Weekly
Close Report
Many
traders have shown it is possible to make investment returns that exceed long
term buy and hold by carefully following shorter rises and falls of trends,
cycles, seasonality, signals, indicators, etc.
I initially
started writing this report to keep myself current with important events affecting
the various market trends. Following is a description of the possible significance
of the information in the report. Although I am only interested in mutual
funds, techniques described herein can be applied to stocks, etc.
Market Climate/Outlook
This
section is a summary of the report, and as such is relatively self evident.
Economic Outlook
This
information is an attempt to describe the current status of the economy and to
show the implied direction of the future economy.
Monetary Liquidity
Increasing
money supply tends to accompany or precede rises in market prices.
M2 money
supply changes are the next best since M3 money supply is no longer available. Examination
of the data from 9/1/1988 shows there is a tendency for the money supply to
correlate with market moves. As usual though, there are exceptions to the rule.
High money
market yields are a low risk alternative to market securities. Higher money
market yields indicate less money is becoming available to the economy.
Changes in the
value of the U.S. Dollar in international currency markets quite often precede
changes in the broad
Psychology/Sentiment
Studies in
the past have shown people exhibit inordinately high levels of optimism at
market tops and inordinately high levels of pessimism at market bottoms. This
typical human behavior makes a good contrary indicator. The trigger levels in
the four indicators in the report were found from past experience to be good
indicators of high and low periods in markets.
Bond Price Trends
There being
approximately ten times as much money in the bond market as in the stock
market, it is important to watch bond price trends. Periods of increasing
interest rates (falling bond prices) offer new investments in bonds, lower risk
with acceptable returns. Thus, this often indicates an approaching high in
market prices.
Stock Market Price Trend Indicators
Levels of
market prices relative to various moving averages indicate current price
trends.
The 50 day
and the 200 day moving averages are often used to indicate price trends and can
be used as buy or sell points when prices cross these levels.
Levels of
market breadth indicators confirm current levels of prices and suggest
potential future levels of prices. The raw data for breadth indicators are the
numbers of new highs, new lows, and advances, declines, up volume and down
volume recorded each day. These numbers are combined in various ways to generate
indicators which include various oscillators, summation indexes, advance/decline
lines, etc.
Advance/decline
and volume summation indicators are similar but the volume summation indicator
appears to give a little clearer picture of current levels and potential future
trends of prices. Divergences in the directions of the breadth oscillators and
summation indexes relative to prices virtual always precede changes in the
direction of price movements. Some times these divergences can persist for
extended periods of time. Trading signals may then be given by crossing trend
lines or crossing slower moving averages.
Relative Long Term Valuation
The average
long term real yield return (corrected for inflation) of bonds over several
hundred years is approximately 3 percent. This is the average historical return for long periods of time of human
economic activity. Bond returns have less volatility than stocks and are
therefore perceived to be less risky.
The average
long term rate of earnings growth of the S & P 500 stocks is six percent while
their average price earnings ratio is near 14.5 percent based on trailing
earnings. The six percent average growth rate of earnings is not corrected for
inflation. Estimated future earnings compared to trailing earnings relative to
current prices provides an indication of expected market price changes.
Stocks and
bonds compete for long term inflation adjusted real returns. Thus we see that
interest rate levels and trends, and earnings levels and trends complicate the
determination of whether stocks or bonds are better current or long term investments.
Relative Short Term Valuation
Due to the
natural behavior of humans to over react; cycles of over and under valuation
appear in stocks and bonds. Current valuations show these ranges of over or
under valuations relative to long range valuations, and thus indicate the
potential future price trends.
The four
year cycle which is associated with political and economic activity is most
easily identified. The 9 month cycle is also important but sometimes the cycle
lows are inverted (they remain high and do not drop as expected).The Federal
Reserve board attempts to moderate these over reaction economic activity cycles
by changing the money supply and short term interest rates.
Long term
bond interest rates have an expected inflation rate added; short term bonds do
not have the expected inflation added. Therefore, usually long term bond rates
are higher than short term rates; this defines the normal yield curve. When
short term rates are higher than long term rates (an inverted yield curve),
financial institutions have difficulties making money through loans which in
turn tends to reduce economic activity.
The
calculation of fair market value of the S & P 500 is described in Appendix
A.
The
calculation of the Stock Value index is in Appendix B.
Dominant Stock Market Indicator
The
dominant market index is the relative strength of the NASDAQ index to the NYSE
index.
Beasley
score values are computed by the FastTools program. Indicators using NYSE and
NASDAQ indexes, their breadth data, and long term bond yields are computed.
Score points are assigned to different levels of the indicators.
Price
Trend Cycles
The cycles
are the stochastic of an MACD of the fund or index of interest with different
defined parameters for each period. The parameters for each cycle are listed in
Appendix C.
I use the ABC
module in FastFtools to compute the MACD data and I use FastRube software to
compute the associated stochastic and moving averages. They can then be displayed
on the screen, one over the other, so cycle correlations can then be observed.
Sector
Averages Ranked
FastTrack
sector families are chosen, and then entered into FastFtools.ini file for the
computation of the corresponding FNU data file averages. A family of the sector
family averages is then created using FastTools. FastTrack software can then be
used to rank the sector averages family over the desired past time periods.
NCALPHA
Mutual Fund Trading Systems
FT/Monitor
Vol. 7, No.4 contains detailed information about NCAlpha software.
Briefly, NCAlpha
selects funds in existence for at least one year, ranked by NCAlpha, Sharpe
Ratio and standard deviation. Funds are then selected, from the universe of
funds, by the sorted values of these three indicators. At the users chosen
signal date the program determines by ranking, the three best funds to buy.
These
programs are required to run this trading system:
FastTrack,
Trade; and famcreateb.ini, ncfgh.fam, ncfam.bat, ncfam.ini, and mc2x.ini
Procedure:
1 - When
mc2x.ini gives a buy signal, run famcreateb.ini to create
$famlosd.fam
from users specified family ncfgh.fam. The ncfgh.fam contains micro cap, small
cap, mid cap funds primarily and excludes funds with loads and some others. Users
should update this family, as I have not done for a while. Keep this family for
use until the sell signal is given.
2 - Then
run ncfam.bat using $famlosd.fam to get the four named ncalpha trading system
FNU trading records.
3 – Put a
trading record, e.g., SHARP into a FT chart TTIJJ for one year where the gain
from signal and gain for one year can be found.
4 -
FastTools menu 1, T- UI can be used to find ANN (CAR) and MDD for these trading
records for various past time periods.
Appendix
A
S
& P 500 Fair Value
These are
three different ways to calculate S&P500 fair value that I found in the
open literature. It seemed like the average of the three would give the best
results.
E =
S&P500 Yield, one year
T = 13 week
T-Bill Yield
I =
(S&P500 Close * E) / T
CPI = Yr/Yr
CPI 3 mo. Average
PE = S&P500
Price / Trailing one earnings of S&P500
M = 23 /
(CPI + PE)
N = M *
S&P500 Close
R = CPI + 3
T =
USGov30Bond Rate / R
U = T *
S&P500 Close
Fair Value
S&P500 = (I + N + U) / 3
Appendix
B
Stock
Value Index
I do not
know the original source of the Stock Value Index. I think it was probably posted
on what is now the www.FT-Talk.com/Forums.
D =
S&P500 Dividend Yield, one year
E =
S&P500 Earnings Yield, one year
T = 13 week
T-Bill Yield (Auction Rate)
Stock Value
Index = ((2 * D + E) / 2) / T
Appendix
C
Cycle
Trend Parameters
Cycle
Period MACD Parameters Stochastic Parameters
5 Weeks 19, 10 10, 4, 2
10 Weeks 37, 19 19, 9, 3
20 Weeks 90, 45 37, 19, 5
9
Months 180, 76 76, 22, 8
The third
stochastic parameter is the exponential moving average signal trigger line.
This method can be used to find these cycles for any mutual fund, market index,
ETF, stock, etc. The method was presented by Fred Werner in FT/Monitor Vol.6,
No.4.
Appendix
D
Available
Resources Used
Following
is the list of resources used to prepare this weekly close report.
1 -
Barron’s Business and Financial weekly. www.Barrons.com
2 –
Microsoft windows software on a computer.
3 –
Software and data: www.fasttrack.net,
Subscribers, Third Party Products
A
- FastTrack software and data.
B
- FastTools software.
C
- FastRube software.
D
- Trade software.
www.FT-Talk.com/forums
contains ongoing postings from individuals interacting to develop better ways
to select funds, develop better trading signals and trading systems. The Dexter
French, http://home.earthlink.net/~dexf/, has maintained a historical list of
postings from this site.
Additionally,
extensive related information can by found at FT/Monitor Publication, http://ftmonitor.com
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