Real Estate Investment Trusts (REITS) have held up well during the May selloff.  As we will see in a moment, this probably should not come as a surprise.  Based on the typical seasonal trend for REITs it might make sense to hold on a little longer.

A Bullish Stretch

Let’s keep it simple.  Figure 1 displays the cumulative growth of $1,000 invested in Fidelity Select Real Estate fund (FRESX) ONLY during the months of March through July every year starting in 1987.

Figure 1 – Growth of $1,000 invested in FRESX March through July 1987-2019

As you can see – while nothing is ever perfect – the sector has showed a strong tendency to perform well from late-winter into mid-summer.

Figure 2 displays the year-by-year results and Figure 3 displays a few key facts and figures.

Figure 2 – Year-by-Year Results

Figure 3 – Facts and Figures

Summary

FRESX has showed a gain since the end of February 2019.  Can we be sure that things will improve between now and the end of July?  Not at all.  But history seems to suggest that that may be the way to bet.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

One thing that keeps me slightly optimistic these days is all the gloom and doom forecasts I read regarding the economy.  Not that there isn’t plenty of truth to what is getting written.  But it just seems like everyone wants to be the first one to “call the top” in the economy.  Is there a way to be objective?  Maybe so.

Where We Are

First let’s get the “politics” out of the way.  The Democrats on one hand want Obama to get the credit for the “roaring” economy while on the other hand claiming that the economy is “not that great”.  Republicans just hope to get to the next election before the next recession kicks in.  All that uselessness aside, we are presently doing very well economically.  Improved growth and profitability, more entrepreneurs taking the plunge, low unemployment and low inflation.  We should all be happy, right?  What, are you crazy?  Debt, deficits, trade wars, overheated housing prices (in some areas) and a slowdown in housing sales (in other areas), an inverted yield curve and so on and so forth are all causing great angst among people who, um, choose to focus on things that cause them angst.

Despite current economic growth, pretty much anyone who knows anything about economic cycles know that “nothing lasts forever”, especially economic growth.  Consider the unemployment rate.  When people hear that unemployment is low they think “great!”  But when they look at the history of unemployment in Figure 1, they tend to think “things can’t get any better so they are likely to get worse.”  And history appears to be on their side.Figure 1 – U.S. Unemployment (Source: www.yardeni.com)

The U.S. and world economy seem to run on a never-ending cycle of “boom” followed by “bust”.  Therefore, since things are “booming” now then we must be closing in on the next “bust” – hence the reason for all the recent negativity.  And there is good reason to pay attention and remain vigilant.  But that is different than just perpetually lamenting that “the end is near”.

So, what can we look at to get an objective handle on – and be able to speak  intelligently about – “the economy”?

What to Follow to Assess “the Economy”

What follows is NOT intended as a “comprehensive” guide to economic forecasting.  Not at all.  What follows is simply a few key things that investors can watch for clues of an actual impending downturn.  In other words, if these factors are not flashing warning signs, for gosh sakes, stop worrying incessantly about the economy and get back to enjoying your life for crying out loud.

But just as importantly, when they do start flashing warning signs, you must absolutely, positively resist the urge to stick your head in the sand and pretend that “all is well” (pssst, which is usually what happens at the top).

Factor #1: Leading versus Coincident Indicators

Figure 2 is from www.Yardeni.com (a source of a tremendous amount of free and useful information).  It displays the ratio of the leading economic indicators to the coincident economic indicators.Figure 2 – Ratio of Leading to Coincident Indicators (Source: www.yardeni.com)

There are three things to note:

1. The blue line rises and falls regularly

2. The grey vertical areas represent period of economic recession in the U.S.

And most importantly:

3. (With the caveat that anything can happen) Every recession in the past 50 years was preceded by a clearly declining trend in this ratio

The point: The line displayed in Figure 1 has stopped advancing in recent months and has begun to “squiggle”.  OH MY GOD THAT MUST MEAN THE ECONOMY IS DOOMED TO FALL APART!!!!!  Oh wait, no that’s not what it means.  It means we should be keeping an eye on it for signs of further weakness and if further weakness does unfold we should then be alert to the fact that the economy may then come under pressure.

But let’s be honest, that’s not nearly as fun or dramatic as shouting OH MY GOD THAT MUST MEAN THE ECONOMY IS DOOMED TO FALL APART!!!!!

Factor #2: Housing Starts

There are several different ways to measure this and – unfortunately – no one best way to objectively identify a turning point.  Figure 3 – also from www.Yardeni.com (I told you it is a great source for useful information) displays “Housing Starts” and “Housing Completions”.  For our purposes we will focus solely on “Housing Starts”.Figure 3 – Housing Starts (Source: www.yardeni.com)

What we see in Figure 3 is that Housing Starts is an extremely volatile data set.  Big swings from lows to highs and vice versa, without a lot of “noise” along the way.

The point: Once again – just as with Factor #1 – every recession in the past 50 years was preceded by a clearly declining trend in this set of data.  So that’s what we should be looking for.

As you can see in Figure 3, the blue line (Housing Starts) has sort of started to “chop around” of late.  While one can choose to wring one’s hands if one so chooses, the more prudent thing to do is to keep a close eye and see if a clear downtrend ensues.  THEN it will be a meaningful sign.

Factor #3: The Yield Curve

Nothing has generated more universal angst about “inevitable” economic disaster as the fact that certain parts of the yield curve have “inverted” (i.e., a longer-term interest rate is below a shorter-term interest rate) of late.  For example, the key 10-year treasury yield has recently fallen below the 2-year yield , the 3-month and Fed Funds rate.  Oh, the horror!

But here is the irony: Yes, it is absolutely, positively true that an inverted yield curve is a potential warning sign of impending economic trouble.  Just not the way it is typically presented of late, i.e., OH MY GOD THE 10-YEAR YIELD DROPPED BELOW THE 2-YEAR YIELD THAT MUST MEAN THE ECONOMY IS DOOMED TO FALL APART!!!!!  However, take a close look at Figure 4 from – where else – www.Yardeni.com that displays the difference between the 10-year treasury yield and the Fed Funds rate.Figure 4 – 10-year treasury yield minus Fed Funds rate (Source: www.yardeni.com)

There are two important things to note – unfortunately most people only seem to focus on #1:

1. Every recession in the past 50 years has been preceded by an inversion (i.e., a negative reading on this chart) of the yield curve

2. However, also note that the recessions did not actually begin until after the yield curve started to rise again after first inverting.

This second point is important. Why?  Consider Figure 5 from www.BullMarkets.co (another terrific source of information) which shows the action of the stock market after the yield curve first inverts.Figure 5 – S&P 500 Index performance after yield curve first inverts (Source: www.BullMarkets.co)

The fact that every previous instance was followed by higher stock prices 2, 3,  6 and 9 months later does NOT mean that things can’t be different this time around.  But the information in Figure 4 does suggest that a lot of the fear and loathing and gnashing of teeth presently occurring may be misplaced.

Summary 

Again, the above list is not intended to be the “be all, end all” when it comes to divining the future course of the economy.  Many other indicators (Initial Unemployment Claims, Purchasing Managers Index to name just two)

I can’t tell you if the economy is about to top out and if all the current “gloom and doom” is warranted.  But I would still like to offer some advice. So here goes: forget all the noise of economic prognostications and keep an eye on the indicators presented above.  If either or both of the first two start to tank and/or if the yield curve begins to “un-invert” it will be time to raise your level of concern.

Until then go ahead and try to enjoy your life.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Some industries are cyclical in nature.  And there is not a darned thing you – or they – can do about it.  Within those industries there are individual companies that are “leaders”, i.e., well run companies that tend to out earn other companies in that given industry and whose stock tends to outperform other companies in that industry.

Unfortunately for them, even they cannot avoid the cyclical nature of the business they are in.  Take Halliburton (ticker HAL) for example.  Halliburton is one of the world’s largest providers of products and services to the energy industry.  And they do a good job of it. Which is nice.  It does not however, release them from the binds of being a leader in a cyclical industry.

A Turning Point at Hand?

A quick glance at Figure 1 clearly illustrates the boom/bust nature of the performance of HAL stock.Figure 1 – Halliburton (HAL) (Courtesy AIQ TradingExpert)

Which raises an interesting question: is there a way to time any of these massive swings?  Well here is where things get a little murky.  If you are talking about “picking timing tops and bottoms with uncanny accuracy”, well, while there are plenty of ads out there claiming to be able to do just that, in reality that is not really “a thing”.  Still, there may be a way to highlight a point in time where:

*Things are really over done to the downside, and

*For a person who is not going to get crazy and “bet the ranch”, and who understands how a stop-loss order works and is willing to use one…

..there is at least one interesting possibility.

It’s involves a little-known indicator that is based on a more well-known another indicator that was developed by legendary trader Larry Williams roughly 15 or more years ago.  William’s indicator is referred to as “VixFix” and attempts to replicate a VIX-like indicator for any market.  The formula is pretty simple, as follows  (the code is from AIQ Expert Design Studio):

*hivalclose is hival([close],22).

*vixfix is (((hivalclose-[low])/hivalclose)*100)+50.

In English, it is the highest close in the last 22-periods minus the current period low, which is then divided by the highest close in the last 22-periods. The result then gets multiplied by 100 and 50 is added.

Figure 2 displays a monthly chart of HAL with William’s VixFix in the lower clip.  In a nutshell, when price declines VixFix rises and vice versa.

Figure 2 – HAL Monthly with William’s VixFix (Courtesy AIQ TradingExpert)

Now let’s go one more step as follows by creating an exponentially smoothed version as follows (the code is from AIQ Expert Design Studio):

*hivalclose is hival([close],22).

*vixfix is (((hivalclose-[low])/hivalclose)*100)+50. <<<Vixfix from above

*vixfixaverage is Expavg(vixfix,3).  <<<3-period exponential MA of Vixfix

*Vixfixaverageave is Expavg(vixfixaverage,7). <<<7-period exp. MA

I refer to this as Vixfixaverageave (Note to myself: get a better name) because it essentially takes an average of an average.  In English (OK, sort of), first Vixfix is calculated, then a 3-period exponential average of Vixfix is calculated (vixfixaverage) and then a 7-period exponential average of vixfixaverage is calculated to arrive at Vixfixaverageave (got that?)

Anyway, this indicator appears on the monthly chart for HAL that appears in Figure 3.Figure 3 – HAL with Vixaverageave (Courtesy AIQ TradingExpert)

So here is the idea:

*When Vixfixaverageave for HAL exceeds 96 it is time to start looking for a buying opportunity.

OK, that last sentence is not nearly as satisfying as one that reads “the instant the indicator reaches 96 it is an automatic buy signal and you can’t lose”.  But it is more accurate.  Previous instances of a 96+ reading for Vixfixaverageave for HAL appear in Figure 4.

Figure 4 – HAL with previous “buy zone” readings from Vixfixaverageave (Courtesy AIQ TradingExpert)

Note that in previous instances, the actual bottom in price action occurred somewhere between the time the indicator first broke above 96 and the time the indicator topped out.  So, to reiterate, Vixfixaverageave is NOT a “precision timing tool”, per se.  But it may be useful in highlighting extremes.

This is potentially relevant because with one week left in May, the monthly Vixfixaverageave value is presently above 96.  This is NOT a “call to action”.  If price rallies in the next week Vixfixaverageave may still drop back below 96 by month-end.  Likewise, even if it is above 96 at the end of May – as discussed above and as highlighted in Figure 4, when the actual bottom might occur is impossible to know.

Let me be clear: this article is NOT purporting to say that now is the time to buy HAL.  Figure 5 displays the largest gain, the largest drawdown and the 12-month gain or loss following months when Vixfixaverageave for HAL first topped 96.  As you can see there is alot of variation and volatility.  

Figure 5 – Previous 1st reading above 96 for HAL Vixfixaverageave

So HAL may be months and/or many % points away from an actual bottom.  But the main point is that the current action of Vixfixaverageave suggests that now is the time to start paying attention.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Once you have been in this business for a while, you start to think you have heard it all.  Then of course, you are reminded that you are wrong.  Which can be a little unsettling – kind of the “I am an Old Dog, and this is a New Trick” challenge.

Anyway, in this article from BullMarkets.co they reference the “Boom/Bust Barometer” tracked by well-known market analyst Ed Yardeni (by the way, I highly recommend his book).  This barometer “takes the CRB Raw Industrial Index and divides it by Initial Jobless Claims.  This is essentially using commodities vs. labor market as a means to gauge the overall health of the economy.”

The article also contained a link to a spreadsheet with the data.  The file contained month-end readings for the Boom/Bust Barometer (or BBB for short) going back to May 1981.  A few notes:

*From doing a little more digging, I believe Mr. Yardeni tracks this on a daily basis, and that there are people who use it as an active market timing tool.  I have no knowledge of the steps they take in order to do that

*For our purposes here all we have is the month-end reading, so we will go with that

*What follows is NOT a “recommended” trading strategy, it is presented solely as a simple example of one potential way to use the data as a bullish/bearish “confirmation tool”

Figure 1 displays the month-end reading for the BBB along with a 48-month exponential moving average.  As you can see, sometime the data trends “up” – i.e., the month-end value is above the moving average, and vice versa.

Figure 1 – Yardeni Boom/Bust Barometer month end values (blue) with a 48-month EMA (orange); 1981-2019

Figure 2 displays the difference between the two lines in Figure 1 (positive means the BBB is above its 48-month EMA and is “trending higher” and negative means the BBB is below its 48-month EMA and is trending lower) along with the month end price for the S&P 500 Index.  From a cursory glance it appears that the BBB does a good job of being on the right side of the market.  This approach would have suggested being out of the market during most all of the 2000-2002 and 2008-2009 bear markets.

Figure 2 – S&P 500 Index (blue) with Boom/Bust Barometer minus 48-month EMA (orange); 1981-2019

Figure 3 displays two equity curves:

*The blue line represents the growth of $1,000 invested in the S&P 500 Index (using month-end price data) when the BBB is ABOVE its 48-month EMA

*The orange line represents the growth of $1,000 invested in the S&P 500 Index (using month-end price data) when the BBB is BELOW its 48-month EMA

Figure 3 – Growth of $1,000 invested in S&P 500 Index when Boom/Bust trend is “+” (blue) versus when Boom/Bust trend is “-” (orange); 1981-2019

Results:

*When the BBB was in an “uptrend” the S&P 500 Index gained +1,460%

*When the BBB was in a “downtrend” the S&P 500 Index gained +42%

Notes:

*As a standalone strategy (which again, is not recommended) this “strategy” would have underperformed a buy and hold approach.  However, as a “perspective” indicator it appears to offer some potentially good value.

*As you can see in Figure 4, this simplistic approach to using BBB is still well into positive territory, i.e.,  bullish – or at the least, not yet flashing a bearish warning ala 1981, 1990, 2000 and 2008.

Figure 4 – Boom/Bust Barometer minus 48-month EMA; 1981-2019

Summary

It should be pointed out that the “method” presented here is almost certainly NOT the way Mr. Yardeni intended this indicator to be used.  So if you do not see any real value in what you just saw, don’t think any less of the indicator itself.

But I do think I will keep an eye on this one for a while.  My thanks to Ed Yardeni and www.BullMarket.co for teaching this Old Dog a New Trick.

Woof.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The “barbell” approach to bond investing typically involves buying a long-term bond fund or ETF and a short-term bond fund or ETF.  The idea is that the long-term component provides the upside potential while the short-term component dampens overall volatility and “smooths” the equity curve.  This article is not intended to examine the relative pros and cons of this approach.  The purpose is to consider an alternative for the years ahead.

The Current Situation

Interest rates bottomed out several years ago and rose significantly from mid-2016 into late 2018.  Just when everyone (OK, roughly defined as “at least myself”) assumed that “rates were about to establish an uptrend” – rates topped in late 2018 and have fallen off since.  Figure 1 displays ticker TYX (the 30-year treasury yield x 10) so you can see for yourself.

Figure 1 – 30-year treasury yields (TNX) (Courtesy AIQ TradingExpert)

In terms of the bigger picture, rates have showed a historical tendency to move in 30-year waves.  If that tendency persists then rates should begin to rise off the lows in recent years in a more meaningful way.  See Figure 2.Figure 2 – 60-year wave in interest rates (Courtesy: www.mcoscillator.com)

Will this happen?  No one can say for sure.  Here is what we do know:  If rates decline, long-term treasuries will perform well (as long-term bonds react inversely to the trend in yields) and if rates rise then long-term bond holders stand to get hurt.

So here is an alternative idea for consideration – a bond “barbell” that includes:

*Long-term treasuries (example: ticker VUSTX)

*Floating rate bonds (example: ticker FFRAX)

Just as treasuries rise when rates fall and vice versa, floating rate bonds tend to rise when rates rise and to fall when rates fall, i.e., (and please excuse the use of the following technical terms) when one “zigs” the other “zags”.  For the record, VUSTX and FFRAX have a monthly correlation of -0.29, meaning they have an inverse correlation.

Figure 3 displays the growth of $1,000 invested separately in VUSTX and FFRAX since FFRAX started trading in 2000.  As you can see the two funds have “unique” equity curves.

Figure 3 – Growth of $1,00 invested in VUSTX and FFRAX separately

Now let’s assume that every year on December 31^st we split the money 50/50 between long-term treasuries and floating rate bonds.  This combined equity curve appears in Figure 4.

Figure 4 – Growth of $1,000 50/50 VUSTX/FFRAX; rebalanced annually

Since 2000, long-treasuries have made the most money.  This is because interest rates declined significantly for most of that period.  If interest rise in the future, long-term treasuries will be expected to perform much more poorly.  However, floating rate bonds should prosper in such an environment.

Figure 5 displays some relevant facts and figures.

Figure 5 – Relevant performance Figures

The key things to note in Figure 5 are:

*The worst 12-month period for VUSTX was -13.5% and the worst 12-month period for FFRAX was -17.1%.  However, when the two funds are traded together the worst 12-month period was just -5.0%.

*The maximum drawdown for VUSTX was -16.7% and the maximum drawdown for FFRAX was -18.2%.  However, when the two funds are traded together the worst 12-month period was just -8.6%.

Summary

The “portfolio” discussed herein is NOT a recommendation, it is merely “food for thought”.  If nothing else, combining two sectors of the “bond world” that are very different (one reacts well to falling rates and the other reacts well to rising rates) certainly appears to reduce the overall volatility.

My opinion is that interest rates will rise in the years ahead and that long-term bonds are a dangerous place to be.  While my default belief is that investors should avoid long-term bonds during a rising rate environment, the test conducted here suggests that there might be ways for holders of long-term bonds to mitigate some of their interest rate risk without selling their long-term bonds.

Like I said, food for thought.

Jay Kaeppel

 Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

In this article I wrote about something I referred to as the “September Barometer” applied to Fidelity Select sector funds.  In this piece we will apply the same principle to single country funds.

The Test

*For non domestic U.S. stock indexes the International Power Zone (IPZ) extends from November 1^st through April 30^th.

*I used ONLY a list of the original 17 iShares single country ETFs  that started trading in 1996 (many other single country ETFs have been opened since then, but they are NOT included in this test – only the original 17).

*Using total monthly return data from the PEP database from Callan Associates, I ranked the single country ETF performance ONLY during the month of September.

*Whichever ETF performed best during the month of September was bought on the last trading day of October and sold six months later at the close on the last trading day of April the following year.

The Results

*Figure 1 displays the annual “International Power Zone” results for the selected fund versus simply buying and holding the broader international MSCI EAFE Index during the same seven-month period each year (i.e., returns for May through October are excluded).

Figure 1 – September Barometer ETF performance versus EAFE Index – Nov. through April; 1996-2019

Figure 2 displays the cumulative equity curve for both the September Barometer and the EAFE Index during the International Power Zone months starting in 1996.

Figure 2 – September Barometer ETF performance versus EAFE Index – Nov. through April; 1996-2019

Things to Note:

*Since 1996 the September Barometer ETF has significantly outperformed the EAFE during the Power Zone months of November through April

*Both the September Barometer ETF and the EAFE Index showed a gain in 19 of the past 23 International Power Zone periods

*The median September Barometer ETF 7-month gain was +12.4% and the median 7-month loss was -4.7%

*The median EAFE Index 7-month gain was +6.8% and the median 7-month loss was -5.5%

*The September Barometer ETF outperformed the EAFE Index during the International Power Zone in 16 of the past 23 years, or 70% of the time

*If we look at 5-year rolling returns, the September Barometer ETF outperformed the EAFE Index in 18 out of 19 completed 5-year periods.

Summary

Does the month of September really “foretell” anything?  And is the idea presented here actually a viable approach to investing?

Repeating now: Hey, this blog just thinks up the stuff.  You take it from there.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Most investors are at least vaguely familiar with the “January Barometer”, first presented by Yale Hirsch, the founder of The Stock Trader’s Almanac, in the early 1970’s.  The gist of the January Barometer can be summed up in the phrase “As January goes, so goes the rest of the year.”

The September Barometer – such as it is – is a little different.  It can be summed up in the following jumble of words: “The top performing Fidelity Select Sector fund during the month of September will tend to perform exceptionally well during the following Power Zone period of November through May.”

Note: I refer to the months of November through May as the “Power Zone” for U.S. stocks (“Power Zone” sounds sexier than “November through May”, no?)

The Test

For the record I arbitrarily excluded two commodity-based funds – Select Gold (FSAGX) and Natural Gas (FSNGX).

*Using total monthly return data from the PEP database from Callan Associates, I ranked the rest of the Fidelity sector funds every year for performance only during the month of September.

*Whichever fund performed best during the month of September was bought on the last trading day of October and sold seven months later at the close on the last trading day of May the following year.

The Results

*Figure 1 displays the annual “Power Zone” results for the selected fund versus simply buying and holding the S&P 500 during the same seven-month period each year (i.e., returns for June through October are excluded).

Figure 1 – September Barometer fund performance versus S&P 500 Index – Nov. through May; 1982-2019

2019* – approximate through 5/14/2019

Figure 2 displays the cumulative equity curve for both the September Barometer and the S&P 500 Index during the Power Zone months starting in 1982.

Figure 2 – September Barometer fund performance versus S&P 500 Index – Nov. through May; 1982-2019 (Growth of $1,000)

Two things jump out from the chart in Figure 2:

*Since 1981 the September Barometer has significantly outperformed the S&P 500 during the Power Zone months of November through May (+11,555% for the September Barometer versus +2,879% for the S&P 500 Index)

*Results are extremely volatile and not for the faint of heart

Other things to note:

*As of 5/14/19 the 2018-2019 September Barometer fund – ticker FSTCX – is down roughly -1.7% versus a gain of +5.6% for the S&P 500 Index since 10/31/2018

*Both the September Barometer fund and the S&P 500 Index showed a gain in 32 of the past 37 years (this assumes FSTCX ends May 2019 with a 7-month loss and the S&P 500 Index with a 7-month gain)

*Through May 2018 the average September Barometer fund 7-month gain was +14.4% versus +9.9% for the S&P 500 Index

*The “big disaster” for the September Barometer was Select Regional Banks (FSRBX) which was the top performer in September 2008 (with a loss of -1.92%).  It then lost -51% in 4 months before ending with a 7-month loss of -24.9%.  This suggests the potential for improvement with, a) a stop-loss of some sort, and/or, b) making no trade if the “best” performer showed a loss in September.

*The other “rough” years were the bear market years ending in 2002 and 2003.  Again, this suggests that some sort of stop-loss or possibly a trend-following filter may add value.

*Probably the key statistic is that the September Barometer fund outperformed the S&P 500 Index during the Power Zone in 27 of the past 39 years (including 2018-2019 and assuming that FSTCX will end May underperforming SPX during the last seven months), or 69% of the time.

Summary

Does the month of September really “foretell” anything?  And is the idea presented here actually a viable approach to investing?

Hey, this blog just thinks up the stuff.  You take it from there.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

2018 witnessed something of a “fake out” in the bond market.  After bottoming out in mid-2016 interest rates finally started to “breakout” to new multi-year highs in mid to late 2018. Then just as suddenly, rates dropped back down.

Figure 1 displays the tendency of interest rates to move in 60-year waves – 30 years up, 30 years down.  The history in this chart suggests that the next major move in interest rates should be higher.Figure 1 – 60-year wave in interest rates (Courtesy: www.mcoscillator.com)

A Way to Track the Long-Term Trend in Rates

Ticker TNX is an index that tracks the yield on 10-year treasury notes (x10).  Figure 2 displays this index with a 120-month exponential moving average overlaid.  Think of it essentially as a smoothed 10-year average.

Figure 2 – Ticker TNX with 120-month EMA (Courtesy AIQ TradingExpert)

Interpretation is pretty darn simple.  If the month-end value for TNX is:

*Above the 120mo EMA then the trend in rates is UP (i.e., bearish for bonds)

*Below the 120mo EMA then the trend in rates is DOWN (i.e., bullish for bonds)

Figure 3 displays 10-year yields since 1900 with the 120mo EMA overlaid.  As you can see, rates tend to move in long-term waves.

Figure 3 – 10-year yield since 1900 with 120-month exponential moving average

Two key things to note:

*This simple measure does a good job of identifying the major trend in interest rates

*It will NEVER pick the top or bottom in rates AND it WILL get whipsawed from time to time (ala 2018).

*Rates were in a continuous uptrend from 1950 to mid-1985 and were in a downtrend form 1985 until the 2018 whipsaw.

*As you can see in Figure 2, it would not take much of a rise in rates to flip the indicator back to an “uptrend”.

With those thoughts in mind, Figure 4 displays the cumulative up or down movement in 10-year yields when, a) rates are in an uptrend (blue) versus when rates are in a downtrend (orange).

Figure 4 – Cumulative move in 10-year yields if interest rate trend is UP (blue) or DOWN (orange)

You can see the large rise in rates from the 1950’s into the 1980’s in the blue line as well as the long-term decline in rates since that time in the orange line.  You can also see the recent whipsaw at the far right of the blue line.

Summary

Where do rates go from here?  It beats me.  As long as the 10-year yield holds below its long-term average I for one will give the bond bull the benefit of the doubt.  But when the day comes that 10-year yields move decisively above their long-term average it will be essential for bond investors to alter their thinking from the mindset of the past 30+ years, as in that environment, long-term bonds will be a difficult place to be.

And that won’t be easy, as old habits die hard.

Figure 5 is from this article from BetterBuyandHold.com and displays the project returns for short, intermediate and long term bonds if rates were to reverse the decline in rates since 1982.Figure 5 – Projected total return for short, intermediate and long-term treasuries if rates reverse decline in rate of past 30+ years (Courtesy: BetterBuyandHold.com)

When rates finally do establish a new rising trend, short-tern and intermediate term bonds will be the place to be.  When that day will come is anyone’s guess.  But the 10-year yield/120mo EMA method at least we have an objective way to identify the trend shortly after the fact.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

2019 has been a terrible year for grain bulls.  The typical first half seasonal strength in soybeans and corn has turned into a rout.  Given the sharp downtrend combined with the fact that that typical seasonal strength is now about to turn into seasonal weakness, makes a very powerful case that grain bulls are “beaten” and should walk away.

And then that ol’ speculative devil on the other shoulder opens his big mouth.

Soybeans

A quick glimpse of Figure 1 pretty much illustrates the devastation.

Figure 1 – August 2019 Soybean futures (Courtesy ProfitSource by HUBB)

Trading wisdom is pretty clear that attempting to pick a bottom in anything is a fool’s game.  And especially so when a security is in a relentless decline with no clear end in sight.  But at some point things get overdone.  There is some evidence that may be near that point with beans.

Figure 2 is from www.sentimentrader.com and shows that trader sentiment is about as bearish as it ever gets for the bean market.  In other words, the bulls are finally throwing in the towel.  As a contrarian signal, this type of capitulation has historically been short-term (2 months) bullish for beans.Figure 2 – Sentiment for Soybeans plummets (Courtesy: Sentimentrader.com)

According to Sentiment Trader “With an Optimism Index at 16, we’re seeing some of the least optimism for any commodity in 29 years. For beans, only 15 other days since ’90 have seen optimism this low. According to the Backtest Engine, that preceded rebounds all 15 times two months later.”Figure 3 – Low optimism tends to be bullish for Beans over the next 2 months (Courtesy Sentimentrader.com)

So, does this mean that soybeans are guaranteed to rally like crazy for the next two months and that we should pile in?  Not at all.  But it does suggest that an opportunity may exist for those “extreme speculative contrarians” (“Hi, my name is Jay”).

The purest play is to buy soybean futures.  In reality, buying soybean futures is something that most trader will never – and should never – do.  An alternative for “the rest of us” is an ETF ticker SOYB which is intended to track the price of soybean futures.  As you can see in Figure 4, it has also been in a relentless decline for quite some time.

Figure 4 – ETF Ticker SOYB (Courtesy AIQ TradingExpert)

Buying shares of SOYB here is pretty much the definition of trying to catch a falling knife.  To make matter worse, note in Figure 5 that the typical “bullish for beans” first part of the year has been a bust AND we are soon to enter the typically bearish part of the year.Figure 5 – Soybean annual seasonality (Courtesy Sentimentrader.com)

As I have said, a pretty good case can be made for NOT playing the bullish side of beans.

Still…..

….for that “wild-eyed speculator” this setup smacks of a short-term bottom:

*The relentless decline

*The big gap lower followed by an intraday reversal

*Sentiment at one of the lowest levels ever

So what to do?  What follows is NOT a recommendation but simply one example of a way to play a (let’s be honest here, ridiculously) speculative situation.  One possibility is to consider the August 14 strike price call option on ticker SOYB.  The particulars appear at the top of Figure 6 and the risk curves appear at the bottom. Figure 6 – SOYB Aug 14 strike price call (Courtesy www.OptionsAnalysis.com)

It should be noted with great caution that this option is very thinly traded and has an extremely wide bid/ask spread ($0.95/$1.15).  For our purposes we assume Figure 6 that we get filled at the midpoint price of $1.05.  This may or may not be possible.

But consider this:

*The trade cost $105 to enter (if filled at the midpoint, $115 is filled at the ask price), which is the maximum risk on the trade.

*If beans do in fact follow the historical trend of rallying in the next two months this option has the potential for a large percentage gain.

*If beans do in fact advance this option would enjoy point for point movement above $15.05 a share (SOYB is at $14.76 a share as this is written).

Summary

Is it a good idea to try to pick tops and bottoms?  Generally speaking – absolutely not!  Is it a good idea to try to pick a bottom now in soybeans?  There is every chance that the answer is – absolutely not!

But markets go to extremes, and when traders “give up” on something that something often has a way of throwing everyone a curve and doing what no one expects.

That being said, the real point of all of this is simply that if you are going to “speculate” on something, put the emphasis on minimizing risk and NOT on maximizing profit.

If your “crazy idea” works out you will make plenty of money.  That’s not the primary area of concern.  The primary area of concern is ensuring that your “crazy idea” doesn’t completely blow up in your face.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.