Big Picture Market Models - 3/22/12March 22, 2012 @ 11:08 AM EST
The State of the Market Models
A weekly review of the Big Picture Models is an easy way to stay in tune with the market. We believe that the first step in successful investing is to identify the "big picture" environment, because, in short, different environments require different strategies.
For example, using the same aggressive strategy that is successful in a Bull Market can be devastating in a Bearish Environment. By reviewing the "Big Picture" on a regular basis, you can be assured that a major change in the environment won't take you and your investments by surprise.
The indicators and models presented in our "Big Picture" Report are intended to provide indications of the market's momentum, trend, fundamentals, sentiment, and valuation. The range of
"Scores" is 0-10, with 10 being the highest. Below is a table displaying the latest readings.
Big Picture Models Explained
- State of the Markets Model: This is our most important market model. The model is been designed to provide an overall reading on the health of the market. The model itself is really a model of models, each successful in their own right. Since we believe in staying "in line" with the overall market environment, 60% of the model is based on key long-term trend and momentum indicators, while the remaining 40% is split between our Sentiment, Valuation, Monetary, and Economic models. In short, staying in tune with the reading of our State of the Market Model has kept us mostly invested during major bull market moves and mostly defensive during bear market periods.
- Long-Term Trend and Momentum Model: If we were forced to choose only one market indicator to take with us to the desert island, this would be the one. Designed to provide a reading on the technical health of the overall market, our Long-Term Trend and Momentum Model takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, we find that when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.
- Monetary Conditions Model: The popular cliche, "Don't fight the Fed" is really a testament to the profound impact that interest rates and Fed policy have on the market. It is a proven fact that monetary conditions are one of the most powerful influnces on the direction of stock prices. Therefore, we force ourselves to focus on the more than 25 indicators that make up the monetary model each and every week.
- Economic Conditions Model: During the middle of bull and bear markets, understanding the overall health of the economy and how it impacts the stock market is one of the few truly logical aspects of the stock market. When our Economic model sports a "positve" reading, history (beginning in 1965) shows that stocks enjoy returns in excess of 21% per year. Yet, when the model's reading falls into the "negative" zone, the S&P has lost nearly -25% per year. However, it is vital to understand that there are times when good economic news is actually bad for stocks and vice versa. Thus, we turn to our Economic model to help us stay in tune with where we are in the ovearll economic cycle.
- Inflation Model: They say that "the tape tells all." However, one of the best "big picture" indicators of what the market is expected to do next is inflation. Simply put, since 1962, when the model indicates that inflationary pressures are strong, stocks have lost ground. Yet, when inflationary pressures are low, the S&P 500 has gained ground at a rate in excess of 13%.
- Market Valuation Model: If you want to get analysts really riled up, you need only to begin a discussion of market valuation. While the question of whether stocks are overvalued or undervalued appears to be a simple one, the subject is actually extremely complex. To simplify the subject dramatically, investors must first determine if they should focus on relative valuation (which include the current level of interest rates) or absolute valuation measures (the more traditional readings of Price/Earnings, Price/Dividend, and Price/Book Value). We believe that it is important to recognize that environments change. And as such, the market's focus and corresponding view of valuations are likely to change as well. Thus, we depend on our Valuation Models to help us keep our eye on the ball.
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