Saturday, October 31, 2015

Needing bots, having bots, superseding bots

Before I talk about the mega-bubble which will eventually become the most important story on the planet, I want to put my new investment strategy in context by reviewing my history of learning about, and interacting with, the stock market.

The first time I ever paid real attention to the market was in the late 1990's when I had my first 403(b) retirement account with TIAA-CREF.  Some time around 1998 I noticed that TIAA-CREF's growth fund was outperforming its value fund, and so I naturally moved all of my savings over to the growth fund(?!).  Soon after that I started reading and following the Motley Fools to try my hand at individual stock picking, and in 2000 I invested in my first four companies, all of them members of the Dow 30.

Everybody knows what happened next; the stock market tanked.  Although the worst damage was done to the dot-com stocks in the NASDAQ exchange, growth stocks in general and the large companies of the Dow 30 were pretty much the next worst places to be.  By 2002 I was thoroughly discouraged, and I put my stock market research on ice.

Around 2005 I learned that an investment adviser named Bob Brinker had predicted both the market top in 2000 and the market bottom in 2003.  I subscribed to his newsletter after that, but more importantly I realized that it was indeed possible to time the stock market, and thereby avoid losses during bear markets.  Since my natural talent is for finding patterns in complex data, I immediately set out to learn why Bob Brinker's method worked, and then to improve on it if possible.  After a couple of years I was back in business; I had found additional market-timing factors which (to my knowledge) were not used by Bob Brinker, including a pre-crash signal in market data that I've never seen anyone else illustrate or otherwise talk about.

In 2007 I started going public on this blog with my own buy and sell signals, albeit still backed up by Bob Brinker's overall view of the market.  Unfortunately I was still doing everything by eye, rather than by impartial calculations, meaning all of my decisions still had to pass through my own emotional filter and hubris.  Even though I had discovered an important pre-crash signal that preceded the crashes of 1929 and 1987, I didn't notice when it happened right under my nose in late 2007 right before the plunge of January 2008.  Once again I was suffering during a bear market despite having put considerable effort into avoiding just that.  To my additional horror, the great Bob Brinker remained 100% invested in stocks all the way through the 2007-2009 bear market.  That ended my trust in Brinker's method.  Fortunately I gathered my wits and clawed back with timely bear fund purchases over the next several months.

I emerged from two stock market bubbles and two bear markets with the following perspectives:
  1. Sometimes economic distortions cause parallel distortions in the stock market, as happened in the late 2000's with the sub-prime housing bubble, but sometimes the stock market experiences a "mania" bubble just from hype, as it did in the late 1990's.  (I'm less convinced about this latter point now.)
  2. Regardless of whether particular market moves are driven by real economics or short-term enthusiasm/panic of the herd, I had found market data "indicators" that correctly signaled market tops and market bottoms in each case.  In other words, it's possible to see the beginning of a buying frenzy or a selloff before it's reflected in the price of stocks, regardless of the cause.  (I remain convinced of this.)
My next goal had to be the design and implementation of an automated market timing method that, once running on a computer, wouldn't rely on me personally to collect data, interpret data, or produce a forecast. After much effort and several starts and stops, the first version of my "market bots" went online in June 2013.

Oh, if only the perfect stock market bot was the only thing we needed to maximize our retirement savings!

Incredibly, now that I have the exact tool I that I've wished for since 1998, I'm suddenly convinced that it's going to be moot when the next bubble pops.  The dot-com bubble was focused on a subset of U.S. stocks; the sub-prime bubble combined a housing bubble with a global stock market bubble; and now I fear the next bubble involves ... just about everything.   Most importantly for investors who wish to preserve a nest egg for retirement, I think the next bear market will include a steep plunge in the value of the U.S. dollar, meaning that even if you preserve the numerical value of your 401(k) by staying out of plunging U.S. stocks, you will still lose your purchasing power anyways because the dollars you managed to hang on to will become almost worthless.

This mega-bubble and my strategy for avoiding it will constitute the next few posts.

Bots back to bullish

The S&P 500 bots turned bullish again on Monday, October 26 (apologies for the delayed post) due to a rare seasonal factor, and I sold all of my shares of HDGE on Tuesday morning.  I anticipate that this seasonal bullishness will gradually fade away by early 2016.

Meanwhile about two-thirds of my total retirement portfolio is in a combination of foreign stock and foreign bond funds, as I will detail in an upcoming post.

Sunday, October 11, 2015

Is it really a bubble? Fair dinkum, mate!

How can anyone really know if the stock market is overvalued or not?  Times change; numbers can be interpreted any number of ways or even be fudged; and some prognosticators are naturally pessimistic while others are optimistic.  Maybe the stock market is just fine, even if the yield is only 2%.  We've already had two bubble peaks that were followed by crashes in 2000 and 2007 - how could we possibly have a third bubble in less than two decades?

Australia, a country that is similar to the U.S. in many ways, can be thought of as a control group in an experiment, and Australia's stock market (All Ordinaries Index) is a nice baseline that we can compare with our S&P 500 Index.

(CLICK TO ENLARGE)

In this chart that spans from 1995 to 2015, we see three massive stock market rallies in the S&P 500, shown in red.  The first rally from 1995 to 2000 was the infamous dot-com bubble which deflated from 2000 to 2002.  The dot-com mania was a mostly American phenomenon centered in Silicon Valley and the NASDAQ stock market, and was sparked in part by low interest rates, particularly a Fed Funds rate of 3% throughout all of 1993.  Australia had neither the glitter of Silicon Valley nor the low interest rates (6% in 1993), and accordingly its stock market (blue) participated in neither the bubble nor the decline.

The second stock market bubble started in 2003 while the S&P was still above the level of Australia's index.  In an effort to cushion the blow from the dot-com bust, the U.S. Federal Reserve set interest rates below 2% from January 2002 through mid-2004, while Australia's interest rate remained above 4%.  Unfortunately for Australia and the rest of the world, low U.S. interest rates encouraged the invention and exportation of sub-prime loans, mortgage-backed securities, and trillions of dollars worth of risky derivatives. Australian stocks, like stocks everywhere, eventually caught up with the U.S. in 2007 as part of the global financial bubble, which then burst in 2008.

Amazingly, at the end of the 2007-2009 bear market, and 14 years after the dot-com bubble began to inflate, the S&P 500 Index and All Ordinaries Index re-aligned.  As the above chart shows, both the S&P and Ordinaries gained about 70% from 1995 to 2009.  At some fundamental level it seems similar economies tend to grow at similar rates over the long haul, despite short term financial turbulence.

But getting back to the turbulence...

The Federal Reserve loves to lower interest rates after bubbles burst, and the bigger the bursting bubble is, the lower the Fed sets the rates afterwards.  As we now know, the entire global economy was in real danger in 2008, and central banks around the world took drastic steps to keep private banks, corporations and countries from going bankrupt.  In December 2008 the Fed lowered interest rates to below 0.25% ... and it hasn't raised them since then.  In addition the Fed has been making trillions of dollars of cash available for banks to borrow in a never-ending series of maneuvers called "Quantitative Easing".  Not surprisingly, the even lower interest rates over an even longer period of time coupled with money printing have fueled another huge rally in U.S. stocks.  Thanks to the Australian stock market, which is dealing with relatively large 2% interest rates and relatively little money printing, we can safely draw the conclusion that yes, we are indeed in a third stock market bubble here in the U.S.

(CLICK TO ENLARGE)

Since early 2010 the S&P 500 has gained 80% in value, while the All Ordinaries Index gained only 5%.  Dividend yields provide further evidence of the discrepancy: the iShares Australia ETF (ticker: EWA) has a whopping 6.9% dividend yield, compared to the paltry 2.1% yield of the SPDR S&P 500 ETF (SPY).

With no other information at hand, there is one play on this Yankee-Aussie split that is likely to win in the long run: betting on the S&P and Ordinaries to meet up again at their long-term trend like they did in 2009.  Equal investments in the U.S. bear market ETF (HDGE) and the Australia ETF (EWA) would result in a net return as long as U.S. stocks and Aussie stocks move back together.  This could happen if Australian stocks rise, but more likely U.S. stocks are poised to fall soon, and they would have to fall about 50% to return to today's Australian market level.  (HDGE would gain ~50%.)  As a bonus, if the U.S. dollar collapses in value relative to the Australian dollar, which is likely to happen if the Fed keeps printing money, then Australian stocks will make gains for American investors simply from the moving exchange rate.

In place of the Australia-only ETF I'm actually going to use Pacific ex-Japan ETFs (EPP, DVYA), which also include stocks from the relatively healthy economies of New Zealand, Hong Kong and Singapore, as the bullish counterbalance to HDGE.

Friday, October 09, 2015

Dollar testing support again

The exchange rate of the U.S. Dollar against other currencies has been bouncing up and down between two converging trend lines for most of 2015.


The dollar has bounced up off of the lower support line four times already (red arrows) in May, June, August, and September.  (It actually fell below the support for one day in August before returning to the range.)  Eventually the trend lines will intersect and by then the dollar will probably start a new upward or downward trend.  It's now reached the lower support line for a 5th time, which raises the possibility that the dollar will break out to the downside here.

If the dollar breaks down, it could be the event I've been waiting for.  At that point I'll move the bulk of my investments overseas with foreign stock and bond ETFs.  Presumably gold and silver could start rising as well, so it would also be a good time to buy the Gold Miners ETF (GDX).