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Publishing Note: I am Traveling Mon-Thursday this week. Daily State of the Markets reports will be published as my schedule permits until Friday.
Good morning. In Friday's report, my main point was that the character of the market changes over time and that traditional indicators of the market's strength and directional bias are no longer as valuable as they once were. I pointed out that while it may be surprising to some; many tried and true trend indicators such as the 20-, 50-, 100-, and 200-day moving averages have become lousy entry and exit signals during the current secular bear market period.
I highlighted the research of Ian Naismith, who is a past President of NAAIM, one heck of a technician, and the President of Sarasota Capital. At a NAAIM meeting last Thursday, Ian surprised a room of 50 active investment managers by informing us that using moving average crosses as buy and sell points has been a complete waste of time since the turn of the century.
Ian's computers found that since the inception of the SPDR S&P 500 Trust - better known as the SPY - in 1993, if one bought the SPY when it closed above its 20-day moving average and then sold to cash when it closed below the ma, you would have been in a world of hurt as the system gained just 15% versus the 157% buy-and-hold gain seen through 9/30/11.
Although Ian says the numbers do improve as you lengthen the moving average, the results are still the same: buy-and-hold beat trading the ma in each case. For example, trading the 50-day produced a cumulative return of just +45% (vs. +157% for buy-and-hold) and only 24% of the trades were profitable. Ouch.
What about using the media favorite 200-day ma, you ask? Ian said the results were significantly better (about even with the buy-and-hold gain of +157%). But to quote Ian, since your trades would have only been "right" 22% of the time and there are no assumptions made in this analysis for trading commissions, fees, or slippage, "The results of this approach are pretty stinky."
If you've been around the stock market game a while, you are probably saying, okay, that makes sense, but everybody knows that simple ma's aren't as good as weighted, exponential, or volume-weighted ma's. Ian anticipated this and then utilized about 7 different ma approaches (two of which I had never even heard of). But the bottom line is that none of these moving average approaches was able to outperform the SPY by any meaningful degree. And since the goal of active management is to enhance returns AND to reduce risk, Ian's point was that using ma's as a stand-alone trading indicator is suicide.
So, after reviewing Ian's data, the natural question becomes: Why have these trend-following indicators (simplistic as they may be) stopped working? In my humble opinion, the answer lies in the ever-increasing ease of trading "the market" and the popularity of technical analysis. We can point to things like the move to trading in decimals, the elimination of the uptick rule, program-trading, sophisticated hedging strategies using futures, the evolution and proliferation of ETF's, and my personal favorite, HFT (high frequency trading) as reasons the market does not "trend" as well as it once did - at least on a daily basis. In short, with markets being whipped back and forth by traders implementing various program-driven strategies using leveraged products, the trend of the market needs to be viewed from a much broader perspective than a simple moving average.
While I plan to continue on this theme in my morning reports as time permits this week, I should say that this data is not a reason to give up hope on actively managing the risks of the stock market. Rest assured that there are LOTS of things that do work fairly well and are both simple to calculate and implement. And yes, I will present a couple ideas that actually do work this week. However, the key point is if you use a moving average to trigger your buy and sell points for the overall market, you now know why you've been so frustrated lately.
Turning to this morning... After initially celebrating the fact that there are now new governments in both Italy and Greece, European markets have pulled back this morning due to the tepid response to Italy's bond auction.
On the Economic Front... There are no economic reports scheduled for release before the opening bell.
Thought for the day... Consider raising your expectations. As Michelangelo said, the danger is not that your hopes are too high, but rather...
Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell...
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Major Foreign Markets:
- Australia: +0.24%
- Shanghai: +1.92%
- Hong Kong: +1.941%
- Japan: +1.05%
- France: -1.33%
- Germany: -1.10%
- Italy: -1.10%
- Spain: -1.19%
- London: -0.50%
- Australia: +0.24%
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Crude Oil Futures: -$0.80 to $98.05
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Gold: -$8.70 to $1779.40
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Dollar: higher against the Yen Euro, and Pound
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10-Year Bond Yield: Currently trading at 2.09%
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Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -4.30
- Dow Jones Industrial Average: -12
- NASDAQ Composite: -5.23
- S&P 500: -4.30
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The opinions and forecasts expressed are those of David Moenning, founder of StateoftheMarkets.com and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of TopStockPortfolios and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. Stocks should always consult an investment professional before making any investment.
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The analysis
