Is Investing About Pontification or Profits?

July 24, 2014

Why Do We Invest?

There is not one correct or proper answer to the question of why do we invest? However, if we answer the question honestly, we can possibly improve our investment outcomes. Having worked on Wall Street for over twenty years and witnessed two massive bubbles and subsequent deflating of those bubbles, we have seen every investment mistake in the book. Since our job is to help clients manage risk and reward, our basic approach to investing can be summed up as follows:

Regardless of our age, social standing, or lot in life, we all want to make money and avoid losing money if possible.

You may or may not agree with the statement above, and there is nothing wrong with that. However, you should be able to define your investment objectives in a similar and simplified manner.

Conflicting Objectives

Notice how the statements below do not necessarily help us “make money and avoid losing money if possible”:

  1. The Fed is juicing the markets.
  2. This whole rally is manufactured and fake.
  3. The bad players in the financial crisis were bailed out.
  4. The whole system is being manipulated.
  5. President Obama’s policies are hurting the economy.
  6. The Republicans are to blame.
  7. Geopolitical risks should be our primary focus.
  8. The Fed’s money printing will lead to runaway inflation.

Stay On Task, Not Personal Agendas

Is there anything wrong with having an opinion about monetary policy, politics, foreign policy, bailouts, or inflation? No, it is a healthy and necessary part of a free society. The hard question to ask yourself is:

Are personal opinions making it difficult to invest consistently, successfully, and objectively?

Before you answer, allow us to take a trip down memory lane. Just a few short years ago, many believed the entire global financial system would implode.

Did You Think Stocks Would Rally For Five Years?

Assume we were polled in early 2009 and asked the following question:

What do you think the odds are the S&P 500 rallies over the next five years and surpasses 1,950?

Personally, my answer would have been “the odds are almost zero”. My guess is many readers would have been justifiably skeptical in late 2008 or early 2009 as well. Guess what? The S&P 500 is trading at 1,991 today.

How about if we were asked this question in early October 2011:

Given the financial crisis in Europe, what do you think the odds are that the S&P 500 rallies smartly over the next 34 months?

Again, my personal answer would have been “the odds are almost zero”. My guess is many readers would have been justifiably skeptical in early October 2011 as well. Guess what? Since early October 2011, the S&P 500 has rallied for 34 months.

How Do We Improve Our Odds Of Success?

The examples above illustrate the potential pitfalls of investing based on personal opinions – your own or that of any writer, talking head, or individual. Let’s assume we thought stocks were way overvalued in 1997. Stocks rallied for three more years, illustrating it is the market’s interpretation of value that matters, not our personal view. Therefore, we can improve our odds of investment success by staying aligned with the net aggregate interpretation of all the meaningful inputs (Fed policy, valuations, inflation, earnings, geopolitical events, bailouts, etc.). Were there ways to see that our personal opinions may have been wrong in early 2009? Yes.

Were there ways to see that policy moves by the European Central Bank were improving the market’s tolerance for risk between October 2011 and the present day? Yes.

Are The 50-Day And 200-Day Perfect?

No, in fact, no moving average, indicator, or ratio represents the holy grail of risk management. Since the 50-day and 200-day can produce whipsaws from time to time, we do not recommend building a system based on these inputs only. However, the moving averages shown here do add value and can be used in conjunction with other “this can improve our odds of success” tools to build a diversified risk management system. This flow diagram is an example of using multiple hard and unbiased inputs on numerous time frames in a diversified manner.

More On Risk Management Systems

If you want to get your creative juices flowing and expand on the concepts presented above, the following articles may be of interest to you:

  1. You Will Never Look At The Markets The Same Way Again
  2. Tired Of Missing Rallies? 4 Ways To Improve Your Game
  3. 5 Reasons Your Simple Bear Market Plans Could Backfire
  4. The Most Important Thing For 2014
  5. With The Fed Stepping Back, Your Portfolio Needs You To Step Up And Lead

Investment Implications – What Does The Market Think?

The market’s opinion determines the value of our investments. The previous sentence speaks to how markets work. What is the market telling us right now? We can use 2011 as a reference point for fear (see chart below).

The same chart shows a much more risk-embracing profile as of Thursday, July 24, 2014.

Therefore, it remains prudent to maintain an exposure to U.S. stocks (SPY) and leading sectors, such as transportation stocks (IYT).

Has All The Pontificating Helped?

The financial media is filled with fear-mongering stories outlining reasons to “raise cash” or “prepare for a stock market top”. The public demands these stories and the media has been delivering them for decades. However, it is prudent to ask yourself how helpful have these gloom-and-doom articles been from an investing perspective? Have they helped you move closer to making money and reducing the odds of losing money? Just as a stopped clock is right two times a day, eventually the fear mongers will appear to be correct. Trouble is they have been wrong for several years.

China – Is It All Fun And Games?

July 24, 2014

On July 23, we noted some potentially bullish developments on the chart of emerging markets (EEM) relative to the S&P 500 (SPY). A few hours after the EEM charts were published China released strong manufacturing data.

China Plays A Big Part In EEM’s Play

If we are to put capital into EEM, our odds of success improve when a higher percentage of individual countries within the index look promising. China makes up almost 18% of EEM.

Know Your Timeframes

We see many reasons to keep both EEM and FXI on our investment radar, but we are also aware of possible hurdles. The dashed blue lines below show a bearish trend channel is still in play for FXI relative to SPY. That channel may be taken out in a bullish manner, but that has not occurred yet. Logically, a short-term trader may not care about longer-term charts. However, they are relevant to investors with longer holding periods.

Charts Can Help With Position Sizing

The monthly chart below also shows similar rallies that have been met with resistance in the past. For example, FXI rallied vs. SPY for four months in 2012, only to be turned back near point A.

The chart above is not necessarily a show-stopper, but it may keep us in “prove it to me mode”. As investors, we may (a) not take any position until the bearish trends are broken, or (b) take a smaller position and see how things play out. A trader may hold FXI or EEM for a few hours or a few days, meaning investors need to understand what it means when a trader says “bullish” and what it does not mean.

ETF Leadership

July 23, 2014

Today’s post can be found on Yahoo Finance.

New Highs: What Do They Mean?

July 22, 2014

Homes Sales Help Spark Rally

The S&P 500 posted a new intraday high Tuesday after encouraging housing data was released. From Reuters:

U.S. home resales hit an eight month-high in June, suggesting the housing market was gradually regaining momentum and would help the economy to stay on a higher growth path this year. The third straight month of home sales gains, reported by the National Association of Realtors on Tuesday, added to employment and retail sales data that have indicated economic growth ended the second quarter on a firmer note.

S&P Has Not Done This Yet

While the headlines referenced new highs, the S&P 500 needs to close over 1985 and change to make a new closing high. Tuesday’s close fell just short with the final print for the day coming in at 1983.

As noted on Twitter, investors can gain some short-term insight based on where stocks head next.

Earnings Playing A Big Role

Earnings have been pleasing to stock market bulls thus far. However, less than half of the companies in the S&P 500 have pulled back their quarterly curtain. From The Wall Street Journal:

Eighty three of the 116 companies in the S&P 500 that have reported earnings to date have beat expectations, according to FactSet. For the Dow, 11 companies of the 14 that have reported have topped estimates. There’s been “a really healthy earnings picture for U.S. corporations so far,” said Michael Marrale, head of research, sales and trading at brokerage firm ITG.

Investment Implications – Bulls Still In Control

As noted on July 21, recent volatility can be put into the “normal” basket. How concerned should we be about the failure of the S&P 500 to post a new closing high? At this point, it is not something to lose sleep over. Our concerns would increase if stocks have not posted a new closing mark over the next couple of weeks. The evidence in hand continues to call for U.S. equity exposure (SPY), coupled with leading sectors, such as transportation (IYT).

Is Recent Volatility Cause For Concern?

July 21, 2014

Earnings: A Big Role This Week

Before we get into the subject of recent volatility, it is important to understand the primary market driver in the days ahead – earnings. From The Wall Street Journal:

Twelve Dow industrials components and 146 S&P 500 companies are set to post earnings this week, including Apple, Microsoft and Ford, according to FactSet. “This is peak earnings season week,” said Doug Cote, chief market strategist at Voya Investment Management. “I’m expecting continued good news. My expectation is that we’re going to handily beat consensus earnings.”

Volatility To Ignore?

In the graph of the S&P 500 below, if markets moved in a linear fashion, managing risk would be much easier. It would be easy to leave our investments alone between point A and point B. It would have been easy to spot that something was changing between points B and C, and much easier to discern something had changed for the worse between points C and D.

Unfortunately, markets are volatile. Therefore, from a risk management perspective it is helpful to have tools that help discern between “volatility to ignore” and “volatility to respect. This week’s video covers the topic in the context of recent volatility in the U.S. stock market.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.



Good Sign For The Economy?

Earnings are not just about numbers. The market is always interested in forward looking statements regarding the economy. Energy producers may be providing some insight. From Reuters:

Halliburton Co (HAL.N), North America’s top oilfield services provider, said it would add fracking equipment and crew to take advantage of higher demand in the region, signaling an industry-wide recovery after a two-year slump.

Investment Implications – Eye On Conflicts

Even with the S&P 500 down as much as 12 points in Monday’s session, support shown in the chart below remained in place.

The markets are dealing with unrest in the Middle East and Ukraine. From The New York Times:

As diplomatic pressure for a cease-fire mounted on the conflict’s 14th day, the Palestinian death toll topped 500 and the number of Israeli soldiers killed hit 25, more than twice as many as in Israel’s last Gaza ground operation in 2009. Two Israeli civilians have also died from rocket and mortar fire.

From a separate New York Times article:

After days of obstruction, Russia-backed separatists in eastern Ukraine permitted Dutch forensics experts on Monday to search the wreckage of the downed Malaysia Airlines jetliner destroyed by a surface-to-air missile, allowed bodies of the victims to be evacuated by train and agreed to give the plane’s flight recorder boxes to the Malaysian government. The movements, four days after Malaysia Airlines Flight 17 exploded and crashed in an eastern Ukraine wheat field, came as President Vladimir V. Putin of Russia faced a growing international clamor to clear the way for a full and unimpeded investigation of the disaster.

The evidence we have in hand continues to call for a prudent allocation to U.S. stocks (SPY), and leading sectors (QQQ). However, with markets nervous about the Fed, geopolitical events, and earnings, flexibility remains as important as ever.

Tuesday brings reports on inflation and housing. Never a dull moment.

Stocks: Volatility To Respect?

July 18, 2014

Still Relevant Big Picture Risk Management Articles - Weekend Reading.
More links and charts on Twitter.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.


Video - Check Link

July 18, 2014

YouTube is processing a little on the slow side tonight. This week’s video should be available on the CCM YouTube Channel sometime between 7:10 and 9:00 pm EDT.

Most Recent Comments Via Twitter

July 18, 2014

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

Most Recent Comments Via Twitter

July 17, 2014

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

New Dow Theory Signal - What Does It Mean?

July 17, 2014

Charts Monitor, Rather Than Dismiss Fundamental Data

Critics of technical analysis often mistakenly believe that using charts discounts the importance of fundamental data, such as earnings, employment, and economic growth. Charts allow investors to monitor the aggregate investor interpretation of all the fundamental data. Said another way, charts are efficient tools used to monitor vast amounts of fundamental data, which is important since fundamentals ultimately determine which assets classes will perform best. When the economy is healthy, stocks tend to beat bonds. When economic fear dominates, bonds tend to beat stocks. In this article, we will cover the latest signal from the markets that came on July 16.

Dow Theory Is Based On Economic Common Sense

Dow Theory is based on a series of Wall Street Journal articles written by Charles Dow. The basic tenets of Dow Theory are easy to understand. Charles Dow believed that:

  1. In order for industrial companies to increase their earnings, they had to produce and sell more goods.
  2. If industrial companies are selling more goods, then transportation companies must be delivering more goods to retailers and wholesalers.
  3. Therefore, in a healthy economy, both industrial companies and transportation companies should be experiencing revenue growth.
  4. If industrial and transportation companies are growing their revenues, then the industrial and transportation stocks should be attractive to investors.
  5. If industrial and transportation companies are doing well and are attractive to investors, both the Dow Jones Industrial Average and the Dow Jones Transportation Average should be making new highs in unison, serving to confirm a healthy economy.

Behind The Averages

After reviewing the companies in the industrial and transportation averages, it is easy to see why they represent logical vehicles to monitor the pulse of the U.S. economy. In 2014, our economy is driven by more than just industrial or manufacturing companies. The present day Dow Jones Industrial Average contains traditional producers, such as IBM (IBM), 3M (MMM), Boeing (BA), Chevron (CVX), and Johnson & Johnson (JNJ). However, the Dow (DIA) also contains Visa (V), Goldman Sachs (GS), and American Express (AXP), since the present day economy relies heavily on the financial sector. The Dow Jones Transportation Average (IYT) still has railroads, such as Union Pacific (UNP) and Norfolk Southern (NSC), but it also contains more modern logistics companies, such as United Parcel Service (UPS), Fed-Ex (FDX), and J.B. Hunt (JBHT).

Just Reconfirmed Primary Bull Market

If investors believe industrial and transportation stocks are healthy and thus, attractive investments, that speaks to demand. When demand is strong, stock prices rise. Despite the recent Fed/Ukraine volatility, the Dow Jones Industrial Average posted a new closing high this week. Notice the slope of the blue 50-day moving average in the chart below; you can compare it to the early stages of a 2011 correction in stocks and to the 2008-2009 bear market later in the article.

Similarly, the Dow Jones Transportation Average also posted a new high on July 16. Again, note the look of the blue 50-day moving average.

2011: How Can This Help Us Manage Risk Today?

If Dow Theory offers a way to monitor the aggregate interpretation of the economy, earnings, and central bank policy, then we would expect charts of the DJIA and DJTA to be helpful in terms of managing investment risk. Since a picture is worth a thousand words, when the Dow’s 50-day rolled over in 2011 (see orange arrows below), the index dropped an additional 16%. Notice how the Dow failed to make a new closing high before the big reversal in 2011. As of July 17, the 2014 Dow chart looks much better (slope of 50-day is up, recent higher high).

2007-2009: Economic Pessimism And Investor Fear

Similar economic warnings came in 2007 and 2008 (see orange arrows in chart below). Notice during the 39% drop in the Dow in 2008 the 50-day never gave a “things are improving” signal, meaning it was helpful from a cash-redeployment perspective. The Dow was not making new highs; instead it was making a series of lower lows, which reflected a period of economic pessimism and investor fear. The 2014 chart looks much better, which is indicative of more favorable economic expectations.

The differences are easy to see side-by-side. The stronger bullish conviction tells us even if stocks pull back in the short-run, the odds are good that buyers would step in and attempt to test the recent highs. Reversals tend to be a process rather than a one day binary event. The charts below speak to probabilities.

The Fed Still Big Part Of Fundamental Equation

Anyone that has followed the markets closely, especially over the last four years, knows that all things being equal the stock market is not fond of any Fed move that slows the printing presses. Thursday’s not too hot, nor too cold data on the economic front most likely keeps a 2015 rate hike on the probability table. From Reuters:

Rising inflation pressures could push the U.S. Federal Reserve to raise interest rates as early as the second quarter of next year, according to a Reuters poll of analysts. America’s jobless rate sank to almost a six-year low in June and consumer prices posted their largest rise in May in more than a year, bolstering the belief that the U.S. economy is turning a corner. Now many Fed watchers are bringing forward forecasts on the timing of when the central bank will raise interest rates. “All things considered, there is now an increased risk of an earlier first rate hike,” economists at Bank of America Merrill Lynch said in a report.

Investment Implications – Time To Pay Closer Attention

Does the recent Dow Theory bullish confirmation mean it is all fun and games for the economy and stock market? No, it simply tells us the market is currently healthy, and the next bout of significant weakness is more likely to be a correction, rather than a full blown bear market. Notice, a correction remains a possibility. As the godfather of technical analysis noted on Twitter, this week’s signal keeps the longer-term bullish case intact.

For Further Study

Since the markets are nervous about rising interest rates, it may be prudent to brush up on risk management strategies:

  1. How To Monitor The Risk Of A Midterm-Election-Year Stock Correction
  2. 5 Reasons Your Simple Bear Market Plans Could Backfire
  3. The 2 Most Important Questions For Investors