Inside The Stock Market ...trends, cross-currents, and outlook

Valuations are high. Market internals are weak. And the MTI is negative. But for those seeking some truly authoritative evidence that there’s stock market danger ahead, consider the accompanying cycle chart unearthed from a gossip column in a 1958 issue of the Minneapolis Star.

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When the Fed surreptitiously began to tighten as we believe (via tapering), in January 2014, history suggested that Consumer Discretionary and Small Caps would be the most likely initial market victims (at least from a relative perspective).

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Foreign stocks’ perpetual underperformance has opened up a valuation gap that should look extremely appealing to anyone with a horizon of more than two years. But proceed with caution.

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Hedge funds have shuttered by the dozen in the past few weeks, with the worst carnage among those focused on Emerging Markets and commodities. But the problem is broader.

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Models can prove helpful in overriding an investor’s natural (and frequently costly) impulses. But we’ve come to believe that our long experience in model building and implementation has succeeded not only in overriding these impulses but in actually modifying them.

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Liquidity “consuming” strategies like price momentum are generally considered to be more volatile than liquidity “providing” approaches like value investing.

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Our original research on price momentum dates back to the late 1960s, and was based not on asset classes but on equity sectors and industry groups. We stumbled upon the Bridesmaid effect, in fact, while testing a handful of simple strategies about a decade ago.

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We recognize that—regardless of their empirical appeal—momentum-oriented approaches aren’t suitable for every investor. For those investors, we’ve identified an alternative sector allocation strategy that’s delivered long-term results almost identical to those of the Bridesmaid approach, but which is based on a single, simple selection criterion that should appeal to the most hard-wired contrarian: The Low P/E.

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A review of the past year’s performance of “Dream” and “Nightmare” equity groups from back in 2014.

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As another Chinese stock market drama is unfolding, we may see a repeat of last summer’s action, where U.S.-listed stocks with pending “going private” deals saw their discounts widen significantly.

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The blue chip U.S. indexes have gone nowhere in 2015, and we expect bulls will soon write off the year as the “pause that refreshes.” But what’s been refreshed?

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While the sequence of index peaks traced out YTD is not exactly a textbook one, the market’s internal diffusion is comparable to that seen at many major tops, including 2000 and 2007.

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While the S&P 500 had erased all but 2% of its August loss as of early December, Small Caps and the “average stock” had recouped only about half their correction losses. Not good.

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The year has been especially tough on managers who might have shared our cyclical worries over the stock market, but who’ve elected to stay fully invested via seemingly lower risk value approaches.

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We tracked the “legal” insider actions of NYSE specialists for many years, until a crackdown on that business model early last decade rendered our old data sets virtually irrelevant.

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The S&P 500 Information Technology sector has just broken out to a 15-year relative strength high, and it jumped two spots to the top scoring broad sector position. The breakout in Tech provides a rare example in which foreign market action presaged a major domestic move.

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Following August’s market break, we produced a set of potential downside targets derived from a mix of technical retracements, “average” bear market declines, and an assumed reversion-to-the-median in S&P 500 valuations. Little has changed here.

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Here’s an example of just how disparate underlying market action has become: with the S&P 500 only 2% away from a cycle high, several major U.S. and foreign market indexes have already moved into an oversold position on the basis of our Very Long Term (VLT) algorithm—with a few (including EAFE, Chart 1) actually triggering “long-term, low-risk” BUY signals in the last two months! We are not sure what to make of this action.

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Is there a statistical relationship between the height scaled by a given bull market and its subsequent decline? That correlation is in fact pretty tenuous, we’ve found.

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In regards to fixed time cycles, Richard Russell—who died last month at 91—used to complain, “Where are they when you need them?” We agree, and present 2015 as just the latest example.

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