Micro MRI Projections
Our portfolios have been defensive for several weeks and I’d
like to show support for why we have that position. This is important to understand because the
fear of missing out on a strong market often compels people to invest at the END
of strong markets, only to experience the market declines.
One can see factors that could lead to a stock price decline,
including currently high valuations of stocks in the context of rising interest
rates, and any pandemic-related surprises.
Factors that could lead to continued price increases include
unprecedented government stimulus, historically low interest rates, and pent-up
demand from the pandemic period.
For a reminder of the language I use, please see this webpage:
https://focused15investing.com/language
Projections for the Micro MRI
Figure 1 shows a projection of the Micro MRI (indicating short-term resilience) through this coming June.
Figure 1. Project and Actual Micro MRI Levels, Plus recent Price Change for DJIA
This chart shows the period from July 2020 through July
2021. The brown line shows the actual price
level of the DJIA from July 2020 to last Friday (February 5, 2021), where the
line stops. The green line shows the
actual Micro MRI used in the investment approach. All my communications in the
past relate to the green line. The
orange line is the projected Micro MRI.
Note that the projections align particularly well with the actual MRI during the recent period, lending credence to the projection analysis. The clear similarity supports the near-term validity of the projection for the future. There are deviations, but they are small. These deviations were caused by current events, which I describe in the Review of 2020 Performance:
https://marketresilience.blogspot.com/2021/02/review-of-2020-performance.html
This Micro MRI projection (orange line) is based on data from 1940 to 2011. From other work, I have found that pricing dynamics of the market since the financial crisis in 2007-9 do not contribute a great deal to making forecasts. I therefore often exclude recent data from analyses. The 2011 end date is arbitrary; it is 10 years ago.
If we look at the projection for the next several weeks, we can see that the Micro MRI is likely to continue to move lower, meaning a period of low resilience.[1] Based on this projection, the Micro MRI will move lower into March. After it reaches a low point, it will begin the upleg of its cycle and the market will be more resilient. Since we rotate ETFs based on resilience as indicated by the movement of the MRI, it is not yet time to get back in the market in a major way. If the market does make a big drop, it will likely do so before the end of March. Thus, I am not making any change in the level of Box #2 Cash being held.
As you know the algorithms consider all MRI (Macro, Exceptional Macro, and Micro), plus other factors. The Macro MRI remain positive and seems to be supporting the market. The algorithms may respond sooner than the trough in the Micro MRI because of the other factors considered.
Prices Currently Hugging a Trend Line
Current price action of the DJIA is hugging what I consider to be an important trend line. The line is formed using Fibonacci analysis. This condition reinforces being patient right now as a reasonable course of action. The details of this analysis are not important to cover here, but the main points are:
- Prices move between and along trend lines that follow consistent rates of return (associated with Fibonacci numbers) over long periods of time.
- When prices move closely along (hug) a trend line for several weeks, they are challenging or “testing” that trend line, and may move above or below the line in the next few weeks.
- When prices break through one of the trend lines (either up or down), they can often make dramatic moves over the next few weeks.
Please keep in mind that these trend lines are not considered in the algorithms. Nonetheless, it is relevant to our investment approach. I have found that the prices break through these important trend lines when MRI-related resilience changes. Figure 2 below adds the trend line to Figure 1.
Figure 2. Projected Current Resilience and Fibonacci Fan
Trend Line
The trend line is blue.
Note how it relates to the DJIA price line (brown). In late 2020, prices shifted above the trend
line after the announcement of an effective vaccine in early November. Point 1 corresponds to the recent GameStop
decline, and prices dropped to the trend line. While prices (brown line) have rebounded over
the last week, bouncing up from the trendline, we still have a few weeks to
before getting to higher Micro resilience.
Until then, there is a higher possibility of breaking through the trend
line and dropping, say, 10 to 15 %.
The GameStop drop produced a sharp decline that precipitated, or at least, corresponded to, the end of a period of Exceptional Macro resilience – which I describe in last week’s post:
Historically, once the Exceptional Macro has ceased, it has been better to wait for the trough of the next Micro MRI cycle (the beginning of its upleg) before getting back into the market – EVEN if it reappears a few weeks later. The Exceptional Macro has returned for the DJIA, but it has ceased for several indexes, which makes me cautious. At the moment, I believe it is best to keep Box #2 Cash levels where they are right now, and wait for the upcoming trough of the Macro MRI.
Thus, while the market seems strong right now, it is too
soon to become fully invested in the stock market. I don’t want my subscribers to get in the
market just as it decides to be concerned about other factors, such as
valuation. Below is a link to the
December research note on valuation.
Valuations are still high by historical standards.
We may look back and see that being conservative and holding cash caused us to miss out on returns. But when resilience is higher, we will be much more aggressive. You do not need to know the information I have presented in last week’s post and this week’s. But know that I am doing these types of analyses to monitor and assess the reasonableness of the MRI conditions and the actions of the algorithms.
[1] The picture is consistent with the percentile level I often use to describe the current level of the MRI. As of last week, the actual Micro MRI was at the 49th percentile of actual levels since 1918, which is visually similar to where it is compared to the upcoming trough of the projected Micro MRI.
