You may see a few articles such as this one about the poor stock market returns that tend to occur in
September. As the article
points out, September can be a trying month that ends with negative returns.
Add in tropical storms and North Korea tensions and we can see why professional
investors become nervous. While I don’t
try to forecast the weather or geopolitical events, I do assess the market’s
ability to recover quickly from whatever events do take place by virtue of the
market’s inherent resilience.
The investment process used to create the Focused 15
Investing model portfolios systematically evaluates whether it makes sense to
reduce exposure to the stock market for the month of September. At the end of
August, it will reduce exposure to stocks if the Micro MRI is higher than a
specific threshold. If this condition is met, I expect price movements to be
negative in September and for prices to remain low for some time. The process
then takes some money out of the market. The rationale is that if the Micro is at
a high level and is likely to turn negative in September and cause assets
to be taken out anyway, do not wait for the turn
negative event ―
just reduce assets at the end of August. This decision rule would not be in the process
if it didn’t add value over the last 100 years.
Indeed, since 1918, these specific conditions have been met in 43* of the
100 years. This “conditional price movement” technique for September adds about 1.67% on an
annualized basis over 100 years, which is a respectable amount. This type of conditional technique working
with the MRI information is important to the investment approach. So important,
in fact, that I named my firm CPM Investing, for conditional price movement.
During the evaluation this
recent August, the conditions were not met, and there was no change in the
target weights. The Micro MRI for stocks was already quite low, which means
that the market is closer to making a short-term move higher. After any decline
in September, the market will most likely follow the trend indicated by the
Macro MRI, which is positive at this time. While September may be bumpy, no
change in target weights is justified.
Current Market Environment
As a quick reminder, I describe the Market Resilience
Indexes in a footnote[1].
A. Stock markets…
Most major stock markets around the world have
strong and positive Macro (long-term) MRIs. This indicates that the longer-term
price trend is still positive. The DJIA has proceeded further along this
positive trend than other major markets and is therefore closer to the
inevitable end of the positive trend. However, for the time being, the trend
for the DJIA continues to be positive. Most major stock markets around the
world can recover quickly from declines related to the near-term events. If the
positive Macro MRIs were absent, the potential for a quick recovery would be
greatly diminished.
Their Micro MRIs have been in the downward leg
of their cycles for several weeks and are not providing any resilience to
negative news. This state indicates
short-term vulnerability, and we have been seeing higher price volatility over
the last several weeks as a result. Importantly, the Micro MRIs already
descended to low levels by the end of August. As of last Friday (September 1st),
the Micro for the DJIA is at the 35th percentile since 1918, which
is a moderately low level – 65% of the weeks since 1918 have higher levels. And
it is trending lower. Other markets have even lower levels, as shown below. The
lower the percentile rank, the more the market has already descended to short-term
lows.
a. DJIA – 35th percentile
b. DJ and S&P Industrial Sectors – 11th
(the “industrial sectors” are more domestically focused than the DJIA listed
above)
c. Russell 2000 – 22nd
d. DJ Transports – 11th
e. NASDAQ – 24th
f. UK Stocks – 14th
g. Europe – 14th
h. Japan – 14th
As you can see, the major stock markets were at relatively low levels as of last Friday. They are likely to shift to a positive reading and provide short-term resilience over the next few weeks. If the curse of September, the storms, and the North Korea tensions occurred when these values were higher, say at the 80th percentile or higher, the downside would be greater and the condition described earlier would have been met.
The net effect of the current condition is that while the markets may decline with the news of the day, they are likely to recover quickly. This leaves little opportunity to exit and re-enter the markets.
B. US 10y Treasury Bond Futures (TY1)
The net effect of the current condition is that while the markets may decline with the news of the day, they are likely to recover quickly. This leaves little opportunity to exit and re-enter the markets.
B. US 10y Treasury Bond Futures (TY1)
The Macro MRI is trending lower and is at a low level (7th percentile since 1986) and the Exceptional Macro appeared recently (8/18/2017). Both suggest that the Macro may shift to a positive state in the coming weeks or months. These longer-term indicators highlight the potential for a strong move higher – one that is beyond what might result from near-term fears linked to the news of the day.
The Micro MRI, which measures shorter-term resilience, has
been trending positive for several weeks. It is at the 43rd
percentile since 1986 and can continue higher for several weeks. The net effect
is more resilient bond prices over both shorter and longer horizons.
C. Commodities
The SPGSCI continues to be rated 3 (highest resilience), but this rating has been borderline for several weeks. Its Macro has been trending positive but is very shallow; it could easily move negative and cease to provide resilience. The Micro MRI is at a high level (80th percentile since 1973) and may cease over the next few weeks. Thus, the 3 rating continues to be borderline and at risk.
D. Dollar (DXY)
DXY is experiencing only Micro (short-term) resilience. Its Macro and Exceptional Macro are not close to turning positive. The Micro MRI is at the 15th percentile since 1970 and could continue to be positive for several weeks. However, DXY’s Micro has been erratic over the recent period (beginning in roughly April); it has shifted between being positive and negative over this time period. Furthermore, its Macro is at a relatively high level, which suggests that there is more downside to DXY than upside.
* An early version of this post indicated 67 years in which the conditions had been met. Of those, 43 were for the September declines and 24 were for March declines.
[1] I use
proprietary metrics to determine where current price levels are relative to
their historical norms. The Market Resilience Indexes indicate where prices are
relative to their long-term (Macro) and short-term (Micro) historical cycles
and whether they are moving toward their historical peaks or troughs. Cycles for the Macro MRI last several quarters
to multiple years. Cycles for the Micro MRI
last four to six months. The presence of
the Exceptional Macro MRI indicates that the Macro MRI is likely to move from a
negative trend to a more positive one.
