A nice rally last week has moved my valuation indicator to a somewhat negative level again, much as it was during most of 2014 and 2015. Since real reported earnings have not made much progress, stock prices at these levels do not look particularly attractive. Future earnings prospects, though, continue to look better but, I must confess, I don't understand where the optimism is coming from. Sentiment factors remain neutral with some groups looking for higher prices and others afraid of a correction. All things considered, my model has reduced its exposure to 30% this week.
The market continues to consolidate recent gains. Earnings expectations remain positive even though earnings as reported are sliding lower. Sentiment is mixed and neutral right now. Some sentiment indicators improved last week while others deteriorated. The reason for the decline in exposure to 60% from 100% relates to valuation levels. Valuation just doesn't seem positive enough to justify a fully invested position. I would categorize it as neutral/negative. Lower stock prices could turn both sentiment and valuation indicators positive and that would present a good opportunity to go back to a fully invested position.
I'm traveling this week and next so I don't have a full update. I may be able to post one in a day or two. In spite of all the negative news - especially regarding the retailers - there is no change in my model's exposure level of 100% to equities at this time. Earnings expectations are holding up well while valuation and sentiment remain neutral factors. My own portfolios are doing OK but there has been some slippage in the performance of the broad market compared to the leading averages. Sentiment is also beginning to look better as small investors and speculators get a little more defensive. Further weakness should present a good buying opportunity unless the earnings outlook just falls apart.
I've been searching for a technical indicator to add to my model but, after many hours of testing, I am unable to come up with anything that improves performance. I did discover, however, that I have been relying on sentiment indicators too much to identify tops. They work very well at bottoms but don't help with pinpointing tops in stock prices. I reworked my model and got much better performance over the entire time period by simply looking at earnings, valuation and sentiment for bottoms only. Currently, both my earnings indicators are positive although one of them is subject to reversal with modest decreases in estimates. Valuation is neutral and sentiment is also neutral. Because of the important role earnings expectations plays in my model, the exposure this week has increased to 100%. Again, I want to restate that my maximum stock exposure is only a part of my overall portfolio. Since I am retired, I have other holdings in bonds and cash in order to reduce risk, generate income and provide stability.
We are now seeing the exact opposite of market dynamics from late last year. The market was down last week but there were more stocks up than down on the NYSE. The Value Line Geometric Average is doing better than the S & P 500. Earnings expectations increased some more last week and continue to be positive. The decline in prices last week brought my valuation indicator to a just barely neutral position from neutral - negative last week and sentiment measures are scattered but generally neutral overall. I have dropped my hedged position and continue to look for attractive stocks to buy up to my model's recommended exposure of 60% this week.
Richard Moore, CFA
With my wife in Hawaii