Market Extremes

I wish to highlight 2 important points.

The first one is to stand behind one of the great market analysts of our times, Dr John Hussman. Yes it’s true his reputation has been smashed by his poor performance the last few years. On this I am not able to defend him as much as I would like as I think the processes he adds to his portfolio construction on top of his macro analysis leave little to be desired. I actually don’t even want to go there, rather I want to stand by his rigorous market climate and valuation approach.

These are the key points and like John I am prepared to fall on my sword and face the ridicule.

Meanwhile, the S&P 500 is more than double its historical valuation norms onreliable measures (with about 90% correlation with actual subsequent 10-year market returns), sentiment is lopsided, and we observe dispersion across market internals, along with widening credit spreads. These and similar considerations present a coherent pattern that has been informative in market cycles across a century of history – including the period since 2009. None of those considerations inform us that the U.S. stock market currently presents a desirable opportunity to accept risk.”

Where he refers to a 90% correlation with actual subsequent returns this refers to his valuation model forecaster. If you go through the math you will see how the model works, but you are safe in the assumption that over the long term this model is pretty darn accurate. See below an example of how it looks.

I end my first point with Hussman’s words highlighting how overvalued we currently are, “The equity market is now more overvalued than at any point in history outside of the 2000 peak, and on the measures that we find best correlated with actual subsequent total returns, is 115% above reliable historical norms and only 15% below the 2000 extreme. Unless QE will persist forever, even 3-4 more years of zero short-term interest rates don’t “justify” more than a 12-16% elevation above historical norms.”

My second point is to just highlight an extreme in market momentum we haven’t seen in its history, I am not sure what to draw from it right now but I wanted to document it as I believe it will be significant when we look back over the fullness of time. For 29 days the S&P500 closed above its 5 day moving average, the previous record of 27 days took place in 1928.

Seasonal Biases

One of my pet hates is trading seasonal biases, they make no sense to me, but as much as I wish to deny their effect I cannot they are pretty clear and present so be warned.

I thought I would highlight two current seasonals, Thanks Giving which I see at +2 days we are due for a pullback which is today with the Asian markets have obliging.



The other seasonal is December month which is the second most favourable month for the S&P500 since 1950.


Visual Market Perspectives

Here are a few snapshots from some of my favourite market commentators.

To start with here is a great view of how each pull back (correction) turned to be a great opportunity to add to your portfolio, all with the benefit of hindsight. In this chart even the loss of 50% looks tame, but who could have known.

We can see in the chart below a key culprit in the rise and fall of the markets and that is the growth in margin debt. What I find quite worrying is the degree of the current expansion. It makes all previous bull “bubbles” babies in comparison. This for me is an extremely bearish omen.

Finally switching tack to get a perspective of the FX markets from MacroMonitors site. The Russian Ruble is in trouble and is possibly telegraphing something geopolitical.



Early Warnings

On Friday I snapped my medial calf muscle while racing my 12yr old son up the hill to our house (100m). It actually popped as I tried to take off and forced me to be house bound for 2 days. It is up there with the most painful injuries I have suffered. The question is why on earth did this happen to a 43yr old 105kg gorilla of quivering passion or as my wife said “why did you do such a stupid thing?” If you ignore the fact that I often behave like Peter Pan, there was a very obvious early warning sign to this injury, which probably makes me look even more silly.

The day before the injury my son challenged me to a race up the hill which I gladly accepted and narrowly lost, later that evening I said let’s go again, this time I was the victor. The following morning (Friday) when I woke up my calves were very stiff from the previous days sprinting (this was my early warning). When David and I were walking home around lunchtime, ever the competitor I said lets settle the sprint championships. The rest is all painful history …….

If you look at market behaviour over the last few weeks and the commentary on every financial news site you will notice how everyone is talking about the change in market behaviour, that a new era of volatility has arrived, and some brave souls are even calling a bear market. My point is that not all the time but most of the time before a major injury/drop/crash there are warning signs. That is not a prediction it is simply a warning that “sudden” future events are more likely.


Let us give the current market environment some context. The market has been more than 1,000 days without a correction. A correction is commonly described as a 10% drawdown. With the low on Wednesday the S&P 500 has had a 9.75% drawdown so the market has not yet offically “corrected” and has simply experienced a pullback. According to intraday data prepared by LPL Financial Research the table below shows how often corrections and pullback have occured in bull markets since World War II.


I thought with all this talk about market corrections and possibly a new bear market it would be interesting to whip out my trusted “Gold Cross” trading system and see whether the current market could handle the challenge of staying with the long term trend. In this simple trading system you go long when the 50 day moving average is great than the 200 day, when the 50 day crosses below the 200 day you go to cash. I have run this system on daily Dow Jones Industrial Average data going back to 1889, this system has seen all types of cycles. In summary the “Gold Cross” system is roughly twice as good as a simple buy and hold strategy and it is telling you to stay long. The question is with all this market discussion about recession and correction can you stay long. For sure it isn’t going to be easy. This is an excellent example of no matter how good your system is do you have the psychological makeup to stay with it. If so, like my calf muscle stiffness you need to treat a downward sloping “Golden Cross” as a warning.