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Liquidity System Buys Small Caps 5/13/14

XLF surpassed 22.19 today, which was the signal to sell TLT and buy IWM (IWM and PTY in system 2).

First there is a correction to my comment on 4/9/14. I indicated that the systems bought TLT at $119.11, which was an error. In fact, they bought at $109.11. So system 1 purchased 879 shares of TLT and system 2 bought 869 shares at that time.

The 3.55 pm price for TLT today was $111.67, and it paid a dividend of $.27 while it was owned. Therefore in system 1 the sale and dividend of 870 shares came to $97,386. In system 869 shares returned $97,275. (Starting point was $100,000 on Feb. 3, 2014)

The 3.59 p.m. price for IWM was $111.44. So system 1 purchased 873 shares.

System 2 put 50% into IWM, which purchased 436 shares. And it bought 2592 shares of PTY at $18.74 (the other 50%).

Since 4/7 when the last switch was made both systems gained 2.58%, while the Russell 2000 fell -1.29%. So that was a good trade.

Since 2/3/14, system 1 is down -2.61%, and system 2 is down -2.73%. The Russell 2000 is up 2.43% since then.

This switch in assets makes me nervous, but at least the system had a gain while the Russell 2000 fell. Also the stop-loss is quite tight at this time.

Sell IWM and PTY (and buy TLT) if XLF falls below 20.71 or the Russell 2000 falls below 1091.49.

The Russell number will stay fixed for some time. It is the 55-day low, set a few days ago. The XLF level will fluctuate daily. It is set at twice the average true range below $22.19, which was a 20-day high for XLF.

I personally think that T-bonds will continue to out-perform small caps. There are a lot of headwinds for the market. I think it is over-valued. Profits cannot grow much because revenues are not likely to grow much, and profit margins are at records. So a market advance would require further PE expansion. This can happen. The late 1990's are when I made a lot of money from PE multiple expansion, but PE's are pretty high already, and future estimates of earnings can be taken with a grain of salt.

High yield bond funds yield 5%, as they did in May, 2013. This is nutty. Those economic powerhouses - Italy and Spain yield less than 3.00% on their 10-year bonds. They don't have their own central banks to buy their bonds, or currencies to inflate. This is nuts. France's 10-year bond yield is well below that of the US, and their economic situation is worse than ours. Is Germany going to save them as France keeps running fiscal deficits? It's nutty.

The divergence between small cap stocks and big caps in the US is considerable. This has happened before without a market collapse, but such divergence is also common prior to bear markets, like mid-2000, and October 2007.

Finally, the taper is continuing. It was not good for stocks after QE1 and QE2 ended, and stocks were at much cheaper levels then.

But, I'm a terrible prognosticator with the best of them; so I have this liquidity system to make decisions for me.

Disclosure: I am long IWM, TWM, NLY, REM.

Additional disclosure: I have hedged the IWM position