Reading This Market: Patience Is a Virtue

Includes: IVV, SPY
by: Jim Delaney

The market, it seems, has reached one of those points where, like a ball tossed up, it is suspended for a moment neither rising nor falling. Unlike a ball however, the market can gather itself and move higher again or like the ball, succumb to gravity and fall from its apex.

These periods are usually marked by a statistic or fact that every pundit being interviewed in and on every mode of media latches onto as the basis for everything else they are about to say or have just said. Here in mid-August that phrase is: “The market is up 49% from its March lows.” As Roberto Duran said in his first fight against Sugar Ray Leonard; “No mas, no mas.”

Numbers and the numbers they produce can be funny at times and you can always “torture the numbers until they speak,” an old boss used to tell me. David Leinweber, a professor at the Haas School of Business at UC Berkeley, has written a book that looks at some of the more inane associations that quantitative analysts have glued together over the years in his new book “Nerds on Wall Street”. The point is not to take aim at “quants”, as he is one himself, but more to highlight the pitfalls of data mining through some rather comical examples.

David’s piste de ressitance is a study he did by comparing annual butter production in Bangladesh with the S&P 500, finding a 75% correlation. When he added U.S. cheese production and the total population of sheep in both Bangladesh and the U.S., the correlation rose to 99%.

With this in mind there have been two articles in Barron’s as of late, one by Jonathan Laing titled “Six Good Reasons to Like Stocks (August 3rd edition) and more recently “For Stocks, the Signs Point Up” by Jack Albin, CIO of Harris Private Bank in Chicago (August 10th).

Laing, a Barron’s reporter, summarizes Wells Capital Management’s Jim Paulsen's outlook in his piece. Paulsen talks about a 2-year bottoming process, cheapness signaled by P/E ratios and “spectacular profit leverage” among other things.

Jack Albin lists his factors more succinctly as: valuation, the economic background, liquidity, psychology and momentum. To this last point, he discusses his method of placing a band around the 200 DMA of the S&P 500 and buying breakouts 5% above the 200DMA and selling those 5% below. He briefly describes the model’s performance with the buy signal it gave in 1998 staying long until 1Q00. From 1Q00 until 4Q02 it was idle before getting and staying long until January of 2008. He notes that a buy signal was generated in mid-July using this model.

CDS spreads have come down precipitously since July 10th and as such would support Jack’s prognosis of higher stock prices. Given, however, that the 200DMA does not move that quickly itself, placing a 10% band around it only slows things down more.

The CDX index on Investment Grade debt moves much more quickly and hit a low on August 7th. The resistance point on the way back up appears to be the 113bps level from 8/4, just before the last leg down. The CDX IG index closed at that same 113bps level last night so we’re at a critical junction.

On an individual basis, many of the CDS/equity combinations in the CEC Universe have not shown as dramatic a reversal as the index itself although a number of long positions have been sold and short positions added over the past few days.

Even the old joke about the young bull and the old bull tells us that patience is a virtue. As such, we will continue to analyze each situation separately and leave the 49% comments for the pundits.