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A Lump Of Coal?

12/14/2014

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I know it is almost unthinkable that the stock market could decline in December but that is indeed what my model is predicting.  For the first time in about a year my allocation to stocks has moved to the short side.  This was caused by a reversal of technical factors combined with continuing over-bullishness by small investors and speculators.  Even earnings are beginning to look like they could reverse to the downside and that would be a much more problematic scenario going forward.  For now, I am still fully hedged.

Earnings:
I am adding in 2015 earnings expectations now that we are in the final half of the year. This
weighted estimate for 2014-2015 is still in an uptrend but estimates for both 2014 and 2015 are being reduced.
As long as the uptrend continues, my first earnings indicator is positive.
Looking at earnings 52 weeks ahead, estimates have reversed and are still marginally negative. This indicator is still rated neutral.
With one indicator positive and the other neutral, the earnings indicator remains at 75%, the same as last week..
Looking at the gap between last twelve month earnings and future 52 week projections, the gap remains at negative levels but the gap is no longer increasing.
The shrinking gap means that there is no adjustment to be factored in.
Total earnings factor exposure and maximum total exposure remains at 75%, same as last week.

Sentiment:
The equity put/call ratio reversed somewhat last week along with the market.
Exposure increases to 35%, up from 20% last week.
Small option buyers have also become a bit less positive.
Exposure increases to 20%, up from 5% last week.
NAAIM managers continued to be fully invested and actually increased their exposure last week.
Exposure remains at -10% this week, same as last week.
When one of my sentiment indicators is maximum negative and the other two are neutral or negative, I assign a sentiment exposure of 0%. This is the same as last week.

Valuation:
My long term valuation indicator remains negative as expected stock returns over the next 10 years are now back below the yield on the ten year treasury bond.
This factor continues to call for 0 equity exposure.
Percentage of stock prices represented by net current assets remained the same last week.
Exposure remains at 20%, same as last week.
Comparison of stock earnings yield to ten year treasury yield increased last week.
Exposure increases to 70%, up from 50% last week.
Total valuation exposure is 30%, up from 23% last week.

To get a combined exposure for these three factors, I multiply them together and then take the cube root.
This week, that number is 0%, same as last week.

Technicals:
My comparison of yields on treasury bonds compared to lower quality corporates remained in a
decline last week.
I subtract 10% to account for this factor.
New highs - new lows on the Nasdaq turned negative last week.
I subtract 10% to account for this factor.
My trend indicator for new highs - new lows on the Nasdaq is not operative now since the previous indicator is negative.
Total technical adjustments this week are -20%, down from +10% last week.

After adjustments, total exposure for the week is -20% or, after rounding, -25% (short).
This level of exposure does not exceed the current earnings cap and is down from 0% last week.

Stock Ideas:
This week the top five ranked stocks used in my aggressive screen are: AMOT, LDL, STRT, CTP and PATK.
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