First off, let’s be clear.  I do think that we will look back on this time period as an outstanding buying opportunity in the energy sector.  What exactly to buy and when exactly to buy it is a whole other question (although I have shared some thoughts on the topic here, here, here and here.  That being said, I don’t know that the energy sector is poised to go “to the moon” anytime soon.  There is a lot of turmoil:

*The March 2020 futures contract incredibly fell to -$37 a barrel

*The U.S. shale oil industry is in grave danger of mass bankruptcies

*Russia and Saudi Arabia have demonstrated that they are willing to create/absorb some instability in the oil market

*Will alternative energy sources become viable replacements for fossil fuels and what will that do to the overall industry

And so on and so forth.  Basically, a thousand and one reasons to steer clear of the energy sector.  Which of course is the number one reason to actually start looking more closely – the old adage of “buying when there is blood in the streets” does seem to be “ringing a bell”. 

One Other Signpost to Consider

Figure 1 below is from this article posted on www.SeekingAlpha.com authored by Rida Morwa.  I am going to be candid and say that I am not exactly sure what the red line in Figure 1 is measuring (more in a moment) – but the message appears to be pretty clear.  Anyway, as I understand it, the red line in Figure 1 measures the current yield on high yield energy stocks minus….something – maybe higher grade energy stocks or a broader index of high grade corporate bonds – I found something similar at Morningstar.

Figure 1 – Energy Credit Spread vs. Oil (Source: Bloomberg and Crescat Capital LLC, courtesy www.SeekingAlpha.com)

In any event, it is hard to ignore the obvious “potential alert” that appears in Figure 1.  In both 2008-2009 and 2015-2016 the credit spread soared and marked the bottom in crude oil.  The red line in Figure 1 soared to an even higher new high in 2020 just as the price of crude oil cratered.

I don’t offer investment advice nor make specific recommendations.  And I am not entirely convinced that crude oil and/or the broader energy sector is destined to rally significantly anytime soon.  All that being said, now does have the earmarks of being a good time to stop hating the energy sector.

Ticker DBO (an ETF that tracks the price of crude oil future but DOES NOT focus entirely on the front month – which can help to mitigate the risks of contango that troubled the more actively traded ticker USO) may not do a thing. But trading under $6 bucks a share, it might look pretty good a few years from now.

Jay Kaeppel

Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author.  The information presented represents the views of the author only and does not constitute a complete description of any investment service.  In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security.  The data presented herein were obtained from various third-party sources.  While the data is believed 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.  International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets.  Past performance is no guarantee of future results.  There is risk of loss in all trading.  Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance.  Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.

A lot of investors “bailed out” during the 2020 coronavirus market panic.  Whether that will ultimately prove to be the right move or the wrong move only time will tell.  But it is understandable.  The one thing that never changes is human nature, and when a person is watching their net worth evaporate at a shocking pace human nature often intervenes shouting “STOP!”

Same as it ever was.

Since the bottom in late March the major indexes (if not necessarily the majority of stocks) have staged a strong rally.  The question on most investor’s mind now is “When can we sound the “All Clear?” The truth is that there is no sure-fire, fool-proof method for doing so.  But there are some things that can help.

The VIX/SPX “Everyone Back into the Pool” Signal

Every once in awhile the stock market gets clobbered.  That is just a fact of life.  When this occurs two things invariably happen

*The S&P 500 Index drops below its 200-day moving average

*The VIX Index soars

So how do we know when the worst is over?  Well, one approach is to look for a reversal of the two things I just mentioned.  So, we can look for:

*The VIX Index to drop back down below its own 200-day moving average

*The S&P 500 Index to rise back above its own 200-day moving average

First the bad news.  This method will occasionally highlight a false breakout.  In other words, VIX will fall below its MA, SPX will rise above its MA, and then – the S&P 500 Index goes south again (see Figures 2 and 5) .  

NOTE: As a result, after a signal it is very important to keep a close eye on the S&P 500 Index to see if it continues to hold above its 200-day moving average or not.  If it does not, you may need to “play defense” again.

The bottom line is that this is by no means an “automatic, you can’t lose” systematic strategy. Still, the “good news” is that more often than not this signal has proven to be a useful confirmation that it is safe to “get back in the pool.”

See the charts below.

Figure 1 – 1998 (Courtesy AIQ TradingExpert)

Figure 2 – 2002-2003 (Courtesy AIQ TradingExpert)

Figure 3 – 2009 (Courtesy AIQ TradingExpert)

Figure 4 – 2011 (Courtesy AIQ TradingExpert)

Figure 5 – 2015-2016 (Courtesy AIQ TradingExpert)

Figure 6 – 2018-2019 (Courtesy AIQ TradingExpert)

Figure 7 – 2020 (Courtesy AIQ TradingExpert)

Investors who want to track VIX and the S&P 500 Index can do so simply at www.StockCharts.com. Enter ticker $VIX and set the “simple moving average” to 200 then Update. then do the same for ticker $SPX.

Figure 8 – Ticker $VIX at www.StockCharts.com

Figure 9 – Ticker $SPX at www.StockCharts.com

Summary

Technically speaking, one can argue that the stock market is in a “downtrend” as long as the S&P 500 Index is below its 200-day moving average – as it is now.  So, a cautious approach to the stock market (i.e., something less than 100% full invested) is warranted.

At the moment, neither part of the “Everyone Back in the Pool” method has been triggered.  So, investors should be keeping a close eye on the VIX Index and the S&P 500 Index for these simple clues that better days might be ahead. 

Jay Kaeppel

Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author.  The information presented represents the views of the author only and does not constitute a complete description of any investment service.  In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security.  The data presented herein were obtained from various third-party sources.  While the data is believed 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.  International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets.  Past performance is no guarantee of future results.  There is risk of loss in all trading.  Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance.  Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.

Intermarket analysis can be an interesting source of ideas.  For example, who would guess that there is a relationship between the metals markets and the bond market?  At first blush it doesn’t make sense.  On one side you have hard, physical metals that have to be dug out of the ground via the use of heavy machinery and mining equipment and on the other side you have pieces of paper issued by governments or companies promising to pay interest over a set period of time and principal at the end.  Not exactly apples and apples.

So why would there be any connection?  The one thing that connects metals and bonds is inflation/deflation, as this can impact both. 

In the simplest terms possible:

*In inflationary times, hard assets such as metals tend to gain ground and paper assets paying a fixed amount of interest tend to lose ground

*In disinflationary and/or deflationary times, hard assets such as metals tend to gain ground and paper assets paying a fixed amount of interest tend to lose ground

Using the Gold/Silver Ratio to Time the Bond Market

The Gold/Silver Ratio (GSR) is exactly as it sounds – the price of gold divided by the price of silver.  For our purposes we will measure this on a weekly basis. We will then use treasury bond futures to measure bond performance.

A = Gold/Silver

B = 2-week exponential moving average of A

C = 28-week exponential moving average of A

D = B-C

So D is the difference between the 2-week and the 28-week exponential average

If D is > 0 it tells use that the gold/silver ratio is trending higher

If D is < 0 it tells us that the gold/silver ratio is trending lower

Figure 1 displays the raw Gold/Silver Ratio since 1975 on a weekly basis.

Figure 1 – Gold/Silver Ratio (1975-2020)

Figure 2 displays the GSR 2-week EMA minus the GSR 28-week EMA (i.e., Value “D” above)

Figure 2 – Gold/Silver Ratio 2-week EMA – Gold/Silver Ratio 28-week MA

Now let’s see if the fluctuations in Figure 2 offer any information about the bond market.

Results

For testing purposes, we will compare the results of holding a long position in t-bond futures when D > 0 versus when D < 0.

T-bond futures are worth $1,000 a point.  So, if t-bond futures gain one full point they value increases by $1,000 and if t-bond futures lose one full point the value decreases by $1,000.

Test Period: 9/9/1977 through 5/1/2020

Figure 3 displays the results of our test.

Figure 3 – +(-) from a long one t-bond futures contract position depending on whether GSR 2wk EMA is above or below 28wk EMA (1977-2020)

Figure 4 shows the results in table form.

Gold/Silver Ratio Measure	T-Bond $ +(-)
GSR 2-week EMA – 28-week EMA > 0	+$150,759
GSR 2-week EMA – 28-week EMA < 0	(-$53,224)

Figure 4 – +(-) from a long one t-bond futures contract position depending on whether GSR 2wk EMA is above or below 28wk EMA (1977-2020)

Summary

The bottom line is that:

*The blue equity line in Figure 1 (performance of t-bonds when GSR 2ema-28ema > 0) slopes lower left to upper right

*The orange equity line in Figure 1 (performance of t-bonds when GSR 2ema-28ema < 0) slopes upper left to lower right

This tells us that the Gold/Silver ratio may be useful in identifying the overall trend of the bond market.

The trend has been bullish for bonds since 1/24/20 and remains so at the present time. This will remain the case until silver gains enough ground on gold to flip Value “D” discussed above back into negative territory.

Notes on Calculations

*For the record I use the weekly reading for ticker GC-SPOTV and ticker SI-SPOTV in ProfitSource by HUBB software to make the weekly Gold/silver Ratio calculation. 

*A simple approach for many investors would be to look at ticker “GLD:SLV” at www.StockCharts.com. This divides the weekly closing price for ticker GLD (a gold bullion ETF) by ticker SLV (a silver bullion ETF).

*You can add 2-week and 28-week exponential moving averages to a weekly chart and note whether the 2-week EMA is above or below the 28-week EMA. 

*It should be noted that different signals may be generated from time-to-time compared to GC-SPOTV and SI-SPOTV (which use spot closing prices for actual gold and silver). 

Figure 5 displays the latest GLD:SLV chart.

Figure 5 – GLD:SLV with 2-week and 28-week EMA’s (Courtesy: www.StockCharts.com)

In Figure 6 you can see the relatively high degree of correlation between the long-term treasury (using ticker TLT as a proxy) versus the chart displayed in Figure 5.

Figure 6 – Long-term treasury ETF ticker TLT (Courtesy: www.StockCharts.com)

Jay Kaeppel

Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author.  The information presented represents the views of the author only and does not constitute a complete description of any investment service.  In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security.  The data presented herein were obtained from various third-party sources.  While the data is believed 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.  International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets.  Past performance is no guarantee of future results.  There is risk of loss in all trading.  Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance.  Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.

In this article I wrote about the propensity for the month of October to be more problematic in the late part of a decade. 

In this article I highlighted the fact that September tends to be weak when August ends with the Dow in a downtrend.

In this final installment we will put the two together.

The Purpose

I am no fan of just buying-and-holding forever in the stock market. While the market has advanced in the long run, a lot of a buy-and-hold investors success depends on when they start.  If you start just prior to a major bear market or at the outset of a long sideways period (1927-1949, 1965-1982, 2000-2012) your results will not likely be what you had expected or hoped for.

Still, a lot of investors are not interested in the difficult game of timing the market.  So, this short series is designed to give long-term investors some tools for helping increase long-term returns while still primarily remaining fully invested.

The Components

We will create a model that can read either -1 or 0

*If the current month is October AND the current year ends in “7”, “8” or “9” the Model = -1

*If the current month is September and if the Dow Jones Industrial Average closed August below its 10-month moving average of monthly closing prices the Model = -1

*Otherwise the Model = 0

Investment Rules

*If the Model = 0 we will hold the Dow Jones Industrial Average

*If the Model = -1 we will be out of the stock market (presumably in cash, money market or very short-term treasuries)

The Test

*When the Model = 0 we will assume the strategy gained or lost the amount (price only for these calculations, no dividends) the percentage gain or loss for the Dow that month

*When the Model = -1 we will assume no gain or loss for the month, just a flat result

NOTE: Theoretically dividends earned while in the market and interest earned while out of the market would inflate the results that follow.  But I am not recommending an investment strategy per se, just providing food for thought.  So, for the purposes of this test we are just measuring the effect of price movement for the Dow.

The Results

*We are running this test using month-end Dow price data from 12/31/1899 through 4/30/2020, a total of 1,444 months

*During this 120.33 year period the Model was -1 only 74 times, or 5% of the time

*In other words, we would be in the market 95% of the time and out only 5% of the time. 

What do we gain for being out that 5% of the time?

It’s actually more about what we miss.  Figure 1 displays the cumulative growth of equity achieved by holding the Dow Jones Industrial Average ONLY during those months when the Model as -1.

Figure 1 – Cumulative Dow price performance during months when Model = -1

*The net result was a loss of -91.2%. 

Cumulative Growth of Equity:

*During Months when Model = 0: +568,172%

*During Months when Model = -1: (-91%)

*On a buy-and-hold basis: +50,191%

By sitting out 74 of 1,444 months we improve buy-and-hold results by a factor of 11.3-to-1.

Figure 2 displays the 10-year cumulative return for each approach.

Figure 2 – 10-Year Rolling % Return for Strategy, inverse strategy and Buy-and-Hold

Figure 3 displays the 10-year cumulative return for the Strategy versus buy-and-hold.  Note that during the 1920’s. 1950’s, 1970’s and 1990’s there were time when buy-and-hold outperformed the Strategy.

Still, looking at 10-year rolling returns the Strategy outperformed buy-and-hold 82% of the time. 

Figure 3 – Strategy 10-year return minus buy-and-hold 10-year return

Finally, Figure 4 divides the growth of $1,000 invested using the Strategy by $1,000 invested using buy-and-hold.  Notice that over time this ratio slopes upper left to lower right.  This tells us that getting out of the market every once in awhile using the rules listed above is resulting in a higher return

Figure 4 – Growth of $1,000 invested using Strategy divided by Growth of $1,000 invested using Buy-and-Hold

Summary

So, is this “World Beater, You Can’t Lose” investing?  Not at all.  Still it does point out that there may be simple ways to improve upon a simple buy-and-hold approach without trying to time every twist and turn in the market.

For the record, the strategy will remain fully invested until at least October of 2027 UNLESS the Dow closes a month of August below its own 10-month moving average of monthly closing prices (which it is presently in danger of doing in 2020), in which case the Strategy would get out of the stock market for the entire month of September before getting back in at the end of September.

Jay Kaeppel

Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author.  The information presented represents the views of the author only and does not constitute a complete description of any investment service.  In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security.  The data presented herein were obtained from various third-party sources.  While the data is believed 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.  International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets.  Past performance is no guarantee of future results.  There is risk of loss in all trading.  Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance.  Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.

In this short series I am attempting to highlight that there may be opportunities for long-term investors to occasionally and successfully hedge their stock market bets (by whatever means – raising cash temporarily, inverse funds, put options, etc.) without attempting to time every twist and turn in the market.

In this article I wrote about the propensity for the month of October to be more problematic in the late part of a decade.  In this missive we will look at the “worst” month of the year – the month of September.

Sordid September

Since 1900 the Dow in September has showed:

*a gain 52 times

*a loss 67 times

*no change 1 time

*an average return of -0.95%

Not pretty. 

But a closer look reveals a slightly different picture. 

September with a 10-month Dow Moving Average

In this test we will determine at the end of each August the Dow Jones Industrial Average is above it’s 10-month moving average (using monthly closing price) or below. 

*If the August Dow close is above the 10-month average we will call it Sep MA UP

*If the August Dow close is below the 10-month average we will call it Sep MA DOWN

Figure 1 displays the cumulative gain for the Dow during the month of September depending on whether its Sep MA UP or Sep MA DOWN

Figure 1 – Dow cumulative September +(-) depending on whether August close was above or below 10-month moving average; 1900-2019

For the record:

*The cumulative price gain for September if Sep MA UP was +20.4%

*The cumulative price loss for September if Sep MA DOWN was -78.5%

Just to make the distinction clear, Figure 2 displays the cumulative price loss for September if Sep MA DOWN.

Figure 2 – Dow cumulative September % if Dow August close was below its 10-month moving average; 1900-2019

The bottom line: the 38 Septembers that followed the Dow closing August below it’s 10-month moving average registered a cumulative decline of -78.5%.

Rhetorical question: What’s the point of “buying-and-holding” through that?

When the Dow closed August ABOVE its 10-month MA:

*the Dow had 41 up Septembers

*the Dow had 41 down Septembers 

*The average result was a gain of +0.29%

When the Dow closed August BELOW its 10-month MA:

*the Dow had 11 up Septembers

*the Dow had 26 down Septembers 

*the Dow had 1 unchanged September

*The average result was a loss of -3.62%

The Net Result

Using monthly closing price data (not total return data including dividends), a buy-and-hold approach using the Dow starting in 1900 gained +45,714%.

Had an investor sat out the market during the 38 Septembers that were preceded by the Dow closing below its 10-month moving average, the gain would be +210,046%.

Jay Kaeppel

Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author.  The information presented represents the views of the author only and does not constitute a complete description of any investment service.  In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security.  The data presented herein were obtained from various third-party sources.  While the data is believed 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.  International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets.  Past performance is no guarantee of future results.  There is risk of loss in all trading.  Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance.  Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.