Annual Performance Review for 2011

Jan. 08, 2012 10:46 PM ETSPY, DIA, QQQ1 Comment
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Long/Short Equity, Contrarian, Medium-Term Horizon, Long-Term Horizon

Contributor Since 2010

Every January, we conduct a comprehensive review of our forecasting, investing and trading performance during the previous year. Accountability is very important to us and this performance review is another way for us to demonstrate our commitment to providing you with a highly reliable service. The audit process itself is admittedly tedious and time-consuming, but we believe it ultimately provides great benefit to both you and us.

Forecasting Audit

In every short-term, intermediate-term and long-term forecast, we provide outlooks based on technical and cycle analysis of the markets that we monitor. Our forecasting methodology identifies two scenarios, one bullish and one bearish, along with the approximate probability of the more likely scenario, providing there is one. These outlooks fall into one of four broad categories.

  • If both scenarios are equally likely, they each have about a 50% chance of occurring.
  • If one scenario is slightly more likely, it has about a 60% chance of occurring.
  • If one scenario is more likely, it has about a 70% chance of occurring.
  • Finally, a highly likely scenario is at least 80% likely to occur.

The likelihoods associated with these outlooks are intentionally imprecise. We do not believe it is possible to calculate probabilities with a high degree of precision when it comes to financial market forecasting, so each category covers a relatively large range and offers only a rough estimate. However, rough estimates are all you need as an investor or trader to be successful over the long run. A disciplined strategy of aligning yourself with likely scenarios and then protecting your assets when outcomes are in doubt will invariably produce gains over time. With the odds consistently on your side, you will be successful.

The key, of course, is to have reliable probabilities on which to base your decisions. We may claim that a given scenario is ~70% likely, but what assurance do you have that this assessment is reasonably accurate? The only way to know for sure if our forecasting process is reliable is to review the results of past predictions. We performed this auditing process for every forecast during 2011 and the results are summarized in the following tables.

Click here to download the daily forecast audit data spreadsheet


Click here to download the weekly forecast audit data spreadsheet

Each column displays the actual performance of a given forecast category during 2011. The top row, labeled “All Markets,” compiles the results for every forecast in every market that we monitor, and then subsequent rows display the results for individual markets. As usual, there was a great deal of variance from market to market, especially in the equally likely category, reflecting underlying long-term trends. If you would like to check the results of the audit yourself, click on the link below the table to download the spreadsheet containing the data.

Our forecasting methodology performed extremely well during 2011. Our computer models produced 2,069 forecasts during the year and the actual probabilities of each category are displayed below.

The equally likely and ~80% likely categories were very close to their theoretical values at 46.6% and 84.0%, respectively. The ~60% likely category was slightly elevated at 66.9% and the ~70% likely category was well above its theoretical value at 80.2%. Our computer models are intentionally conservative with their projections, especially when it comes to scenarios that are at least 70% likely, but these results suggest that we remain a little too conservative for the ~60% and ~70% categories. We will use these audit data to fine-tune our forecasting process moving forward, but an important takeaway from these results is that our computer models continue to perform exceptionally well when it comes to identifying likely scenarios. In other words, when we forecast that a given scenario is ~70% or ~80% probable, you can be confident that it is at least that likely. The actual probabilities for all categories since we began auditing our forecasts are displayed in the following table.

Inflection Point Identification Audit

Our cycle analysis (CA) methodology identifies temporal inflection points across all time frames for the markets that we monitor. Once a confirmed cycle low is in place, we use CA to determine the window during which the next low is likely to occur. We have tested our methodology using several decades of historical data and the results of this validation process indicate that approximately 70% of all cycle lows should occur within the predicted window. Of the lows that develop outside of the window, about 20% should occur before it begins and 10% should occur after it ends. The following table summarizes the performance of our CA during 2011.

There were 66 cycle lows across all markets and 51 (77.3%) of them occurred in the predicted window, aligning relatively closely with theoretical expectations. Of the remaining lows that formed outside of the window, 12 (18.2%) occurred before the window and 3 (4.5%) occurred after it, also aligning relatively well with expectations given the small annual sample size. While it is important for actual forecasting results to align closely with theoretical expectations, the ultimate goal of CA is to reliably identify temporal inflection points as they are developing. In this regard, we had another very successful year, as 53 (80.3%) of the 66 lows were correctly identified in real-time as they formed. Even when a given low does not develop within the predicted window, having an accurate time frame for its arrival still enables it to be reliably identified, regardless of whether it is “early” or “late.”

Our CA methodology also predicted the formation of most intracycle inflection points as they developed and the following series of charts display the identified turning points.

S&P 500 Index Short-term Inflection Points

10-year Treasury Note Yield Short-term Inflection Points

US Dollar Index Short-term Inflection Points

Gold Market Short-term Inflection Points

Oil Market Short-term Inflection Points

S&P 500 Index Intermediate-term Inflection Points

10-year Treasury Note Yield Intermediate-term Inflection Points

US Dollar Index Intermediate-term Inflection Points

Gold Market Intermediate-term Inflection Points

Oil Market Intermediate-term Inflection Points

Overall, our inflection point identification process performed exceptionally well in 2011 and we do not foresee making any meaningful changes to the methodology.

Model Investment Portfolio

The PMI Index, which tracks the value of our model investment portfolio, produced a gain of 2.4% during 2011.

The portfolio remained fully defensive throughout 2011 as our analysis indicated that the stock market would likely struggle during the year. Our Secular Trend Score (STS) moved higher during the year and finished at -19, its highest annual close since the 1990s. The sharp rise off of the low in late 2009 near -90 suggests that the secular bear market from 2000 is maturing. However, a secular buy signal will not be issued until the score moves above the 80 level, so it is highly likely that the secular downtrend is still several years away from its terminal phase.

The stock market behaved exactly as predicted by our long-term computer model in 2011. At the beginning of the year, our analysis suggested that the second quantitative easing program initiated by the US Federal Reserve in late 2009 was fully priced into equities. We forecast that stocks would likely struggle for the remainder of the year and predicted that the extreme move off of the 2009 low would almost certainly be followed by a violent correction. The anticipated correction developed in late July and stocks struggled during the second half of 2011, forming a highly likely cyclical top in May. The S&P 500 index finished the year unchanged.

Given that the broad stock market, as represented by the S&P 500 index, is the benchmark by which we measure the relative performance of our model portfolio, the PMI Index outperformed by 2.4%. Asset preservation remains our priority in the current secular environment and our model portfolio continues to outperform stocks by a wide margin since its inception at the beginning of the secular bear market in 2000.

Inception Date: January 3, 2000
Compound Annual Return Since Inception: 10.9%
S&P 500 Compound Annual Return Since 1/3/00: 0.3%

Cyclical Trend Trading System

The long trade from May 2009 was closed on March 4 at 1,329.44 on the S&P 500 when the price oscillator overbought threshold was exceeded, resulting in a cumulative gain of 37%.

Our cyclical trend trading system generated a sell signal on September 9 after our Cyclical Trend Score (CTS) moved into sell territory following the violent decline in August. The resulting short trade has been closed temporarily twice when the initial breakdowns did not proceed as expected. The position was reopened on December 28 at 1,261.55 on the S&P 500 index when the uptrend from early October broke down. The current stop level for the trade is at 1,327.95.

Market behavior has exhibited extreme volatility following the long-term breakdown in August, but it remains highly likely that a cyclical bear market began in May. If the new cyclical downtrend is confirmed by a subsequent close below the October low, our CTS will have correctly identified all five cyclical inflection points since the current secular bear market began in 2000.

If the cyclical bear market develops as expected, the current short position will likely be closed sometime during the next 6 to 18 months as the next cyclical bottom as approached in 2012 or early 2013.


Our forecasting based upon technical and cycle analysis provided extremely reliable outlooks throughout the year, with our likely (~70%) and highly likely (~80%) categories resulting in actual probabilities of 80.2% and 84.0%, respectively. Our inflection point identification process had a very successful year as well, correctly identifying the window during which the next cycle low would occur 77.3% of the time and identifying developing lows in real-time 80.3% of the time. The PMI Index outperformed the S&P 500 index by only 2.4%, but the year was characterized by extremely volatile moves higher and lower in stocks, and we believe that our defensive portfolio positioning was well justified. Finally, our cyclical trend trading system generated a sell signal in September, signaling the highly likely start of a cyclical bear market in May.

Overall, it was another violent, volatile year in the markets that we monitor, which is precisely what we anticipated at this stage of the secular bear market in stocks that began in 2000. The secular bear is still several years away from its terminal phase, so we expect the current environment of volatility and violent swings higher and lower to persist during the coming year. We look forward to profitably navigating these interesting times with you.

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