Richard Shaw | Aug 31, 2015 02:16AM ET
The S&P 500 is the most important US stock index — most followed, most used as a benchmark, most used to measure and compensate fund managers, among the longest histories, and covering most of the market-cap of the US. That index is in a downtrend, and a more defensive position is appropriate.
Moving averages are the simplest way to judge whether a trend is UP or DOWN. A trend, whether UP or DOWN remains in force until proven otherwise. No proof of a reversal back to UP is evident at this time.
However, over long periods, downtrends such as this become less of a problem as the length of the period increases (thanks to Frank Case of AlacrityConsultingAssociates for pointing us to this chart from Charles Schwab), which clearly makes the point).
Just how much more defensive you should be varies:
There are many forms of being more defensive, only one of which is exiting the stock market – for example:
Let me be very clear, the aggregate historical evidence is that attempting to enter and exit the market (except for major Bears, like 2000 and 2008), results in underperformance. You get out after a decline has begun, and get back in after a recovery has taken place (or worse yet, you are whipsawed and get in and out a few times during a cycle with each round trip being less profitable than having stayed invested). Getting in and out is a two decision process, why and when to exit, and why and when to re-enter. For most people that means underperformance.
However, for those for whom preservation and avoidance of major drawdowns during periods of withdrawal is paramount, underperformance is an acceptable “opportunity cost” in exchange for “risk of ruin” (outliving assets). The risk of outliving assets is increased when a schedule of fixed or rising withdrawals is made from a highly volatile portfolio (thus the rationale for holding bonds as well as stock over the long haul); and is particularly dangerous if the early years of retirement are characterized by declining markets.
This chart for JP Morgan Asset Management shows the impact of being out of the market for certain numbers of top performing days from 1980 through 2014 (note that some of the top performing days are during early days of recoveries).
We’ll talk more about that and sustainable retirement withdrawal rates in a future post.
So what you should or should not do is quite particular to your circumstances.
All that said, what is the condition of the stock market today? It is in a downtrend, but what are some of the details?
A summary of US stock market details is this:
Here is a table that lists and quantifies the indicators. Following the table are the charts from which we pulled the indicator values (along with a bullet point discussion of each chart). You can decide for yourself if you agree with our UP and DOWN readings on the indicators that required a visual inspection.
THE SUPPORTING CHARTS
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OBSERVATIONS ON FIGURE 1
FIGURE 1
OBSERVATIONS ON FIGURE 2
FIGURE 2
OBSERVATIONS ON FIGURE 3
FIGURE 3
OBSERVATIONS ON FIGURE 4
FIGURE 4
OBSERVATIONS ON FIGURE 5
FIGURE 5
OBSERVATIONS ON FIGURE 6
FIGURE 6
OBSERVATIONS ON FIGURE 7
FIGURE 7
OBSERVATIONS ON FIGURE 8
FIGURE 8
OBSERVATIONS ON FIGURE 9
FIGURE 9
OBSERVATIONS ON FIGURE 10
FIGURE 10
OBSERVATIONS ON FIGURE 11
FIGURE 11
Patience tends to be rewarded in markets. We may reach Bear status, but so far the technical data is mixed and not conclusive that a Bear comes next or soon (although one may be statistically due because of the age of the Bull market).
Reflecting the mixed data, for those client in or near retirement, and who do not have excess assets, we are essentially half invested and half cash within our equity policy allocation, and have been for about a month or more.
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NOTES ABOUT SOME INDICATORS
Yield Curve (steep, flat or inverted from short-term to intermediate to long-term): We use the ratio of the yields instead of the spread to “normalize” the relationship over long periods where rates are sometimes very high with large absolute differences, and other times when rates are low and the absolute differences are much smaller. The ratio approach eliminates that comparison problem. While the yield curve has predicted 11 of the past 9 recessions, a recession has NOT begun without a preceding or coincident flat or inverted yield curve. Stocks begin Bear markets before recessions, and the yield curve almost always goes flat before stocks move to a Bear. Here is what the New York Fed said:
“The difference between long-term and short-term interest rates (“the slope of the yield curve” or “the term spread”) has borne a consistent negative relationship with subsequent real economic activity in the United States, with a lead time of about four to six quarters. The measures of the yield curve most frequently employed are based on differences between interest rates on Treasury securities of contrasting maturities, for instance, ten years minus three months.
The measures of real activity for which predictive power has been found include GNP and GDP growth, growth in consumption, investment and industrial production, and economic recessions as dated by the National Bureau of Economic Research (NBER).
… The yield curve has predicted essentially every U.S. recession since 1950 with only one “false” signal, which preceded the credit crunch and slowdown in production in 1967″.
This chart illustrates the yield curve predicting recessions:
This chart shows how the yield curve tends of go flat before the stock market goes into a Bear:
FEDERAL RESERVE STRESS INDEXES
St. Louis Fed Financial Stress Index
The STLFSI measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress. Accordingly, as the level of financial stress in the economy changes, the data series are likely to move together. The latest STLFSI press release, with commentary, can be found here .
Cleveland Financial Stress Index
The CFSI tracks stress in six types of markets: credit markets, equity markets, foreign exchange markets, funding markets (interbank markets), real estate markets, and securitization markets. The CFSI is a coincident indicator of systemic stress, where a high value of CFSI indicates high systemic financial stress. Units of CFSI are expressed as standardized differences from the mean (z-scores). here
ETFs DIRECTLY REFERENCED:
S&P 500 (NYSE:SPY), S&P 400 (NYSE:MDY), S&P 600 (NYSE:IJR), Russell Top 200 (NYSE:IWL), Russell 800 (NYSE:IWR), Russell 2000 (NYSE:IWM), Equal Weight S&P 500 (NYSE:RSP), Equal Weight Russell Top 200 (NYSE:EQWL), Equal Weight Russell 800 (NYSE:EWRM), Equal Weight Russell 2000 (NYSE:EWRS)
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