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Roman Chuyan
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Roman Chuyan, President Model Capital Management LLC is a tactical investment manager. As opposed to buy-and-hold strategies that follow the market's ups and downs, tactical management adjusts the asset mix in order to reduce the market downside, but to participate in the upside. Model Capital... More
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  • More Downside Is Expected For Equities And Commodities  0 comments
    May 11, 2012 9:56 AM | about stocks: SPY, DIA, QQQ, IWM, HYG, JNK, SHY, TLT, GLD, OIL, CRUD, JPM, CSCO

    U.S. Equities: Expected Return Continues to Be Negative

    Results as of April 30, 2012

    The PAR model moved to a somewhat larger negative position in April:

    S&P 500 6-m expected return: 6.8%

    Recommended allocation: Underweight

    Prior month -5.2%

    Change -1.6%

    As we started predicting in our March-31st report, equities are expected to decline in the next 4-6 months. So far in May, the S&P 500 dropped by about 3%, so it is likely to go down more from here. Several catalysts are triggering this drop - weaker than expected earnings in the US (JPM, CSCO are recent examples), the European debt problems and election results; but it is important to understand that these and other macro and economic reasons existed for a while, and it's important to have a tool that allows one to account for most relevant factors and to calculate the expected equity index return - this is what our PAR model does.

    Also worth noting, this time, major commodities are following equities down - Gold, Oil - which tells us that a broad risk-off scenario is developing, rather than equity-only.

    Putting It in Perspective

    Starting in 2008, the Federal Reserve has implemented monetary stimulus measures that were unprecedented in their size, in order to help the U.S. economy recover from its deep recession. These efforts supported credit creation and the prices of capital and real assets; and the economy has been recovering, albeit slowly. Inevitably however, a portion of the tremendous amount of liquidity has found its way directly into liquid financial assets (such as stocks, bonds, and commodity futures), moving their prices to higher levels than they would be otherwise.

    In 2012, the Fed started signaling that, while it is committed to keeping rates low for a while longer, it is done with new easing. The central bankers are clearly counting on the economy to start growing on it own, without additional stimulus.

    Our PAR model was detecting the statistical significance of the Money Supply in 2011, which was present in the model all year. At the beginning of 2012 however, the model detected that equity returns are no longer driven by money supply. This potentially confirms the Fed's view, at least directionally.

    With the economic growth in the U.S. now picking up, the returns are being exceedingly driven by economic factors. The PAR model detected this important shift in the drivers of equity returns, with two economic variables added in January - the Economic Cycle Research Institute's (ECRI) Leading Index, and Durable Goods Orders.

    Suppose that we agree with the qualitative argument above. But how can we quantify what effect all these factors have on the equity return in the near future? And are there other significant factors that we are not capturing yet? The PAR models provides the answers:

    • The price of crude oil, above $100 per barrel, extends significant negative influence on the expected equity return.
    • The Economic group of factors are still at levels where they have a net negative contribution.
    • Equity valuation is positive.

    The PAR model indicates, based on all its relevant factors in combination, that the S&P 500 return is expected to be a negative 6.8%.

    The PAR model is a factor model designed to estimate the expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of the S&P 500 returns over economic, valuation and market variables. The factors are chosen each month as part of the model run, based on their statistical significance, from the set of 15 factors that have proven to be significant over time.

    The PAR model provides answers that tactical asset allocation managers need, such as:

    - What's the expected equity risk premium right now?

    - What are the factors that we should be looking at, that really affect equities?

    For more information or for the full report, please visit our web site: TAAcomplete.com

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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