Creating Your Own Metrics To Determine Market Direction

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Includes: AMD, AMZN, ARRS, BKD, BMRN, BRKR, CAG, COG, CVG, CYH, DIA, ENDP, ENS, GLD, GNTX, HDY, HLX, HOLX, IPGP, IVC, JCOM, KND, LUV, MINI, NFLX, NUS, PETM, PKG, PKI, QSR, RHT, ROC, RSG, RSTI, SCHL, SJNK, SPY, STX, SYKE, VSAT, ZBRA
by: Papa of Four

Summary

CNBC's Million Dollar Portfolio Challenge. The game and why it is relevant.

A 468% gain is worth having. A look at the performance and what it tells us.

Getting the message. Indications for the future and possible causes of a severe pullback in the broader Markets.

What are the current risks? A look at what may cause the markets to loose 15 - 25% next year.

What differentiates your investment strategy from the broader market? How do you know where the market is heading? There are some who just trade off every news item. There are others who trade in opposition to current sentiment. I love watch lists, I have about 30 of them that I monitor frequently. Some are baskets of ETFs and Reverse ETFs, others include ADRs, tech, commodities etc. I use the performance of these watch lists to help identify areas of opportunity and risk. Creating my own metrics by which I can judge market performance and try to get a sense of what is coming next. The one I want to share with you today was created for a game, but that makes it no less valuable. It was created near the market lows, during the financial crisis.

"CNBC's Million Dollar Portfolio Challenge is a fantasy stock and currency competition that allows investors of all levels to play with virtual money for a chance to win one million dollars." From CNBC.

I imagine that many of you are familiar with the game and probably played at some point. I participated, but did not like the idea of people having many multiple portfolios. It seemed to me a little like cheating or just random luck if people were allowed to create 30 portfolios and choose the best variation. I thought the whole point was $1 million each. A level playing field, an arena for the contestants. A chance to display their investing prowess.

The last time I played was fall 2008. On October 29th 2008 I put together my portfolio allocating, $861,841 to stocks and $138,159 left as cash. It was made up of everything I thought could do well. I will remind you that "well" was not a common theme at that time as we were in the middle of the financial crisis. I created my own watch list in order calculate individual stock allocations prior to entering them into the game. The watch list has remained unaltered ever since. I now use it as a barometer for how I think things are going generally. I should also note that this strategy was completely useless in the game and was abandoned the first week.

A 468% return is worth having.

I hope you all enjoyed Thanksgiving. It is a great day for doing many things including research. As I get ready to round up 2014 and start looking at what 2015 may hold; my aforementioned watch list is one of the places I go. For the first time in over six years I decided to clean it up a bit. It no longer reflected what had really happened. For example there were seven defunct ticker symbols, one stock showing too many gains because of a reverse split and another two that had split in the other direction. So here are the results of the clean up.

Symbol

Last Trade

Qty

Price Paid

Starting Cost

Gain $

Gain %

Market Val

$ Div.

(NYSE:COG)*

$33.61

37,456

$2.14

$20,039

$1,238,857

6182%

$1,258,896

$10,862

(WFM)*

$48.30

15,896

$2.64

$20,983

$746,794

3559%

$767,777

$37,356

(NASDAQ:STX)

$65.99

3,100

$6.45

$19,995

$184,574

923%

$204,569

$14,539

TWTC $

$42.78

4,158

$4.81

$20,000

$157,879

789%

$177,879

$0

(NYSE:ROC)

$78.97

1,960

$10.20

$19,992

$134,789

674%

$154,781

$8,036

(NASDAQ:ARRS)

$30.22

4,192

$4.77

$19,996

$106,686

534%

$126,682

$0

(NASDAQ:BMRN)

$89.38

1,306

$15.31

$19,995

$96,735

484%

$116,730

$0

(NYSE:ENS)

$61.01

1,806

$11.07

$19,992

$90,192

451%

$110,184

$1,589

(NASDAQ:IPGP)

$72.86

1,509

$13.25

$19,994

$89,951

450%

$109,946

$981

(NYSE:BKD)

$35.32

3,062

$6.53

$19,995

$88,155

441%

$108,150

$0

(NYSE:RHT)

$62.00

1,727

$11.58

$19,999

$87,081

435%

$107,079

$0

(NYSE:PKG)

$73.66

1,312

$15.24

$19,995

$76,647

383%

$96,642

$7,885

(NASDAQ:ENDP)

$72.47

1,322

$15.12

$19,989

$75,817

379%

$95,805

$0

(NASDAQ:PETM)

$78.63

1,092

$18.30

$19,984

$65,880

330%

$85,864

$3,702

(NASDAQ:ZBRA)

$73.24

1,134

$17.64

$20,004

$63,050

315%

$83,054

$0

(NASDAQ:VSAT)

$66.84

1,222

$16.36

$19,992

$61,687

309%

$81,678

$0

(NASDAQ:GNTX)

$34.97

2,293

$8.72

$19,995

$60,180

301%

$80,175

$6,902

TBL $

$43.00

1,795

$11.14

$19,996

$57,189

286%

$77,185

$0

(NASDAQ:BRKR)

$18.94

3,861

$5.18

$20,000

$53,127

266%

$73,127

$0

(NASDAQ:JCOM)

$56.77

1,281

$15.61

$19,996

$52,726

264%

$72,722

$3,945

(NYSE:LUV)

$39.19

1,934

$10.84

$20,965

$54,829

262%

$75,793

$619

(NYSE:NUS)

$42.39

1,692

$11.82

$19,999

$51,724

259%

$71,724

$8,054

(NYSE:CVG)

$20.94

3,115

$6.42

$19,998

$45,230

226%

$65,228

$1,838

(NYSE:HLX)

$25.36

2,503

$7.99

$19,999

$43,477

217%

$63,476

$0

(NYSE:CYH)

$47.83

1,297

$15.42

$20,000

$42,036

210%

$62,036

$0

(NASDAQ:MINI)

$42.66

1,319

$15.16

$19,996

$36,273

181%

$56,269

$673

(NYSE:PKI)

$45.61

1,181

$16.93

$19,994

$33,871

169%

$53,865

$1,027

ARTC $

$48.60

1,070

$18.69

$19,998

$32,004

160%

$52,002

$0

(NASDAQ:HOLX)

$26.53

1,765

$11.33

$19,997

$26,828

134%

$46,825

$0

(NASDAQ:SCHL)

$35.54

1,171

$17.07

$19,989

$21,628

108%

$41,617

$3,162

(NYSE:CAG)

$35.73

1,150

$17.39

$19,999

$21,091

105%

$41,090

$6,325

(NYSE:RSG)

$39.63

1,022

$19.56

$19,990

$20,512

103%

$40,502

$5,406

(BKW)

$34.67

1,154

$17.33

$19,999

$20,010

100%

$40,009

$346

SEPR $

$22.00

1,654

$12.09

$19,997

$16,391

82%

$36,388

$0

(NASDAQ:SYKE)

$23.45

1,498

$13.35

$19,998

$15,130

76%

$35,128

$0

(NYSE:KND)

$19.97

1,463

$13.67

$19,999

$9,217

46%

$29,216

$878

(NASDAQ:RSTI)

$27.42

1,022

$19.57

$20,001

$8,023

40%

$28,023

$0

(NASDAQ:AMD)

$2.82

7,042

$2.84

$19,999

-$176

-1%

$19,823

$0

(NYSE:IVC)

$15.35

1,181

$16.93

$19,994

-$1,866

-9%

$18,128

$283

CLWR $

$5.00

3,322

$6.02

$19,998

-$3,388

-17%

$16,610

$0

(NYSE:HDY) #

$1.42

8,932

$0.28

$20,007

-$7,323

-37%

$12,684

$0

DVR

$0.12

3,322

$6.02

$19,998

-$19,600

-98%

$399

$0

THQIQ

$0.00

2,666

$7.50

$19,995

-$19,995

-100%

$0

$0

Totals

$ 861,841

$ 4,033,922

468.06%

$ 4,895,763

$124,409

Buyout/Merger $

Split *

R. Split #

The table above represents what would have happened if you had just invested the money on October 29th, 2008, and forgotten about it. The bankruptcy resulting in a total loss, the buyouts reflecting the value at the time the deals closed. The dividends are cumulative and have not been included in the 470% gain, and are not part of some reinvestment plan. The dividends alone represent an additional 14% return on the initial $862K investment over the last six years. The overall portfolio performance would look something like this.

Date

Cash

Assets

Cash As %

Total

10/29/2008

$138,159

$861,841

16%

$1,000,000

11/27/2014

$622,632

$4,535,699

14%

$5,158,330

Change

$484,473

$3,673,858

-2%

$4,158,330

Gain %

351%

426%

416%

The change in cash position does not include any interest earned but does reflect the cumulative dividend payments and the accrued cash values from the buyouts and mergers. The 416% total gain is still substantial and represents an average of almost $700K per year on the original $1 million. It has of course been a bumper six years for everyone. To put this into some sort of perspective we should compare to the broader markets over the same time period.

^NDX Chart

^NDX data by YCharts

Pie in the Sky. At this time I have no positions in any of the stocks mentioned (mores' the pity). This is all just fiction. So what is the point? As I said near the start, "I use it as a barometer for how I think things are going generally." There are lessons to be learned by comparing these outsized gains to the rest of the markets. They are an exaggeration of what is happening and in many cases make it easier to deduce what is happening as a whole. You will note that there are not too many household names in there. No Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), Netflix (NASDAQ:NFLX) or (NYSE:GM). This fact alone gives me some sort of protection from market hype and helps to sharpen the overall picture.

Getting the Message. When I looked through all of the charts one theme shouted and screamed at me. Continually Higher Prices on consistently Lower Volumes. This is not true in every instance but the general pattern is there. If we take a look at the Dow, the same thing is characterized there.

What are the possible causes of this phenomenon? I came up with five plausible reasons.

  • Over Confidence. No one is trading any of their positions because they are happy with what they have and everything is going up anyway. This continued hold could lead to a decline in volumes.
  • Lack of confidence. If everyone had no confidence that the market was worth investing in it could cause a decline in volumes. If confidence returns so do the buyers. I do think that can be true but is not relevant to the current situation. We are almost 200% above the bottom in all markets. If people are not already in I'm not sure they are coming.
  • No more easy money. No more stimulus, no more excess liquidity to boost volumes. If this is the reason volumes have declined it would be very worrying. Remind me when is the Fed going to raise rates?
  • Minimal Growth. It is true that the strength of this recovery has been questioned by many. If this is the reason for the lower volumes, then why are the markets up so much? Do we start talking about the impacts of stimulus again?
  • Income Stagnation. It is possible that as prices have increased that stocks are just less affordable. If a 25-year-old was allocating $250 per month to a 401K in 2008, they could have bought over 90 shares of Whole Food Markets, No. 2 on the watch list. Today that same $250 would only purchase five shares. They may want to increase their retirement savings but have not had any wage appreciation. Could that be part of the reason for the decline in volumes?

In my opinion one of these could be seen as positive for the markets. One is neutral and three are negative, not a particularly bullish signal. This is especially true in a week when some have declared that we are only six years into a 20-year Bull Run. I have no doubt that in 20 years the markets will be higher than they are today. If you are looking at that sort of time frame, the financial crisis could be characterized as a normal market correction. However if you had planned to retire in 2010, you might have had a different view of it.

Another thing I noticed is that most of the charts in the watch list are, or recently have been, in overbought territory. When a stock is on a strong run, the chart can show it as overbought for long periods of time. The same is true for the markets and on its own is not enough to worry about. I would in fact be "normal" to experience a pullback, correction or consolidation at some point. What I find concerning is the number of stocks that are overbought or have already started to correct. Note both the position of the RSI and a possible MACD cross.

What turns a correction into a collapse?

  • Systemic Risk
  • Acts of Terror
  • Political Uncertainty
  • Bubbles

I would argue that more often than not it is a combination of two or more of these things which causes a collapse. I am also not sure that I like the word collapse as a description. Perhaps Big Correction is closer to the truth. If you look at a chart from 1995 to the present most instances could be described as a pullback or correction. It's that 20-year time frame again.

What are the current risks? Which of the aforementioned culprits currently exist?

Acts of terror. One of those things you cannot really plan for or anticipate. I have no idea what color the threat level is at the moment but, with the rise of the Islamic State, the continued existence of Al-Qaeda and other organization, it's always a possibility.

Political Uncertainty. We made it through the mid terms. In my article Quick Picks for 2014, published 12/03/2013 I said:

"ahead of the midterm elections. I see us muddling through 2014 in much the same way we did in 2012. The initial months of the year may be more fraught as talks begin again around the debt ceiling. January and February are the most likely candidates to host the pullback from current highs."

The Dow Started the year at 16,572. The low for the year was Feb 3rd was 15,356. The Sep 19th high 17,351 evaporated through mid October hitting a 15,855 low on the 15th. From there it rallied and one week before the elections closed at 16,974. Just about 400 points above where we started the year.

The continued rally from that Oct 15th low has nothing to do with the election result. The market was already turning its attention to the holiday season and the anticipation of a Santa Claus rally, not to mention lower oil prices. There is always the end of QE to factor in as well as a lot of stronger than expected data.

As always we will get to see what the market really thinks of the new Congress in early January. Once the Christmas sugar high is over and everyone remembers it's just another year.

The Republicans may have taken control of the House and Senate for the first time in 20 years, but that does not mean we have less uncertainty. We are not even sure that they can govern as a cohesive party. The amount of infighting displayed in recent years does not lend confidence to a more stable future. Say they decide to dismantle the Affordable Care Act again. They have the votes this time, but it would almost certainly be vetoed. What would the response be, another shut down? Perhaps they decide to go with fiscal responsibility and austerity. Is the economy strong enough? I though rate increases were off the table for spring. Maybe it is just as simple as repealing or deregulating something - another bubble anyone? The political future is far from certain and I did not even mention immigration reform.

Systemic Risk is always on the table. It does not tend to shine out like your Thanksgiving centerpiece until it is a little too late. Mostly this appears to happen during times of deregulation, when the reforms that were put in place to stop this from happening are repealed. Everyone makes a ton of money for a while. It all gets out of hand and the economy tanks again. It is right about then that everyone starts talking about Systemic Risk.

Bubbles are pretty while they last. There has been a lot written about them over the past few years so I will keep this short. Lack of regulation in any industry or part of the economy can lead to a bubble. I am not convinced that we do not have an unseen QE bubble right now and may be the reason we are so frothy given the anemic growth of the last six years.

So are we at risk of a Big Correction? It could certainly be argued that many of the elements are in place. Will the Santa Claus Rally continue to pump air into a bubble? What will make it pop? I don't know, I just know that if it exists something will make it pop.

In a thinly traded market, movements can be sudden and a little extreme. There is just more volatility. Once volumes pick up, it is normally panic selling that exacerbates the situation and turns the pullback into one of the bigger corrections. At least that's my opinion.

Conclusions

If you put a large amount of money to work near a market bottom you will eventually make lots more. So no surprise there then.

The major markets and many individual stocks have been overbought for some time. This is suggesting we are due a correction at some point in the near future. Over the last six years the markets have become more and more thinly traded, suggesting the markets could become more volatile. This comes at a time when the VIX is near all time lows. It may be possible that we see Dow 18,000 in the near future. I would take that as an exit sign given how frothy the markets appear to be. A 25% pullback from those levels would only drop us to 13,500, but would be devastating to most portfolios. Even a 15% correction would erase all of the gains since the Feb. 3rd low of 15,356. There is nothing wrong with banking some of those gains. Gold, or the GLD, has looked unattractive for some time but is only 2.3% down from my January long recommendation. Continued declines will make the precious metals more attractive. Trading the CBOE Market Volatility Index may be more beneficial.

VIX Chart

VIX data by YCharts

You could consider putting some cash to work in a short-term bond ETF like SJNK which also pays a monthly dividend.

SJNK Chart

SJNK data by YCharts

Whatever eventually happens good or bad, uncertainty is going to increase. I will stay away from the DIA and SPY as I do not take short positions. I hope that you have found this useful and I intend to write a full review of my "quick picks for 2014" and suggestions for 2015 in the near future.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article may contain certain forward-looking statements. I have tried, whenever possible, to identify these forward-looking statements using words such as "anticipates," "believes," "estimates," "expects," "plans," "intends," "potential" and similar expressions. These statements reflect my current beliefs and are based on information currently available. Accordingly, such forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause actual results, performance or achievements to differ materially from those expressed in or implied by such statements. I undertake no obligation to update or provide advice in the event of any change, addition or alteration to the information contained in this article, including such forward-looking statements.

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