Putting the pieces together...

Pierre Bernier's VIXEE and the 2CS

Pierre Bernier has kindly permitted me to post this chart of his sentiment indicator VIXEE using new VIX and the ISEE  new (or opening) position put/call volume ratio. You can read about ISEE here. I was delighted to see that it matches 2CS pretty closely even though I am using old VIX (VXO) and the total CBOE put/call ratio which includes all options volume whether to open or close a position. Pierre also sent me a chart of several indicators based upon his VIXEE. I need to study his indicators some more and think about them before I can confidently discuss them.

 

 

(Left click on the chart for a larger version.)

 

Sentiment Update

As of today the 2CS of bearish sentiment (five day running total of each day's product of CBOE VXO and each day's CBOE combined P/C ratio) is 91.69 which is the lowest it has been in 2009. The highest reading this year was 256.50 on March 5, 2009. the highest for 2008 was 463.19 on November 21, 2008. That November reading was also the highest bearish reading since I began computing it daily in 1996. The lowest ever reading for this bear sentiment measure was 41.38 on November 20 (hmmmm...there's that date again), 2006 and nearly matched by low 40's readings in December until Christmas 2006. There were a few last low 40's readings in the week of February 5-9, 2007.

 

Longer bear market rallies as in 2001 and 2002 and the rally to May in 2008 saw the 2CS reach readings in the 70's, so it is reasonable to expect we will see such readings with a lot more bullish excitement before this rally is over, whether it is bear rally or a first phase of a new bull market.

 

The last time that 2CS was in the low 90's in this rally from March was July 21 when the SPX closed at 954.60 and on August 5 when the SPX closed at 1002.70. So there has been a "stealth" SPX move up of about 75 SPX handles since July 21 without moving the 2CS off of neutral sentiment levels.

 

I am of course aware that other sentiment indicators looked at by other analysts say that US stock market sentiment is extremely bullish and has been for the past month. Compared to March and last November, it may seem so; but historically it is still muted as judged by the 2CS. Suggestions that the data have changed have been raised in various places or that VIX indexes were being manipulated by new derivatives based on VIX. The CBOE combined P/C ratio has not changed any computation rules since January 2005. Those most knowledgeable about all the VIX's, specifically including Bill Luby http://vixandmore.blogspot.com/ , concluded that there is no evidence for a manipulated VIX, and that VXO, which I use for historical real time continuity, would be virtually impossible to manipulate as it has no options or futures based on it. Also some suggestions have been made that very low interest rates might cause dislocations of VXO or PCR, as it has done with backwardation in SP futures to SPX. But we have had low interest rates before (2002-2004) with no such effects noted.

 

Based on my daily work with the indicator since 1996, I think the stock markets still have a good run ahead of them. The longer the 2CS remains high due to frequent small pullbacks, the longer the markets can run and the higher they can go. Likewise if markets start to get very frothy quickly with multiple big up days 2CS could sink unto the 70's in a few weeks to a month. That is when other timing and technical studies will be helpful to decide if that is a likely intermediate term top or we really are in a new bull market.

"Is He Bullish or Bearish?"

I get emails occasionally asking why I sound bullish sometimes and bearish sometimes. For example my last post below sounds relatively bearish. First of all, in answer, I think one can and should always be bearish on some asset classes or markets and bullish on others. Second, I am always thinking in multiple time frames, and I am bullish in some time frames and bearish in others.

 

My shortest time frame is the approximately four to eleven day cycle of the tides. In this time frame I was bullish on stocks for a week into yesterday, and now I will be expecting the stock market to go sideways to down for a week to ten days. I don't buy and sell much at these short term bottoms and tops, but I do use the tops to take some profits on some positions if I am seeing other things I might want to own. (Bonds and Yen tend to be upside down to stocks and gold on these cycles.) I did take profits on part of a gold fund (CEF) yesterday for example, and I added to PAUIX which is heavily weighted toward bonds. When tide cycle lows appear, I sometimes add to existing positions or initiate new ones occasionally.

 

My next longer time frame would be the sentiment cycle which can run from a few months to a few years. This starts from when investors hate stocks (or other assets) at low prices to when they are loving them to death at price highs. I'd be untruthful to imply that I catch the highs and lows. I invariably sell some assets before the top and some after, and I do the same with bottoms. I've discussed here how I gradually got out of stocks of various classes (commodity, gold, real estate, balanced, and foreign stock funds and longer term bond funds) from early 2007 to last August 2008, and how I started buying back oil & gas stocks late last fall and winter, and then not buying much else until April and May of this year. Regardless what happens next week with a pullback in stock indexes ("generic stocks") possible, I certainly don't think this sentiment cycle is done yet. Clearly, when I do begin to see excessive bullishness of the "top-forming" type, I will be selling more at tide top dates and not buying at tide lows, or at least buying a different  asset class.

 

My next longest cycle is, or was, the economic wave of Kondratieff. Since the events of last summer I have had to re-evaluate my views on this cycle, or at least its timing. I had considered it as having topped in 1974 and having bottomed between 1998 and 2003. Assuming the wave is still valid, and I think it is, it may really have topped on November 20,1980 and have bottomed November 20, 2008 to March 2009. This long wave cycle is to help us in asset class selection: index stocks, bonds, real estate, commodities, gold, or forex, etc. Right now this cycle isn't helping me very much, but that is why I spend so much time wondering and thinking about inflation versus deflation. I lean toward 2009 being a lot like 1949, but we'll have to wait a while to be clearer.

 

The longest time frame is the 244 year US stock market rising natural (ln) logarithmic channel since 1765. The data base came from Glenn Neely with an explanation of the data and a chart in the last chapter of his 1990 book, "Mastering Elliott Wave". The great depression and bear market from 1835 to 1860 and the other one from 1929 to 1932 and 1949 set the channel boundaries. There was an upside channel breakout in 1987 which even the crash did not erase. Nor did the 2000-2003 or 2007-2009 declines bring the Dow back to the top of the 244 year channel. So one can safely say the very long term of the Dow Jones is up, at least in nominal (current) dollars. In 1988 when Glenn Neely first published his natural log chart of the Dow from 1765, he projected the Dow at over 100,000 by 2060.

 

To sum up on August 22, 2009: the short term tide cycle is sideways to down; the sentiment cycle is up; the Kondratieff Long Wave cycle is in doubt; and the very long term cycle is up. For myself, taking all these time frames and my various degrees of certainty about them into consideration, I have about 40% of total liquid invested capital in money market funds (6%) and short term municipal funds (33%). Another 25% is in intermediate term bond funds of various types (3-6 years). Another 25%  is largely in high yield and other hedge fund style vehicles, and 10% is in physical gold. Very little (~3% in the "hedge-like" category ) is  actually in "generic" or index type stocks. As I have discussed here, most of the higher yield assets are held in tax-deferred accounts. The munis and gold and most hedge-like funds are, of course, in taxable accounts.

De-leveraging

I'm not as sure as I was earlier about the inevitability of higher interest rates. Steve Keen, an Australian academic economist who is on my "Blogs I Like" list, has persuasively written about the effects of de-leveraging the economy over time. Other people mention de-leveraging but no one I have seen has explained it as clearly as Keene, at least to my economics-challenged mind.

 

In  this paper  on his website Keen is talking about the Australian economy, but the lessons and playout will be similar everywhere. He thinks it will take years to get the debt down to manageable levels, and that the process could lower GDP growth possibilities by 3-5% per year!! He uses the examples of the 1890's and 1930's in Australia. It's a good but challenging read and quite sobering.

 

If Keen is correct, the authorities in most places, notably the US, haven't even accepted the idea that deleveraging must occur at all. We'll just add scads more of debt, sprinkle it about, and all will be well.

 

John Hussman, also on my list, this week has similar ideas about the potential "growth" of the next decade. He sees a maximum growth probability of less than 3% per year for a decade.

 

Both of these writers and economists are basically describing a Japanese-like outcome with minimal growth and probable recurring recessions. This is a far cry from the happy face "green shoots" BS that is sustaining us currently. It suggests that growth will be slow with recurrent recessions. This is not an inflationary outcome with high inflation and high interest rates!

 

Of course this is not a definitive outcome, just economic opinion. I could personally "live with" a non-inflationary era, but it would be a tough road for civilian societies in quite a few ways which would impact us all.

 

 

 

 

Tide and 2CS

As suggested on August 7, stocks (SPX) made high on that date. The maximum tide count for the next low was a 3/6 (meaning three of six measures at an extreme) on Friday, August 14. However, there were still 2/6 on Saturday. I prefer not to allow any variance but will allow one day +/- in the case of sharp moves. So today could still be the low. Various internals and sentiment factors were slumping from August 7 so I feel comfortable until tomorrow that we have a low today and did not have a high on Friday, August 14. Also we filled one SPX gap today.

The other assets I follow on 24 hour futures charts (silver, gold, crude oil, natural gas, T bonds, Yen, Euro) all have blown through the Friday, August 14 tide date, suggesting a very large position change. If no reversal is made by tomorrow, this could indicate a trend change downward for stocks and gold and silver and an upward trend for bonds and yen. Usually such blow-through events occur in established and very strong moves, in my experience. But one must not be blind to the possibility of a trend change thereby ignoring possibilities and taking big hits.

2CS sentiment remains supportive of further gain in this bull move from March 2008. I have seen a chart, possibly from Fuller, which compiles a weekly combination of P/C ratio, VIX, and four polled sentiment measures which makes the same points I have made about "range shifting" in bear as opposed to bull markets. I am not a fan of polled sentiment, but even this chart I am referring to shows that bullish sentiment is not yet as high as in bear market rallies from 1999-2003. Of course if it is indeed a new bull market, which I doubt, it is FAR from a bullishly exuberant top at this time. So even if the stock trend changes short term to go down and fill other gaps or meet supports, this decline will have pushed out in time the final top for this rally or bull leg from March.

 

2CS Flip?

If VXO and CBOE combined P/C closed today where they are now, the 2CS would still only be about 98 which is too high--it's inverted-- for a top. Since there have been signs of "emerging exuberance" this week, it seems reasonable to suppose that will follow through over the next few weeks to month and make a real and quite typical bear market exuberant rally top. However, that in turn brings up the possibility that it will NOT make top any time soon. It has been very "resistant"--I'm being anthropomorphic here--to get near an exuberant level all through this rally since March. This analysis is to demonstrate how the emergence of exuberance can flip the possibilities from rather bearish to bullish. To many that's counter-intuitive, but market sentiment is like that, much like political sentiment.

 

We do however have a potential tidal turn top today and SPX is hitting the 0.382 retracement of the entire bear market decline from 2007 to 2008 at 1014, so coming back down to re-test 1000 would be a reasonable possibility.

 

As Gilda Radner said, "it's always something".

 

Gone for a week. Take care.

 

 

Breakout

Despite my comments and worry yesterday, today was the most bullish day I have seen in 15 months in stocks. SPX stayed on support, and the market-based sentiment I follow (2CS plus two others) finally jumped up to a reasonable level from being deeply depressed. My guess is that shorts and side-lined players flush with cash are being forced into the stock market (for very different reasons!) above 1000 spx.

There is still plenty of overhead sentiment room and any and all pullbacks are being bought.

2CS Again

I've been concerned about the fact that many market sentiment measures like the 2CS haven't reached normal bullish exuberance levels after such a long rally in price and time. Actually it has kept me long, so I can't complain about that aspect of the issue.

A friend sent me an email on it today, and here is the exchange:

"While I have no doubt the 2cs formula is still valid, the baselines may have shifted....as they should/could over the years"

"Of course there is that possibility, but there is a more common and likelier reason for a change...What I have called "range shifting". It has happened routinely in bear versus bull markets. Rally tops in bear markets don't make market players get as bullishly exuberant as at tops during bull markets. One case that might be similar to now was the rally from the October 2002 low into Thanksgiving. It was a very dynamic bull 21% move out of the October pit, but the 2CS only dropped to as low as 109 versus levels routinely in the 70's or even much lower in bull markets.

It's at 99 tonight and was as low as 93 on July 21...so we could have "sentiment divergence" here with price higher and 2cs higher too, but at the same time bear market "range shifting" with a plausible top in the 90's is saying the bear isn't done yet. It's making me nervous like Richard Russell is about his Lowry data."

There are so many signs of price topping action (and I have been bullish for quite a while). If the market tops with this "range shifting" in place, we could be heading for the lows again. I'm going away in a few days and am lightening up just in case.

Portfolio Update: More Hedge-like Funds

As readers here know, I was invested primarily in  inflation beneficiary funds (commodity stocks) from 1999 and then also in balanced stock funds (generic index type stocks and bonds, domestic and global) from 2003 to 2006/7. I started getting more interested in income stocks and bonds as I formally "retired" in December 2006.

 

Until 2006 and 2007 I had assumed I could find a "set and forget" portfolio emphasizing income but also continuing to hedge inflation with gold (as always) and energy and other new commodity vehicles. By mid 2007 there had already been two breaks of stock prices larger than in years, and some balanced fund total return charts began breaking under up trend lines. This had rarely happened since 1988 except for the 1998 crash. Even during 2000-2003 SGENX, LSBDX, VWINX, and HSGFX had performed well due to their value approach, adroit hedging in the broad sense of the word, and the continuing bond rally. Now they were beginning to wobble in new ways to me.

 

I did not get out of everything, but I started exiting after getting and staying nervous about anything other than gold and other inflation stocks, and I began shortening maturities in taxable and municipal bonds. By early 2008 it was become clearer that things weren't looking too good overall in the economy, and I speeded up cashing out of generic stocks and even my old balanced fund favorites like SGENX, DODBX, and VWINX/VWIAX after the March break. By June and July I was exiting my favorite largely corporate and foreign bond fund, LSBDX, and my old friends in energy, metals, and pure commodity funds. I was left with what I had originally called the Hillary Portfolio of short term munis and gold bullion to which I added short term "Federales" via the Vanguard short term federal fund, VSGDX. I still expected inflation to come roaring back after what I called the  "vacation from inflation" completed.

 

At no time did I know what was going to happen after mid year 2008. I was primarily motivated by the fear of losing a lot of money in the second year of my retirement due to my not understanding what the markets were doing to my old fund friends. Fear can be useful if it motivates constructive changes. Also the principal managers of several of the funds I owned announced retirement plans, always cause for concern in the best of times. This also was a helpful hint to me.

 

The short term muni funds and "federales" funds with bond durations of between one and two years were paying more than money market funds were paying, but actually gained in price a bit anyway due to the crash of money market fund yields which sent even very short duration funds up in price. I kept the long/short Rydex Trader Vic Commodity fund RYMFX and some of HSTRX. With few exceptions I stayed in this largely "near cash" mode until March 2009. The few exceptions were adding back on very big down days, of which there were many, to the high-yield oil and gas trusts I had partly liquidated before the crash, and by trying to buy some closed end bond funds that had been totally decimated and were yielding over 20% in some cases. Had I not been so scared I'd have bought even more. I was then and remain now very proud of the fact that I ended up 2008 with a meaningless gain of 0.18% for the year on a total return basis including all accounts. That's 18/100ths of one percent! We all know people who lost 30-60% last year. I was at least 75% plus in the short term bonds funds all fall and winter.

 

Before and more so after the March low I started buying not stocks but dear old LSBDX and some high-paying closed ends plus some gold and silver royalty stocks, GDX, etc. Up until now I have remained heavily at the short end in the bond funds with some timid excursion into duration in TIPs (now liquidated) and GNMAs. I have wondered if I would ever again be able to find a portfolio I didn't need to look at every day or hedge repeatedly. The bond  funds, hedge-like funds, and golds and oils have done well enough that I am up 7.9% year to July 31, including all portfolios and including all money market funds.

 

As a former commodity trader for decades I was fairly ignorant about bonds except for the 30 year Treasury bond futures. I accepted on faith that one included bonds in a portfolio as one got older to increase income and reduce volatility. What I began to learn from LSBDX was that quality corporate bonds trade more like stocks than like Treasurys. So I started to see them as preferable to generic stocks on a yield basis but also having equity-like price curves. Then  too there were foreign sovereign bonds both of developed A-rated countries and bonds of emerging countries. Also mortgage bonds of all types including very safe GNMA's (VFIIX/VFIJX). Not having been a stock investor very much in my life except for commodity stocks, I migrated pretty easily to bonds of all kinds. Vanguard and PIMCO do them all well and PIMCO has some very creative funds.

 

Gradually, after thinking and studying in the wake of the crash of 2008-2009, I began looking at all the old and new hedge fund-like ETFs, CEFs, and mutual funds. I have mentioned previously RYMFX and HSTRX which are like good conservative hedge funds with little or no leverage. Most of the funds are bond related in whole or in part, even RYMFX. I do have Gabelli's Gold Fund GGN which buys good gold and resource stocks and sells call options on them and another old favorite, Templeton Global Income fund GIM in pretty good half size portions each. Most of these were owned by hedge funds and others who had to liquidate, and they got beaten down to bargain basement or "T J Maxx" prices where I bought them. I didn't get the very lows of course, but by buying gradually in small pieces I got pretty good average prices.

 

I also added back more in HSTRX and started a position in PIMCO's All Asset-All Authority Fund PAUIX advised by Rob Arnott and by Robert Greer. Several readers here had recommended it in the past, but I had wanted to see how it worked over a whole cycle. With the death of all "un-correlated" assets last year, even PAUIX took some losses but they were modest, and they have come right back. I plan to increase this fund in all accounts, whether taxable or non-taxable. Another I plan to add again is HSGFX or Hussman's Growth (stock) Fund which is a very strict buy/write fund. That being the case it's possible to buy it at any time even if the markets are higher. Hussman gave up his short hedges too early last fall and made an unusual, for him, loss. Because of that and the fact that I have so few real generic stocks in any of my funds, I am going to match it with FPACX (FPA Crescent) which is a balanced fund with a very, very good long term returns. They had about one-third each in stocks, cash and short term bonds last fall and even now. They are very adept and come from a great Los Angeles firm.

 

So in the taxable fund I will still be about 66% in short term munis and will maybe move that out to the intermediate term (five year duration) fund. The other 33% will be devoted to equal parts of PAUIX, HSTRX, RYMFX, the package of HSGFX and FPACX, and finally CEF the Canadian Central Fund holding gold and silver bullion which I bought earlier this year. These funds all have experienced and excellent managers. I'll have exposure to all asset classes and they all produce some income, but most income will come from the munis which still seems the right thing to do with tax hikes looming.

 

The tax-deferred funds are almost entirely in income funds as I have written before: equal portions of LSBDX, PTTRX, VFIJX, PAUIX, a package of GIM and GGN, the oil and gas funds at 150% of the rest, and a few smaller pieces of some specially bond funds. I wrote earlier this year about possibly cashing out this entire account to pay the inevitable taxes at lower rates this year instead of higher rates next year and beyond. I can still do that at any time before the end of this year depending upon events in high places. Otherwise I am set to have it be an income fund with some hedging. As a side note I started a small position of Vanguard's EDV which is a zero coupon Treasury long bond fund. It has a duration of 25.5 years so if interest rates drop (or rise) by 2% the fund will go up (or down) 51%. It did go up 50% last November/December in the panic, and may do so again but at a slower pace if deflation overcomes us. It is paying over 4% now and had a nice big run this past week. I was hoping to buy more lower down, but at least I got some under 93. It doesn't trade much volume, so it's not for everyone. WHOSX and BTTRX are mutual funds which do largely the same thing.

 

So that's current project and plan in the tax-deferrred retirement accounts: income funds and some true hedge funds that hedge while also producing some income. Always bear in mind the context here at this site. I am living on my money including a cash annuity and Social Security, and I live well, travel, and have insurance. I am not trying to greatly increase my capital but to make it give me income and protect it as best as I can from inflation and taxes at the same time. And I'd like not to have to spend every day on it as I and many of us did for much of the past year. Fire fighting is essential in bad times, but I hope to do less of it.

 

The chart shows some of the funds I have discussed today. A few of these, HSTRX and RYMFX, I've had for a long time, a few only recently, and a few are being accumulated now. The chart starts from the first day of trading for RYMFX but conveniently also near the top for most assets in 2007. Even LSBDX, the worst of these six, has come back very well, and I was fortunate to avoid it during the worst of the panic. Ditto for HSGFX.

 

One source of ideas for high yield stocks or bonds is Carla Pasternak's High Yield Investing which any internet search engine can get you to. Actually Pasternak doesn't recommend funds very often, but there are lots of good ideas to investigate. Mainly I use Morningstar, Yahoo, ETFConnect, and my favorite software program, Investors FastTrack to find and compare total returns.

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