February 24, we featured a daily chart in our member's only Intelligent Market Risk Analysis (IMRA) that showed SPY (the S&P 500 ETF) with a resistance level just above current market prices. Then on Tuesday, it appeared that the ETF bounced off this resistance level with the downward day. We identified that as a possible strong bearish setup and bought two inverse ETF's for each portfolio at Wednesday's open. Each of those ETF's logged temporary losses in the last three days.
As you can see from Chart 1 below, the S&P 500 moved up fairly sharply on Wednesday and Thursday before dropping a bit on Friday. We identified the line in the sand at 195 for SPY. The ETF closed above that level on Thursday and opened above it on Friday. For the week, it closed at 195.09. Therefore, our thesis hasn't been negated, but there is a possibility that this index will continue higher in the coming days or weeks and subscribers who are holding the inverse ETF's in our portfolios will experience additional paper losses.
CHART 1: SPY finished the week at the top of our first resistance level at 195.
As shown in Chart 1, the next level of resistance is at 200 (2000 on the S&P 500), which is less than 3% higher. This area is both the broken support of the November/December highs, as well as being a 61.8% Fibonacci level from the August lows to the November highs. Both establish very strong resistance near 200.
Also notice that the 200-day moving average (dotted red line) is declining and is currently at the 201 level. It's possible that this powerful combination of three resistance factors around the 200 level will coincide to create a top for market prices before the downtrend resumes. On the other hand, prices could drop from here, giving us profits.
PRIMARY TREND REMAINS DOWNWARD
For the investors who are holding the inverse ETF's in our model portfolios, we have some words of advice: Stop watching the market's daily action!
The day-to-day craziness that accompanies the market can easily undermine our conclusions and your resolve. This is especially true if you are watching channels like CNBC. The manic talking heads on TV will twist and turn your mind in ways that you don't intend. Humans are notoriously bad decision makers when placed under emotional distress, and there's nothing more emotional to us than losing (even if it's on paper) our hard-earned money.
Rather than focus on the short term and the poor decisions it can produce, is always prudent to look at a big picture view of the market. IntelligentValue rarely analyzes daily charts because of the incredible volatility that accompanies daily prices. Using technical analysis, we analyze the market on a weekly basis and also rebalance our portfolios on a weekly basis.
However, sometimes it's important to take an even bigger-picture view of the market. To do this, we regularly analyze monthly charts going back for many years. The monthly charts, using a very simple 10-month Moving Average and standard settings on a basic Moving Average Convergence/Divergence (MACD) indicator can provide us with the major turnpoints of the market.
These turnpoints are not perfect and may be a bit early or late. However, we have tested them back to 1960 and they always eleminate massive drawdowns from an investor's portfolio and thereby, maximize returns.
Chart 2 below shows the S&P 500 index analyzed from 1995 to present using these two indicators. As you can see from the chart, these indicators were excellent markers of each of the upturns and downturns in the last 20 years. Using this simple system, investors could avoid the major downturns and have a 100% record of winning trades.
CHART 2: The S&P 500 index shows its major turn signals using a monthly chart, the 10-month moving average, and the MACD indicator.
Chart 3 below shows the Russell 2000 (small-cap) index for the same timeframe and with the same settings. The Russell 2000 contains most of the remaining 20% of the stock market, and features a number of great small companies that are growing rapidly. However, these stocks are prone to more volatility that their larger breathren because they are more affected by the economic winds that blow hot and cold.
CHART 3: The Russell 2000 index shows its major turn signals using a monthly chart, the 10-month moving average, and the MACD indicator.
As you can see from these two charts, the current, long-term indicators for each group of stocks is signaling that the primary trend is downward.
EARNINGS CONTINUE TO DECLINE
Market bulls are rallying around the short-term reversal that has taken place since mid-February with calls for all-time highs in the near future. However, they would be hard-pressed
to justify those positions based on fundamentals. Chart 4 below shows the S&P 500's prices since 2011 in the top window, its PE ratio in the middle window, and its quarterly earnings in the bottom window.
CHART 4: The S&P 500's PE ratio continues to remain at nosebleed levels despite the decline of prices and earnings.
Despite a declining level of earnings each quarter for a full year, accompanied by declining prices since mid-2015, the index' PE ratio remains extremely elevated. One year ago, when declining earnings began, the PE on the S&P 500 was 18.95. Today it stands at 22.44. The PE on the Russell 2000 (small-cap) index is at a sky-high 295.81!!! The market has nowhere to go but down.
OUR PLAN FOR THIS WEEK
We will remain in our two inverse positions in each portfolio. Subscribers may experience additional paper losses in the coming week or two, but we expect stocks to turn back downward soon. When that downturn occurs, we will add additional, targeted inverse position to our portfolios and profit from a selloff that may be quite long and devastating for those who are invested long.
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 IntelligentValue.com, nor any of its employees or affiliates are responsible for losses you may incur.