A Holistic Approach to Profiting in the Stock Market => Primary Bull and Bear Markets Understanding the Environment: A Historical Reference Point • The aftermath of the Great Depression

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A Holistic Approach to Stock Market Analysis History, Philosophy, Fundamental analysis, Technical analysis

Tim Nguyen CMT, CFA, CPWA

Framework

Understanding the

Environment

Understanding Market

Behavior

Strategy and Discipline

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Perspective => Primary Bull and Bear Markets

Understanding the Environment: A Historical Reference Point

• The aftermath of the Great Depression is similar in social, political, and business conditions.

• November 1, 1936 in regard to GOP candidate Governor Al Landon, Billings Gazette reports: – “how can we be in recovery with 11MM still

unemployed” – “FDR biggest spender in peacetime history” – “FDR biggest borrower in peacetime history” – “Country running to economic bankruptcy and chaos” – “Borrowing now is taking away from our children”

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• 1936 FDR (a democrat) was in his 2nd term and democrats enjoyed a majority in Congress. Moreover, democrats increased their majority from FDR’s 1st term.

• In 1936 FDR wanted to raise the minimum wage; same thing is being proposed today.

• In 1936 Labor and capital were at extreme odds: – GM/Ford vs. Unions – Ship owners vs. Maritime union workers – “Monterey County to consider union strike”

• Today: – Hockey strike 2012/2013 – NBA strike 2011 – NFL lockout March – July 2011

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• Currency manipulation and a race to devalue – November 1, 1936 from the Oakland Tribune “Italy

joins the race to devalue by devaluing the lira.” • Word of caution: must be careful not to assume that

events today will transpire exactly like they had in the past given similar socio-political conditions. Knowing how things will be different is just as important. – Example: took the market over 25 years to reach the

nominal high of 1929. Today, has taken only 4 years.

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Understanding the Environment: The Fab 5

• The 5 main groups that dictate whether the market goes up or down: – Consumers – Businesses – Government/Policy – Financial intermediaries – Investors: Smart Money

• The economic definition of disequilibrium is very important: – Disequilibrium => when changes in demand, opportunities,

or relative prices causes economic actors to change their behavior to increase gains or reduce losses.

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Understanding the Environment: Consumers

Savings rate has spiked Up! Although, did have a Sharp drop in January

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Popularized by John Maynard Keynes, the Paradox of Thrift states that if savings increases During times of economic weakness, then aggregate demand will fall and total savings in The population will fall as well.


Financial obligations ratio is very close to 30-yr low.

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Household debt as % of Annual disposable income getting lower, but still high Relative to historical standards

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Eventually, household debt Deleveraging can lead to another recession

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Non-revolving debt going up as consumers take advantage of historically low Interest rates. Revolving debt on a down trajectory as consumers pay down credit cards.


• An article in the January 3, 1937 article of the Oakland Tribune: – “it is quite possible that less private credit will be

extended next year especially to consumers. In view of the large volume in installment sales which have been made by the automobile, electrical equipment and other industries during the recent years of recovery it may be safely assumed the consumer credit has been considerably depleted and that a period of retrenchment is due.”

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• Income statements are strong • Balance sheets still debt laden • Increase in savings is first sign of consumer spending slow-down. • Real estate will fuel the rest of this rally. • General feeling:

– “I am going to spend cautiously” – “I am going to take advantage of low rates”

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Understanding the Environment: Businesses

Companies hoarding cash!

Since the bottom in 2009 companies favoring dividend increases and stock buybacks

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Capex rubbing up against October ‘07 levels; Still not as much as one would think given High level of liquidity.


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Revenue share of EPS growth Getting weaker


Latest capacity utilization is 78.5, still 1.2 below its long run average

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• Summary – Companies admitting that there just isn’t enough

attractive investment opportunities. – Until capacity utilization rises significantly business

investment may be subdued. – General feeling:

• “I can’t overcome the hurdle rate for any new investments, thus I will return cash back to shareholders.”

• “Yay! Low financing rates.”

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Understanding the Environment: Policy & Government

Consumer deleveraging offset by Government Leveraging. - Debt-to-GDP > 100%

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Understanding the Environment: Policy & Government

• Balanced approach: – Sequestration over 10 years; $85B in 2013

• Recent 2% payroll tax expiration • World monetary policy is very accommodative

– Japan: Abenomics – Europe: Much of Europe favoring pro-growth spending measures vs.

continued austerity – US

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Understanding the Environment: Policy and Government

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A major underpinning of Keynesian Economic Philosophy is the Phillips Curve. Bernanke will continue to print until u/e drops Below 6.5% or until inflation rises above 2.5%

Understanding the Environment: Policy and Government

• Summary – Monetary policy: error on the side of inflation not the

domestic economy. – Fiscal deficit issues will be partially offset by

accommodative monetary policy. – Seems like countries are in a race to devalue. – Either inflation will result or finally there may be

admission that monetary policy just isn’t working. – General feeling:

• “print, print, print, until we absolutely can no longer do so.” • “balanced approach to the deficit”

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Understanding the Environment: Banking & Financial

Intermediaries Banks are buying securities. This is why many regulators want the Volcker Rule so bank’s don’t trade their capital. Only recently has this liquidity started going Into real estate again.

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Understanding the Environment: Banks and Financial

Intermediaries • In the January survey, “generally modest fractions of

domestic banks reported having eased their standards across major loan categories over the past three months on net. Domestic respondents indicated that demand for business loans, prime residential mortgages, and auto loans had strengthened, on balance, while demand for other types of loans was about unchanged. U.S. branches and agencies of foreign banks, which mainly lend to businesses, reported little change in their lending standards, while demand for their loans was reportedly stronger on net”.

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Intermediaries

Average FICO score high! How many Qualified buyers are there?

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Intermediaries • Summary:

– Lending standards not improving – Velocity of money is low – Fannie and Freddie backed loans increasing – Liquidity flowing into bonds and stocks – General feeling: “I will lend only to the right buyer, in

the meantime, I will invest my money”

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Investors – Smart Money

1. From October 2008 to February 2009 the market was making a new low, however the smart money was not confirming. The start of a primary bull market was underway.

2. From October 2009 to December 2009 the market was making a new high, but the smart money was not confirming. A drop of 7% that lasted 1 month ensued. 3. As of January 2013, the smart money has not been confirming the DJIA with new highs. 27

Investors – “Gurus”Smart Money

Aggregate guru’s seem to be moving to cyclical industries

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Investors - Insiders Insiders have a tendency to be big buyers at significant market lows. Insider buy/sell ratio has room to get closer to zero, meaning more sellers.

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Investors

• Summary – Smart money still looking for outperformance on the

upside. However, divergence between market and Smart Money Index, suggests that the smart money may soon be changing their risk appetite.

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Understanding the Environment: Summary

• Disequilibrium – when a change in demand, opportunities, or relative prices causes economic actors to change their behavior to increase gains or reduce losses.

• Always think in terms of rate of change! • Consumers – strong income statements, but still relatively weak

balance sheets. Realistic expectations. • Businesses – heavy regulation, policy uncertainty, relatively weak

demand, and low capacity utilization will favor dividends and stock buy backs.

• Policy and Government – monetary tail winds, but fiscal head winds. • Banks and financial intermediaries – banks not much change in

lending standards. Intermediaries doing more lending. Buying financial assets.

• Smart money – still being opportunistic, but opportunities are running out.

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Market Behavior – Averages and Medians

• Average primary bull market lasts 58 months • Median primary bull market lasts 34 months • Average primary bull market return is 208%; take out

1982 – 1999 and average drops to 124% • Median primary bull market return is 77%; take out 1982

– 1999 and average drops to 69%

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Market Behavior – Market Lead Times Before Recessions

• Pre WWII 1900 - 1945: – Primary bear market begins May 1901; recession

beginning Sept. 1902 => 16 months. • Panic of 1901 caused by fight over Northern Pacific Railway

between major financiers of that time, included was JP Morgan.

• Exacerbated by assassination of William McKinley in Sept. 1901.

– Primary bear market begins January 1906; recession beginning May 2007 => 16 months

• San Francisco earthquake 1906 – Primary bear market begins Dec. 1909; recession

declared Jan. 2010 => 1 month 33

Market Behavior – Market Lead Times Before Recessions

• Primary bear market begins Sept. 1912; recession declared January 1913 => 4 months

• Primary bear market begins Oct. 1919; recession

declared Jan. 1920 => 3 months • Primary bear market begins March 1937; recession

declared May 1937 => 2 months • Primary bear market begins Oct. 2007; recession

declared Dec. 2007 => 2 months

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Market Behavior – Retail Investors

Retail investors still not bullish enough!

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Market Behavior – Divergence Weekly 3-yr chart

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Market Behavior – Divergence on a 15-yr Monthly Chart

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Market Behavior – Resistance 15-yr Monthly Chart

If resistance is decisively broken to the upside, it will Be strong support; expect a lot of volatility around this area.

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Market Behavior: Market Breadth- AD 6 Month Weekly

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Market Behavior – Breadth October 1936 – March 1937

-600

-400

-200

0

200

400

600

800

Oct

. 3, 1

936

Oct

. 10,

193

6O

ct. 1

7, 1

936

Oct

. 24,

193

6O

ct. 3

1, 1

936

Nov

. 7, 1

936

Nov

. 21,

193

6N

ov. 2

8, 1

936

Dec.

5,1

936

Dec.

12,

193

6De

c. 1

9, 1

936

Jan.

2, 1

937

Jan.

9, 1

937

Jan.

16,

193

7Ja

n. 2

3, 1

937

Jan.

30,

193

7Fe

b. 1

3, 1

937

Feb.

20,

193

7Fe

b. 2

7, 1

937

Mar

. 6, 1

937

Mar

. 13,

193

7M

ar. 2

0, 1

937

Mar

. 27,

193

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Cumulative Advancers minus Decliners

Cumulative Advancers minus Decliners

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Market Behavior - % stocks above 200 day MA

Contrarian Indicator: • Between 2003 - 2007 no significant drop in market • Bigger drops post 2007 • Readings above 80% good contrarian indicator that a potential drop is

near, but does not tell us magnitude 41

Market Behavior: Valuation

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Modestly overvalued at 106% market cap to GDP

“total market cap relative to US GDP is probably the best single measure of where valuations Stand at any given moment.” Warren Buffet 90 – 115% = modestly overvalued > 115% = significantly overvalued

Market Behavior: Breadth

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Summary • Environment

• Okay, not great. • Money flowing into risk assets because rates so low.

• Market behavior • Market breadth strong • No clear negative divergences

• Conclusion • No sign of a primary bear market within next 6 months. • Doesn’t preclude minor 5-8% correction, which would be

normal. • Any correction used as buying opportunity.

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Conquering the Bull and the Bear: A Holistic Approach to Profiting in the

Stock Market • Increase your market IQ by

having a holistic view of the stock market.

• www.marketi-q.com • National book debut May 7,

2013.

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http://www.marketi-q.com/

Documents

A Holistic Approach to Profiting in the Stock Market => Primary Bull and Bear Markets Understanding the Environment: A Historical Reference Point • The aftermath of the Great Depression