Whipsaws are never enjoyable and my model has suffered from two of them in the last few weeks. The flip-flop in NH-NL is understandable. The indicator gives poor signals from time to time. Earnings trends, however, are more problematic. I've had to make some adjustments to deal with future possible problems:
The trend in estimated earnings for the S & P 500 is still slightly down. The trend is improving,
though, primarily because I am slowly giving more weight to 2013 estimates. So, 2012 estimates are now around $103 and 2013 estimates are around $115. Even though both of these yearly estimates are slightly declining, the weighted number looks better and it is easy to see that it will begin to increase unless estimates are reduced at a faster rate. I've made some adjustments to my trigger points in order to account for times like this. The fact that earnings so far this year are essentially flat at $90 makes it hard to see how the estimates for this year can possibly be achieved but they are what they are.
Exposure = 25%, up from 0% last week.
Investors in the Rydex Funds continued to hold extremely bullish positions. I've started using an indicator that tracks just the leveraged funds because it is a bit more responsive to sentiment changes. Last week there were two or three days that showed ten times as much invested in the NASDAQ leveraged long fund as there was invested in the NASDAQ leveraged short fund. Exposure = -10%, maximum bearish position.
NAAIM investors became more confidant and increased their stock holdings.
Exposure = 5%, down from 20% last week.
Small option buyers took a more bullish position but not enough to move them out of the neutral
Exposure = 50%, same as last week.
Total sentiment factor exposure = 15%, down from 20% last week.
Percentage of value represented by net current assets remained the same.
Exposure = 40%, same as last week.
Comparison of bond yields to stock earnings yields stayed the same last week.
Exposure = 30%, same as last week.
Total valuation factor exposure = 35%, same as last week.
To arrive at my exposure number from these factors, I multiply them together and then take the cube root. This week, that number is 24%, up from -72.5% last week.
The trend in high yield bonds compared to treasuries is still in a very slight uptrend so I add 10%.
NH-NL is now positive so I add 10% for that indicator.
Total technical adjustments are +20% and exposure = 44%, up from (62.5%) last week.
Two week moving average is -9%, up from -66% last week. However, I do not go short when NH-NL is positive so my exposure
this week is 0%.
Richard Moore, CFA
With my wife in Hawaii