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It should come as no surprise that the uber-bulls have found their voice, and forced their way back into the media spotlight.  After all, the major stock market averages continue their assault on the all-time nominal highs registered just as the financial crisis gathered momentum during the autumn of 2007.

Caution is now perceived as a dirty word and stock market bears have gone into hibernation, as bullish opinion is in vogue and virtually certain to capture the public’s imagination – and a sizable share of their hard-earned savings.  However, savers need to be aware that the positive commentary is often misguided – and occasionally downright dangerous.

The latest opinion piece to catch the eye was penned by James Glassman, who co-authored the infamous 1999 investment book, ‘Dow 36,000,’ in which he and the economist, Kevin Hassett, argued that the stock market index could reach the headline number within three to five years.

Unfortunately for the authors, the powerful bull market that began almost two decades earlier in the autumn of 1982, came to an end just months after the book’s publication, and the Dow Jones Industrial Average registered a percentage point decline of close to forty per cent over the 33 months that followed the equity index’s secular peak.

Stock prices resumed their upward trajectory over the next five years, but the financial crisis pushed the index down to 6,547 by the spring of 2009 – a level that was more than eighty per cent below the book’s catchy title.

Glassman remains undeterred however, and believes that the original forecast is within reach.  He writes, “From its low of 6,547 on March 9, 2009, the Dow has risen 117 per cent.  Another 117 per cent in four years would put it at 31,022, just 16 percentage points shy of the magic number.”

It is important to remember that Glassman’s original thesis was premised on the belief that, “investors had mistakenly judged the risk in stocks to be greater than it really was.”  The authors argued that the stock market deserved a higher valuation multiple, since the historical data demonstrated that, “over long periods, stocks were no more volatile, or risky than bonds.”

The basic idea is that time washes away all sins, and as a result, stocks are a safe asset for investors with sufficiently long investment horizons.  Known as time diversification, the contention rests on the use of the standard deviation of annualised returns as the appropriate risk measure, which as a matter of basic statistical fact, decreases as the time horizon increases.

The argument is totally misleading however, because it is the terminal portfolio value that matters to investors, and in this regard, it is the standard deviation of total returns that is the appropriate risk measure.  It may well be true that the standard deviation of annualised returns decreases in proportion to the square root of time, but the standard deviation of total returns does the opposite.  In other words, a 25-year investment is five times as risky as a one-year investment – the dispersion of potential terminal portfolio values grows ever larger as the time horizon increases.

The idea that stock market investments are safe in the long-run rests not only upon the standard deviation argument, but also upon the observation that the probability of loss decreases with time.  However, the problem with this line of reasoning is that losses of different magnitudes are treated the same.  Is a thirty per cent loss on a $1 million retirement fund in year-thirty really equivalent to a thirty per cent loss in year-one?

It is important to note that not only does the potential magnitude of losses increase with time, but so too does the risk of catastrophic losses.  For example, incurring a loss of forty per cent is ten times more likely after three years than it is after one year.  It is clear that the risk in stock investing is very real as the time horizon grows.

For those who remain unconvinced, then consider the words of Professor Zvi Bodie, “If it were true that stocks are less risky in the long-run, then the cost of insuring against earning less than the risk-free rate of interest should decline as the length of the investment horizon increases.  But the opposite is true.”

Stocks may still be safe for long-term investors if returns are mean-reverting.  Fortunately, there is substantial evidence to support this case and valuation multiples typically act as the pendulum.  In this regard, the verdict is against the uber-bulls and believers in Dow 36,000, as valuation indicators with statistically significant, predictive ability call for minimal investment in stocks right now.

It is a sign of the times that the champions of time diversification are back in the media spotlight, but investors should be aware that the advice could prove hazardous to their financial health.  The arguments were bogus when Dow 36,000 was published in 1999, and they remain bogus today.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

It is a low-return world, and even the Chairman of the Federal Reserve, Ben Bernanke, recently admitted that he, “takes very seriously…the possibility that very low interest rates” could prompt “portfolio managers dissatisfied with low returns” to “reach for yield.”  Unfortunately, such concern is already reality, as ultra-accommodative monetary policy has helped push the yields available on both ‘risk’ and ‘safe’ assets to levels that virtually assure lacklustre returns for a traditional 60:40 equity/bond policy mix over long horizons of ten years or more.

The less-than-inspiring outlook for long-term investment returns is a matter of simple arithmetic, yet much of the investment community continues to cling to the belief or hope that pension plan assets will ultimately deliver satisfactory outcomes for long-term savers.  There are few who dispute that ‘safe’ assets are likely to deliver sub-optimal returns over long horizons, but many – conditioned by the outsized investment performance of the 1980s and 1990s – continue to argue that the gains on ‘risk’ assets will make up the difference.  The ill-founded arguments are likely to prove wrong.

The fact of the matter is that the rewards generated from traditional asset allocations has been so good for so long that many have come to see high inflation-adjusted returns as some sort of birthright.  Both global equities and bonds have delivered annualised real returns in excess of six per cent over the past thirty years, but current valuations suggest expectations that extrapolate this trend for a traditional 60:40 mix into the future are nothing more than wishful thinking.

Real bond returns have been nothing short of breathtaking over the past three decades, but with twenty-twenty vision, that’s understandable given both the starting point and subsequent fundamentals.  Ten-year Treasuries offered a yield of more than fifteen per cent in the autumn of 1981, but the disinflationary monetary policy conducted by Paul Volcker during his time at the helm of the world’s leading central bank, saw the yield drop below nine per cent by the time he was replaced by Alan Greenspan six years later.

Monetary policy that prioritised opportunistic disinflation continued under Greenspan, and by the end of the 1990s, the yield available on the benchmark Treasury bond hovered around six per cent.  All told, Treasury bond investors earned annualised real returns of close to eight per cent during the 1980s and 1990s – the best two-decade performance in all of American financial history.

More was to follow of course, as the disinflationary trend gave way to deflation fears following the South-East Asian crisis in the late-1990s and the collapse of the stock market bubble at the turn of the New Millennium, but the biggest fillip to the realised returns on ‘safe’ assets came with the crisis in structured finance that stemmed from misguided lending in the sub-prime mortgage space.

Treasury yields continued their long journey downwards, and the inadequate recovery in the post-crisis economy ensured that yields remained close to all-time lows.  That remains true today, with the ten-year benchmark bond yielding less than two per cent, a level that does not compensate for long-term inflation expectations.  This virtually assures that – absent deflation – investors can expect to realise negative real returns in ‘safe’ US assets over the next ten years.

Traditional investors might turn to corporate credit to boost returns, but the story – adjusted for risk – is much the same.  The current spreads for lesser-quality corporate credit imply a real yield of just two per cent, and incorporating likely default rates and recoveries, suggests that investors can expect to earn even less.

The debt markets provide little optimism for high future returns, so all hope rests on the equity market.  Stock returns exceeded all expectations during the 1980s and 1990s, and though equity markets endured a torrid decade during the first ten years of the New Millennium, the major market averages still sport valuations that are well above long-term norms.

Indeed, the stock market’s current dividend yield in combination with long-term real growth suggests that investors should expect no more than three per cent per annum in real terms – less than half the historic average.  Of course, even this sub-optimal outcome does not take account of the well-known tendency for valuation ratios to mean revert, in which case the most likely annualised real return is closer to one or two per cent.

It is a low-return world, and traditional policy mixes are unlikely to deliver annualised real returns of more than one to two per cent over the next ten years.  The plain facts may well encourage return-chasing, but the astute will keep their powder dry – and remember the words of the late investment visionary, Peter Bernstein, “The market’s not a very accommodating machine; it won’t provide high returns just because you need them.”

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

I think it’s worth taking a look at gold once more. The precious metal has been trending lower since about the middle of the third quarter last year, having stalled out once more in the 1800 area (front month futures).  This comes as little surprise in that the moves in gold have largely followed those in the dollar, which was weakened by the move toward Quantitative Easing expansion by the Federal Reserve last year, and since has fared well as other currencies have come under pressure while talk in the US has begun to revolve around the Fed ending or rolling back its QE efforts.

As the chart below shows, the market has been pretty consistent in its ranging pattern over the last couple of years. It has repeatedly failed on attempts to get back above the 1800 level since falling through there in 2011, and likewise has continuously failed on attempted drops below 1550.

The most recent action has seen yet another attempt at the bottom end of the range produce a quick upside reversal. Two aspects to the chart provide a modicum of support for gold to get stronger from here. One is the fact that the recent low was higher than the previous ones. The other is that the most recent peak was also higher than those which came before. These are very modest developments, however, so I would not weigh them too heavily. The fact that there wasn’t significant variation from prior peaks and troughs just tends to support the ranging case.

That said, I have my eyes on the area around 1650. It was support during the consolidation before the test of 1550. It was also the top end of the consolidation area formed after the last move to test 1550. As such, it is now important resistance. The market has been working back toward it of late, so a test is forthcoming. A failure would be significant, indicating a weak market which very likely would make a serious run at breaking the 1550 for real.

A break through that resistance area, though, would at least make a strong case for the market continuing a move back toward the upper part of the long-running range. This latter scenario actually fits in with what I wrote about concerning the USD a couple weeks ago. We shall see how thing fall out.

Either way, it bespeaks some interesting times in the markets over the next few months. Certainly we are not lacking in economic and political stories that could drive such moves.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Stocks are trending higher and the dollar is doing the same. That’s not something we’ve seen much of over the years. We can see from the chart below comparing the S&P 500 to the USD Index how unusual it is for the two to move in the same direction. No doubt the recent positive correlation has thrown a number of algos for a loop.

Of course the whole risk-on, risk-off pattern of the markets holding forth during long periods since the Financial Crisis played a major part in defining a negative correlation between stocks and the US dollar. Traders and investors would either flee from “risky” assets into the safety of the greenback (and US Treasuries), or do the reverse. Obviously, that’s not what’s happening at the moment.

So what’s happening now?

I’d argue we’re back to more “normal” markets which are less psychological and more fundamental. By that I mean exchange rates are moving on market participants’ perceptions of the differences between economies, rather than just reacting to fear.

That said, it is often the case that the USD falls in periods of economic strength. This is driven by American demand for imports. These days the US seems to be the strongest among the major Western economies, so we would expect to see a similar pattern. The markets, however, are reflecting other dynamics at work. Monetary policy is a big factor.

Better economic figures in the US lead investors to start to look at when the Fed will start taking a less accommodative stance. In and of itself, that tends to be positive for the greenback (less or no asset purchases means reduced increase in dollar supply). At the same time, though, Europe continues to have significant issues, and the same can be said of Japan. No one is talking about tighter monetary there, so those currencies are suffering by comparison.

The question is how long that will continue.

As we can see from the chart below, which includes the German DAX index as the lower plot, European stocks too have broken the 2011 highs and are close to the ones from 2007 (the FTSE is showing comparable performance).

The implication of rising stocks on a global basis is the anticipation of better times ahead. Stock market investors may have it wrong (wouldn’t be the first time), but if they don’t, then we should look for improvement in the European situation in the months ahead. That would very likely then mean the dollar losing its strength as more traditional patterns are seen (dollar weak in good economic times). That will be worth watching, as it we don’t see the USD rolling over before too long it may be a sign the stock rally will have trouble continuing.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The whole area of alternative investments is a major talking point in both academia and the industry these days. Not that this is something new, of course. There has always been some kind of alternative investing going on. For many years it was the commodity market which was the main focus, often through Commodity Trading Advisors (CTAs) – though that is rather a catch-all category for what today would just as likely be considered hedge funds as in many cases similar trading strategies are employed. Today alternative investing has expanded to include a great many different areas of investing, to include the currency market, and commodities have remained a focal point thanks to the growth of ETFs.

The fun part of being a PhD student is that you pick up all kinds of interesting information through your research, attending conferences, and sitting in on seminars. This week I’ve been in a workshop put on by a visiting faculty member, part of which focused on alternative investing, with a specific concentration on commodities. Naturally, he told us all about various research into the subject matter, and included a significant bit of his own.

Here’s the unexpected conclusion he presented to us. Despite the fact that commodities have been hyped for years as providing diversification for investors who otherwise play stocks and bonds, the evidence doesn’t support the case – at least when looking at them in aggregate (as we would with a commodity index or ETF). This is especially understandable in recent times given how commodities have become much more correlated with stocks and bonds of late, at least partly thanks to the increased use of commodities in asset allocation (decisions which drive the choice to invest in financial assets correspond to those to invest in hard assets).

The one exception to this discovery is gold. The research supports the idea that diversification into gold is actually worthwhile. No doubt there are many gold bugs out there saying that was obvious all the time.

By the way, one of the major selling points in investing in commodities is the rates of return of commodity indices like the GSCI. These indices, however, have a built-in upside bias based on the way they are constructed. In other words, they don’t really tell the full story about what commodities are doing, but they are great for selling a good story to drive investment.

So, if the commodity market isn’t so great for alternative investment, is it time to look for an alternative alternative?

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

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Equity prices have vaulted to within touching distance of all-time highs, and the upturn in investors’ fortunes has pushed valuation ratios to levels that have preceded protracted periods of poor stock market performance in the past.  The widespread belief that stock market returns mean revert over long horizons means that it could well be possible to use the information contained in high valuation ratios to time the market, and capture the favorable combination of lower risk and higher returns.

An interesting paper authored by Elroy Dimson, Paul Marsh, and Mike Staunton of the London Business School, and recently published in the ‘Credit Suisse Global Investment Returns Yearbook,’ casts doubt on this view.  The academics assess the predictive ability of a cyclically-adjusted price-dividend ratio – the ratio of the current real index level to the average of the preceding ten years’ real dividends – across a variety of world stock markets, and conclude that, “we learn far less from valuation ratios about how to make profits in the future than about how we might have profited in the past.”

The choice of valuation metric appears reasonable, since dividend payments, unlike earnings, cannot be manipulated, and often reflect a company’s own view of its long-term earnings power.  However, there is no theoretical reason as to why a cyclically-adjusted dividend-price ratio should mean-revert, since the higher multiple might simply reflect substantive changes in the percentage of earnings that companies decide to pay to shareholders.

It is important to appreciate that stock market value is made up of both current dividends and expectations for future growth.  The pace at which dividends grow in the future depends on the percentage of earnings that a company distributes to its owners, and the rate at which retained earnings are reinvested in the business.  In other words, a low dividend yield might simply reflect a lower payout ratio, and higher expectations of future growth.

Historical data for the US demonstrates that the corporate sector’s payout ratio has been in secular decline for decades.  The ten-year average payout ratio dropped from a peak of almost ninety per cent in 1940, when expectations for future growth were virtually non-existent, to below forty per cent in 2007, when expectations for uninterrupted growth for the indefinite future held sway.  Long-term differences in payout policy means that it is impossible to identify a mean around which the cyclically-adjusted dividend-price ratio might oscillate.

Financial theory suggests that we should be able to observe a negative relationship between corporations’ payout ratios and subsequent growth rates in earnings and dividends.  In other words, higher growth rates would be expected to follow lower payout ratios and vice versa, but if this expectation is frustrated, then the dividend-price ratio might retain some predictive ability, as disappointing growth outcomes are reflected in lower share values.

The historical evidence in both the UK and the US reveals that low payout ratios have typically been followed by surprisingly low real growth rates over subsequent ten-year periods, and not the high rates of expansion that might have been expected at the outset.  This surprising outcome suggests that the corporate sector is either over-investing, or that  competitive markets quickly erode excess returns, or that low payout ratios reflect management’s intention to signal lower future growth to shareholders.

In light of the above, the dividend-price ratio does retain some predictive ability regarding future real returns, but it is still not possible to say what level is indicative of fair value.  As a result, it would be wise to replace the cyclically-adjusted dividend-price multiple with a valuation metric that rests on sounder theoretical footing.

In this regard, the Q-ratio, developed by the late Nobel laureate James Tobin in 1969, is a natural choice.  This metric measures the market value of equity relative to its replacement cost, and a fundamental relationship should exist between the market value and replacement cost; corporations should be valued at their cost of creation in the long-run, and as a result, the multiple should hover around unity given rational expectations.

The “law of one price” or “build-or-buy” arbitrage should ensure that the relationship holds over long horizons.  A ratio above unity implies that it is cheaper to invest in new capital rather than buy existing capital, while a figure below unity suggests the opposite.  The historical data confirms that the Q-ratio does indeed demonstrate mean-reverting properties, and importantly, the analysis reveals that the adjustment takes place through a change in real share prices rather than changes in the capital stock.  In other words, Tobin’s Q can be used to predict long-term real returns.

Unfortunately for equity investors, the current value of Tobin’s Q is almost forty per cent above its long-term mean – a level that has rarely been exceeded in the past.  The ratio’s elevated level, in tandem with its mean-reverting properties, does not mean a catastrophic decline is imminent, but it does suggest that disappointing real returns are virtually assured over long horizons.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The big news of the weekend, not just in the markets, was the Moody’s downgrade of the UK credit rating. As some readers will know, I currently live in England. The news coverage here – national, not just business – has been all over it. Naturally, it has become a political discussion at least as much as a financial markets one. We saw much the same when the US went through this a while back.

Of course the markets have anticipated this sort of thing for some time now. As the chart below shows, GBP/USD has been steadily losing ground since the end of 2012.

We can see that another new low was put in at the start of the new week’s trading in reaction to the news. As of this writing, though, that has been reversed in what looks to be a case of “sell the news”.

We can similarly see that UK yields have been anticipating a development like the ratings downgrade for some time now. The 10yr Gilt chart below tells a similar story as that of GBP/USD in terms of a market which has been generally trending one way this year. Interestingly there, though, UK yields have backed off their highs of late even has the currency made new lows, indicating there’s been some kind of shift in the markets of late.

Of course the trend higher in rates and lower in GBP/USD in 2013 is contrary to what many folks expect to see, namely higher rates equating to a stronger currency. The falling pound coming with rising yields in this case points to a declining interest in UK assets and investments rather than some kind of anticipation of tighter monetary policy by the central bank to combat increased inflation. If we think about the relatively poor performance of the UK economy in the last year, this should come as no real surprise.

Just goes to show that one cannot make pat assumptions about cross-market relationships. There is a causality to the way markets correlate which comes from the fundamental underpinning of the markets.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The ‘risk-on’ trade is back in vogue, as less bad economic data alongside investors’ blind faith in central bankers’ ability to implement the necessary policies to prevent unfavourable outcomes, has pushed the major stock market averages upward by as much as ten per cent since early-June.  The bulls are back in charge for now, but the antiquated views of the world that underpin their investment strategies, are unlikely to generate superior performance for return-starved clients.

It goes without saying that the recent turnaround in the stock market’s fortunes has seen the traditional long-only bulls applaud themselves for their seemingly prescient views.  The song remains the same for this particular breed of investor – stocks are the most appropriate vehicle for long-term investors, and investors should stand firm in the face of sporadic weakness.  The ‘buy-and-hold’ mantra persists, even though the major market averages have made no discernible headway in more than thirteen years.

Unfortunately, the continued complacency has seen few if any of the diehard bulls question why the frequent pullbacks during the three-year old cyclical upturn in stock prices, have ranged between ten to twenty per cent – or more than twice the magnitude of the typical correction in the years before the global financial crisis.  The oversight could well prove costly, as the reasons behind the equity market’s outsized moves, suggest the secular downturn that began more than twelve years ago, is not over.

The double-digit percentage point moves in stock prices, both upwards and downwards, reflects the equity market’s increased sensitivity to the economy’s underlying momentum.  In fact, macroeconomic developments explain more than three-quarters of the stock market’s performance in recent years, much to the frustration of bottom-up investors, who champion the sharp, albeit low-quality, improvement in corporate fundamentals.

The increased importance of macro as an explanatory factor behind the stock market’s fluctuations in recent times stands in sharp contrast to the extended upturns in equity values from the summer of 1949 to the winter of 1968, and from the autumn of 1982 to the spring of 2000.  During these periods, cyclical developments were typically overwhelmed by powerful secular forces that allowed for private sector credit expansion, such that bear market declines of more than twenty per cent were few and far between.

The secular bull market that began in the summer of 1949 encountered three recessions during its first eleven years, yet the stock market did not register a cyclical bear market decline on any of these occasions. In fact, equity investors did not endure one single recession-induced decline of more than twenty per cent during this nineteen-year long secular upturn, and suffered the first major setback only when President Kennedy’s took on the steel industry in 1962 over ill-advised price hikes, which triggered a valuation correction that paved the way for further gains.

Similarly, common stock investors did not suffer one single recession-induced bear market during the period that extended from the autumn of 1982 to the spring of 2000; the record-breaking bull market was notable for the fact that the economy spent just eight months or less than four per cent of the time in recession.  The only major setback that investors endured during this almost eighteen-year long stretch was a nasty valuation correction in 1987, which was precipitated by a confluence of negative factors.

It is fair to say that the more than three-year old upturn in stock prices that began during the spring of 2009 looks nothing like these former periods, as the major market averages have already suffered several percentage point declines of more than ten per cent, while the macro-driven fluctuations in stock prices are symptomatic of an ongoing secular bear market.  Thoughtful investors need to appreciate what lies behind the stock market’s increased economic sensitivity.

Several commentators who have detected this particular feature of the current cyclical upturn typically trace its origin to globalisation, but it is far more likely that the macro-driven market is a function of the regime in which the economy currently resides.  Equity investors enjoyed a disinflationary boom from 1982 onwards, as powerful secular tailwinds combined to precipitate a sustained decline in macroeconomic volatility and an improvement in potential future growth, but the so-called ‘Great Moderation’ came to an abrupt end, once the global financial crisis unleashed dangerous deflationary forces.

Common stock investors are now facing a tug-of-war between destructive debt deflation and successful policy-induced reflation with the probability of each moving in sync with the economy’s underlying momentum.  Negative macro surprises increase the chances of the former and reduce the probability of the latter, while positive surprises have the opposite effect.  It is hardly surprising in this context that seemingly small changes in economic momentum have an outsized impact on market performance.

The risk-on/risk-off trade has characterised stock price behaviour ever since the global financial crisis struck four years ago.  The volatility reflects the ongoing tussle between deflation and reflation – ultra-bearish and bullish outcomes respectively.  Top-down investing is king for now.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

One of the subject that’s come up in market discussion of late is the low level of the VIX, the so-called “fear index”. It has reached its lowest levels since back in the early days of the Financial Crisis in 2007. The chart below shows how the VIX has moved up and down since 1992.

The question which comes to my mind is whether we’re seeing a pattern similar to the one following the 1998-2003 period of elevated VIX value where the index retraces back to a lower level for a while as it did in the middle 1990s. The action in the markets in the early 2000s and the likes of Enron knocked a lot of individual investors out of stocks, just as recent developments have done. That makes a case for a similar kind of shift in volatility.

Just for the sake of comparison, I think it’s worth looking at volatility in other ways as well to see how things are playing out. The chart below shows the S&P 500 over the same time frame as the VIX chart. The two subplots show the relative width of the monthly Bollinger Bands (BWI) and a normalized 14-month reading of Average True Range (N-ATR). These give us a reading on how much movement there is in monthly closing prices and how wide the monthly ranges are respectively.

It is interesting to note that the Bollingers are back to being nearly as narrow as they were in the middle 2000s after working back from getting very wide back in 2009. As with the VIX, there is still some room to work lower to match prior lows, but we’re back into roughly the same range.

The N-ADR reading is a different story, though. In this case we’re nowhere near back to the lows of the middle 2000s and middle 1990s. In fact, N-ADR has been rising the last year! This tells us that while price changes from month to month may be getting smaller, the inter-month volatility remains elevated. Could this be a tip-off?

As a technical analyst I have a major concern with the way the S&P 500 made a lower low on the monthly chart back in 2009. That’s a big negative. Add to that the fact that momentum in the rally since then has backed off, as indicated by the lessening beats of prior highs for recent new highs, and you get reason for concern. If the market cannot overcome the 2007 highs on this rally, we could be in for quite a bit of a tumble. And when stocks tumble, volatility tends to rise quite dramatically. Generally speaking, before the top is put in the N-ATR reading is already on the rise. We’re seeing that now, so it’s definitely worth keeping that in mind, though given that we’re looking at monthly charts here, it may be a while yet before any sort of roll-over takes place.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

In terms of making an investment that’s not in sync with the stock market while still battling market volatility, managed futures are looking like one of the diversified investor’s weapons of choice. Their biggest strengths come from an ability to thrive in all sorts of market conditions, divergence from the performance of more traditional investments, and the management of Commodity Trade Advisor’s whose strategies hedge risk.

As equities continuously suffer the wrath of unfortunate global economic health, we find ourselves in the optimum environment for alternative investing. Alan Reid, CEO of investment advisory firm Forward, says it best (and simplest) with, “managed futures strategies have a record of zigging when equity markets zag”. And he has the data to back it up.

A recent report produced by Forward plainly demonstrates managed futures immense lack of correlation by looking at the performance of the Barclay’s CTA, an index measuring the performance of Commodity Trading Advisors (managed futures specialists). During the first few years of the new millennium while the dot-com bust wrought devastation upon the stock markets, the Barclay CTA continued to deliver positive returns.

According to Forward’s report, over a 32-year period ending December 31, 2011, the CTA Index gained 5.21 percent annually, while the S&P 500 saw average gains of only 0.31 percent. During the last two major financial crises, the gains of the CTA Index remained in the double-digits, while those of the S&P hit negatives. How’s that for all weather investment?

Now more than ever, with global economic growth in question and strong market volatility threatening confidence in stocks, investors should be focusing on playing defense. And what better way to do that than with an alternative investment that’s past performance has demonstrated it clearly zigging when the equities markets zag?

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