August was an excellent month for the broader market averages! After a late July and early August swoon of a mere -4.35%, the equity markets rallied to brand new highs over the balance of the month of August as you can see below. Only the European markets failed to earn 3% plus markets.
Of course I sarcastically used the word "swoon" above. Really a 4.35% correction is tiny in market terms! We still have not seen a significant correction in this "managed market" since the summer of 2011. A view of the weekly stock chart of the S&P 500 shows just how "managed" this market has been.
Can you see the difference between the two periods highlighted in orange and green?
Look at 2009-2013 in orange, this market was also managed during this period, but it was managed only at points where the powers that be thought it might crumble and fall much precipitously. This was not good for trend followers because we committed to the inverse or short positions just to have the Central Bankers stimulate significant reversals on those positions on very short notice, but at least there was some market volatility at this time.
In the new managed market (in green; 2013 to date) there is no volatility. This market just keeps creeping up. Which makes me very nervous!
So the natural questions becomes, why don't you just add leverage and enjoy the ride as others have done? Or change our trend following models to be less sensitive to what market volatility there in the market at the moment?
The simple answer comes down to the story of the frog and the boiling water.
They say that if you put a frog into a pot of boiling water,
it will leap out right away to escape the danger.
But, if you put a frog in a kettle that is filled with water that is cool and pleasant,
and then you gradually heat the kettle until it starts boiling,
the frog will not become aware of the threat until it is too late.
The frog's survival instincts are geared towards detecting sudden changes.
This is a story that is used to illustrate how people might get themselves into terrible trouble.
This parable is often used to illustrate how humans have to be careful to watch slowly changing trends in the environment, not just the sudden changes. Its a warning to keep us paying attention not just to obvious threats but to more slowly developing ones.
It's natural to start ignoring trend following signals since they have not been working well, but just like the the frog and the boiling water, if we don't stay vigilant we may just find our selves in very hot water. In all my years of investing, now over 20 years, I have never seen a more dangerous market and one in which so many participants are total complacent.
Also making profitable returns is only half the equation, the other half is making sure you keep those returns! That my friends is what I view as the biggest challenge ahead and is why I am a trend follower!Stock-Signal.com Performance
So here is the rub for August. Stock-Signal.com did very well in indexes with bullish buy signals. This would make sense since "buy and hold" still continues to rule actively managed strategies.
Stock-Signal.com did poorly in indexes with signal changes in general and roughly broke even in bearish continuation signals from the prior month.
The sample portfolios (see below) generated positive returns, but we dragged down by a late signal change in the high yield (8/15) and by sideways action in an inverse position in the EAFE Index.
I also want to point out that in July, the NewEdge CTA Trend Follower Index appeared to top Stock-Signal.com, but this average was dramatically adjusted after posting to a loss of -1.06%. So despite this month's dramatic outperformance by the former index, cumulative year-to-date returns are not as strong as originally thought and most of its y-t-d outperformance came last month from the commodities and currencies positions most CTA overweight vs. the above sample portfolios.
Of the above indexes, the EAFE index in particular has yet to give us a buy signal. Despite an oversold bounce in this index, our signals so far are saying there is more trouble to come here.
Note how the EAFE Index has yet to move to new highs or break resistance at 1944. It's 20 period moving average is also below its 50 period moving average of daily price.
After seeing the recent PMI figure for the Eurozone of just 50.7, this market appears to be in trouble! This is the lowest PMI in more than a year and was well below the 51.8 of July and the flash estimate of 50.8 by economists.
Unfortunately, in life timing is everything and this market rallied enough to erase many of our earlier gains and hurt our sample portfolio performances.
High yield gave us a buy signal in the middle of the month, but it certainly does not look very healthy. Take a look at the chart of the high yield index.
Note how price moved to the former highs but now appears to be rolling back over. The moving averages are also lower relative to the prior time price was at the highs. This divergence with price is considered at least a short-term negative.
I must also add that many times the high yield index seems to lead equity indexes in a move either up or down. Could this be the direction U.S. equity markets want to head as well? Only time will tell but obviously care must be exercised here not to fall victim to slowly rising water temperatures like the frog in hot water who never realizes that his goose is cooked literally!Our Market Forecast
This exercise used to be a whole lot easier before the aforementioned Central Bank managing of markets. Today it is kind of like living in Florida where every day is warm and sunny and there is really no need to listen to the weather unless there is a hurricane in the Atlantic or Gulf of Mexico.
However, given that disclaimer, I will go out on a limb and say that absent Quantitative Easing in Europe, the European markets are rolling over and is entering a recessionary period. Some Eurozone countries are already in recession.
This is easy to see when you look at interest rates in those countries (below). Falling rates generally mean slowing or slow growth. Note even the economic engine of Europe, Germany, appears to be slowing.
Even if QE is introduced in Euro, I just don't see how much it will really do to ease recessionary pressures since it has already been proven here and in Japan that it only kicks the can down the road and that it does not stimulate real growth.
Look for European equities and the EAFE Index to be in bear market mode before the end of this calendar year, if not sooner. That is my bold forecast for European equities.
I believe U.S. equities will muddle along into 2015 when we likewise will be hit with further recessionary pressures. In the mean time, there is probably further upside into year end in U.S. equities.