Richard Shaw's  Instablog

It hardly escapes attention that stocks have been on the move upward.  Let’s look at some internal measures of the NYSE listings to see how they look.

click image to enlarge

[ image at QVM site ]

The percentage of NYSE stocks with bullish point & figure charts is over 70% as it was at the beginning of the bull following the 2003 bottom.

The VIX (an S&P 500 measure) is well below its peak at the recent market lows, but still above its often referred to complacency level seen during the last bull phase and the pre-2000 bull phase.

The percentage of NYSE stocks above their 200-day simple moving average is in the high 80’s, similar to its level at the beginning of the post-2003 bull.

Of course, none of these measures is diagnostic, and none provide guarantees, but they do add to the evidence that the markets are leaving the crisis behind.

Short-term interest rates are still quite low, which provides some negative counter balance to the positive notes sounded by stock market internals.

Junk bonds have risen sharply and the spread between junk and investment grade bonds has narrowed substantially, both indications of improved overall economic conditions.

The market humbles all men, and may do the same in this time period, but at this moment, things are looking up.

Richard Shaw
QVM Group LLC

These weekly charts provide a common comparison basis for several key asset categories.

Each chart is from 1/1/2007 through 8/7/2009 (or as close to 1/1/2007 as possible based on the inception date of the fund).  The indicators are Fibonacci retracement lines from the highest point in 2007; the 40-week (gold color) and 20-week (green color) simple moving averages; and the odds cones for prices out 9 weeks based on the price volatility over the past 26 weeks (95% probability range in red, and 67% probability range in blue).

The odds cones may be useful to some investors to help set stop levels, and to others to select option strike prices (selling options outside the odds cone and buying options inside the odds cone).  Note that the length of the period used to measure historical volatility is important and the 26-weeks we used may not be the best period for your own purposes.

The 40-week/20-week SMA cross-over is a popular indicator developing trend direction changes.  Note cross-over methods work best in strongly trending markets with major “hills” and “valleys” in the price chart — they work less well or poorly in “non-hilly” periods.

The Fibonacci lines give a good visual indication of where prices are today versus a prior high.

[ continued at QVM site ]
 

Securities mentioned: AGG, TLT, MUB, LQD, SPY, EFA, VWO, VNQ, DBC, GLD.

Disclosure: We may own any or all of these securities from time-to-time in various accounts.

When possible, we like to back test systems talked about in the financial press.  In this week’s Barron’s (August 10, 2009 issue), Jack Albin, Chief Investment Officer of Harris Private Bank (Chicago) said in “For Stocks, the Signs Point Up“,

“At Harris, our simple momentum-trading rule is to buy the market when it crosses above its 200-day moving average plus 5%, and stay invested until it crosses below its 200-day moving average minus 5%.”

That’s a pretty straight forward system.  Let’s see how well it worked in the past.

We used the MetaStock system tester on the S&P 500 index (symbol .SPX).

The formulas which we believe reflect the system as described by Mr. Albin were:

BUY IF C>(Mov(C,200,S)*1.05)

SELL IF C<(Mov(C,200,S)*0.95)

The system was either all in or all out with no leverage. “C” represents the closing price.  “Mov” is the moving average function.  “S” indicates use of a simple moving average.  “200″ is the number of periods in the moving average.

We tested over three distinct time periods: 1983-2009 YTD, 1983-1993 and 1994-2009.  The year 1994 was the year the internet caught on commercially and the dot com market began.

Before we present the results of the back test, here is a chart of the SPX over the full time period.

[ image at QVM site ]

Back Test Results:

The Harris Private Bank method outperformed the buy & hold for the S&P 500 by a wide margin in the 1994-2009 test, slightly underperformed buy & hold for the S&P 500 in the 1983-2009 test, and underperformed buy & hold for the S&P 500 by a wide margin in the 1983-1993 test.

Here are the details:

• 1994-2009:  Summary Results |  Positions (dates & values)
• 1983-1993:  Summary Results |  Positions (dates & values)
• 1983-2009:  Summary Results |  Positions (dates & values)

Mr. Albin also said about the system, “[it] has taken on increased prominence in the past decade.” A moving average cross-over system like theirs requires a “hilly” price pattern with significant direction reversals that persist for some time.  A comparatively smooth period like that in the 1983-1993 period (1987 notwithstanding) creates more false signals with this cross-over system and is ineffective.

We expect Harris Private Bank will continue to benefit from their system in the near term, because we expect the “hilliness” to persist for a while at least through the trend reversal that is in development at this time.  However, if the market smooths out, then Harris Private Bank will have to utilize other tools for analyzing price patterns.

Optimizing the System:

While we were in the system tester, we used the optimization feature to see if other parameters within the same approach obtained better results.

For the 1983-1993 period, the 10-day simple moving average crossing over the 200-day simple moving average, and a 2% envelope, outperformed the Harris Private Bank 1-day average (the price) with a 5% envelope, but still underperformed buy & hold.

For the 1983-2009 YTD period, the 40-day simple moving average crossing over the 200-day average, and a 1% envelope, outperformed the 1-day and 5% method by several points and a provided a material advantage over buy & hold.

For the 1994-2009 YTD period, the 40-day and 1% method also outperformed the Harris Private Bank parameters (both methods outperformed buy & hold).

Here are the details for the optimized parameters:

• 1994-2009:  Summary Results |  Positions (dates & values)
• 1983-1993:  Summary Results |  Positions (dates & values)
• 1983-2009:  Summary Results |  Positions (dates & values)

Takeaways:

The two major takeaways are:

1.  Different types of timing systems are necessary for different price action conditions — a single method may work for years or decades, but not forever or for all securities

2.  Optimization of parameters is helpful as price action shifts over time, and for different securities, each with their own peculiarities

We agree with Mr. Albin’s current market assessment (although a short-term setback is quite possible), and we believe his system is currently appropriate.  However, we caution readers not to over interpret the the utility of the system by assuming that it is good for all types of markets, all time periods or all securities.

Relevant Securities:

SPY and IVV directly, IVM and VTI indirectly, as well as mutual funds such as VFINX

Disclosure: We own SPY and VTI in some accounts.

Richard Shaw
QVM Group LLC