In my last piece I note that the U.S. stock market presently stands alone in terms of recent performance.  While virtually every major U.S. stock market average has run to new highs in the last several weeks, not one other individual country has really even come close.  While this might induce spontaneous chants of “USA, USA”, the truth is that this may not necessarily be a good thing.

(Please see also The One Asset Class Per Month Strategy)

This current disconnect will likely be resolved in one of two ways:

A) The USA will drag the rest of the world screaming and kicking to enjoy in our newfound prosperity (assuming of course that we finally stumble upon that actual newfound prosperity that the stock market is telling us we should be celebrating).

B) The USA fails to pull up the rest of the world and the US stock market gets “dragged down” with the rest of the world’s bourses.

This is the part in the article where a skilled market analyst would offer up a clear and concise opinion of what will happen next and why.  And if one happens to stop by the office in the next few minutes or so I will ask him or her what they think.  All I know is that at the moment the US stock market is in an uptrend and that the majority of the rest of the world’s stock markets are fair to middling at best (with many looking much worse).

Until something changes I will stick to the US market, thank you very much.

A Little “Worldly” Perspective

What follows is essentially the world (stock markets) in pictures.  The purpose is simply to provide you with some perspective regarding the state of the markets around the globe.

The key thing to note is:

*Figure 1 shows U.S. stocks making new highs

*Figures 2 through 6 show the rest of the world’s stock markets lagging far behind

Click Figures 1 through 6 to enlarge

Figure 1 – U.S. Stocks soaring to new highs (Courtesy AIQ TradingExpert)

Figure 2 – My Own Index of Single Country ETFs; -17% below 2014 high (Courtesy AIQ TradingExpert)

In Figures 3 through 6 note that the overall “stock market malaise” is not limited to one portion of our earth,  but rather stretches pretty far East, West, North, South and pretty much all  points in between.

Figure 3 – Middle East Stocks; -40% below 2007 high (Courtesy AIQ TradingExpert)

Figure 4 – European Stocks; -36% below 2007 high (Courtesy AIQ TradingExpert)

Figure 5 – Asia-Pacific Stocks;-17% below 2014 high (Courtesy AIQ TradingExpert)

Figure 6 – North/South America Stocks;  -22% below 2011 high (Courtesy AIQ TradingExpert)

Wishing you (please choose any or all of the following that are applicable):

*Merry Christmas

*Happy New Year

*Happy Holidays

*Joy

*Peace on Earth

*[Some other phrase that you do not find offensive here]

Jay Kaeppel

In this seemingly ever more divided and ever more electronic age, “perspective” is not a word (or action) that gets mentioned (or employed) with as much frequency as it used to.  The default approach for a lot of things appears to be:

a) Decide ones opinion

b) Take to the internet to shout categorically that said opinion is the only possible “correct” opinion

c) Excoriate anyone who disagrees

Well, sure that is one approach.  But when it comes to investing it is fairly important to raise one’s head and take a look around every once in awhile.

Hey, how about now?

(See also One Answer to the Large-Cap/Small-Cap Argument)

The U.S. Stock Market Post Election

Since the election in November the U.S. stock market has been on a quite a tear, with the major market averages breaking out to new all-time highs as seen in Figure 1.Figure 1 – Major market U.S. averages breakout to new highs (Courtesy AIQ TradingExpert)

Now per a, b and c above, some will argue that this is a testament to the booming economy that #44 is leaving #45 while others will argue that it is a sign of new hope for the U.S. economy under a new adminstration.

My response: Whatever

Don’t get me wrong, I am all for a bull market.  I hung in there all year despite a lot of doubts mostly because my trend-following indicators just kept staying bullish.  And they remain thus.  But like I said before a little perspective can sometimes go a long way.

A New (Republican) Administration

The historical fact is that the last 3 Republican administrations that followed Democratic administrations (Nixon, Reagan, Bush 43) did not experience great “stock market joy” during their first two years in office.  Specifically, the first 21 months of the new four-year election cycle (i.e., starting on Dec. 31^st of the election year through the end of September of the mid-term year) for each of these prior administrations witnessed a fair amount of “pain.”

Peruse Figures 2, 3 and 4 (which displays the % gain or loss for the Dow Jones Industrials Average for 21 months starting on December 31st of the election year) and see if you notice a trend.Figure 2 – Dow % +(-); Dec-1968 thru Sep-1970 (Nixon – 1st 21 months)

Figure 3 – Dow % +(-); Dec-1980 thru Sep-1982 (Reagan – 1st 21 months)

Figure 4 – Dow % +(-); Dec-2000 thru Sep-2002 (Bush 43 – 1st 21 months)

The Good News is that there is no reason why this history has to repeat itself this time around.  The Bad News is….that it very well could.

The Current Euphoria

As I stated earlier, when it comes to bull markets, I vote “YES”.  I will take one anytime I can get it.  And I also try to avoid being one of those “know it all types” (in the interest of full disclosure I am actually more one of those “sneaky” types who tries to intimate that he actually does know it all by trying not to act like a know it all – which is technically probably worse.  But, hey, at least now you know) who routinely “talks down” a bull market (“Oh sure, things are great now but just you wait….” And so on).  That “just you wait” stuff gets really old after a short while.

So here we stand.  The major U.S. averages are bursting forth to new highs – so who am I to be a naysayer?  Still, there is that pesky “perceptive” thing I mentioned earlier.  Before getting too carried away with bullish euphoria please sear Figures 2, 3 and 4 above somewhere into the back of your brain – just in case.

Also note that the U.S. stock market is virtually alone in the world in terms of making new highs.  Figure 5 displays:

Ticker VTI – Vanguard Total (U.S.) Stock Market ETF

Ticker VEU – Vanguard All World ex-U.S. Stock Market ETF

To be clear, ticker VTI essentially covers the entire U.S. stock market.  Ticker VEU covers a broad array of major world stock  markets BUT does not include U.S. stocks.Figure 5 – U.S. Total Stock Market = New Highs; World Total Stock Market = NOT New Highs (Courtesy AIQ TradingExpert)

Note that the U.S. market has broken out strongly to new highs while the “whole world” of markets is nowhere close to doing so.  Certainly one can adopt the “What, me worry?” approach and argue that “the U.S. market will lead the other world markets to reach new highs.”  And maybe that will prove to be the case.

But as I will highlight soon – and as reflected by tickers VTI and VEU – the U.S. stock market looks great while virtually the rest of the markets around the globe look pretty not so great.  So please check back for Part II soon

In the meantime, enjoy the rally and the Holidays – I know I will.

Jay Kaeppel

Disclaimer/Caveat/Warning: The idea I am going to discuss here is definitely not for everyone.  As traders and investors we are told time and again that it is “foolish” to attempt to “pick tops or bottoms” in the financial markets.

And generally speaking, that refrain is spot on.  Still, part of being a trader is developing the ability to make money in ways other than just “buying and holding for the long-term”.  So the counter argument put forth is that it is OK to “speculate” as long as you don’t “bet the ranch.”  Let’s look at one example.

See also One Answer to the Large-Cap/Small-Cap Argument

Treasury Bonds

As you can see in Figure 1, long—term treasury bonds have been (and technically still are) in a freefall (down roughly 15% since July). Figure 1 – TLT plunging (Courtesy AIQ TradingExpert)

Conventionally wisdom would suggest that the dumbest thing a person could do right now is to try guess when bonds are going to bottom out.  And I concur that trying to pinpoint the “exact low” with any accuracy is essentially not possible.  But I have also seen enough freefall declines in my time followed by a “bounce” to know that money can be made quickly if and when the bounce comes.

So what if a trader (preferably one who has taken speculative positions before and understands the potential psychological “kick in the head” that can accompany a speculative trade that fails quickly) thinks that jut maybe bonds will ”bounce” between now and the end of the year.

Should he, a) turn away quickly and let the notion pass?  Or b) enter a speculative, limited risk trade?

The answer to that question is not for me to say.  But choose wisely.  Let’s look at one hypothetical possibility using options on ticker TLT – an ETF that tracks the long bond.

The Trade

*Buy 14 TLT DecQ4 116.5 calls @ 1.96

*Sell 21 TLT DecQ4 118.5 calls @ 0.98

*Buy 7 TLT DecQ4 120.5 calls @ 0.43

The particulars appear in Figure 2 and the risk curves in Figure 3Figure 2 – TLT DecQ4 Option trade (Courtesy www.OptionsAnalysis.com)

Figure 3 – TLT DecQ4 Option trade risk curves (Courtesy www.OptionsAnalysis.com)

As you can see, this trade stands to:

a) Make money if TLT bounces higher between now and the end of the year

b) Lose money if TLT continues to trend lower

Managing the Trade

This is not a “set it and forget it” trade.  A traders actions going forward is very much dependent upon what happens to the price of TLT.  Let’s talk first about risk management.

The risk on this hypothetical position is -$987.   If TLT is below $116.50 at the end of the year that would be the maximum loss. As you can see, dollar risk increases sharply with time decay as options expiration (the black line risk curve) approaches.  If TLT trends lower and does not appear likely to get back above the breakeven price, a trader might consider cutting his or her loss in the last week or so prior to expiration (although also note that the last 5 trading days of the month are often when bonds rally the most).

On the upside, this trade would make money with TLT at any price above $117.21. As long as TLT holds above that price (assuming of course that it ever even gets above that price between now and then) a trader could hold the position and exit soon before the close.

Summary

Is this a trade that everyone should rush out and put on?  Not at all.  In fact as always please not that this is not a recommendation.  The truth is that this is the kind of trade that can make you look  really stupid really fast.

Like I said at the outset, it’s not for everyone.  This piece is intended to serve simply as an example of one way to speculate with limited risk.

Jay Kaeppel

One of the ongoing arguments among investors and financial pundits involves touting the benefits of large-cap stocks versus small-cap stocks, and vice versa.

At any given point in time it is possible to make a cogent argument that this short-term trend or that long-term trend favors large-cap stocks (or small cap stocks as the case may be).  Today let’s skip all the bickering and highlight one approach to choosing between one size versus the other.

See also The One Asset Class Per Month Strategy 

Jay’s Large-Cap/Small Cap Seasonal Strategy (JLCSCS)

First off let’s note that historically neither large-caps nor small-caps perform particularly well during certain months (think January and the summer months).  So we will allocate to intermediate-term treasury bonds during those “seasonally unfavorable” periods.

Or illustrative purpose we will use monthly index total return data for the large and small-cap stock allocations.  We will use monthly total return data for Fidelity Government Income Fund (ticker FGOVX) for the bond portion.  The monthly allocation appears in Figure 1 below.

Figure 1 – Monthly Allocations for Jay’s Large-Cap/Small Cap Seasonal Strategy

The Results

Figure 2 displays the growth of $1,000 invested using the monthly allocations shown in Figure 1 above since 12/31/1978Figure 2 – Growth of $1,000 invested using (JLCSCS) versus buying and holding both RUI and RUT; 12/31/78-10/31/16

Some key facts and figures regarding performance appear in Figure 3

Figure 3 – Performance Results

Summary

As always, the results displayed above are or “informational” purposes only and I am not recommending that anyone start trading using this approach without doing some serious homework of their own first.

Is this simple “system” the definitive approach to trading different stock capitalization sizes? Hardly.  But it might not be bad place to start either.

Jay Kaeppel