TSX TrendWatch Weekly

With a relatively calm week behind us, I pulled out a few charts to convince us even further, that (although we may see some pull-backs in the weeks to come) we are in a very good space right now for investing in Canadian equities. I’m going to talk a bit about the “smart money” concept and have a look at trends in volatility, but let me get the summary of last week’s action out of the way first.

WEEKLY REVIEW… After a shakey start the net result over the week was fairly moderate. The S&P/TSX Composite Index rose +1.0%, while the S&P/TSX Venture Index  drifted lower -0.6%.  In the US, the Dow lost -1.2%, the S&P500 -0.3%, and the Nasdaq managed a +0.6% gain.  Ho hum overall!

The percentage of stocks with positive trend values remained unchanged at 74% at the end of last week.  Let me remind you that it’s virtually unprecedented to see these numbers above 70% for so long!  Lower values in the coming weeks would still be considered normal.  Think about it.  Right now you could pick your stocks randomly and roughly 7 or 8 of them out of 10 will be on an upward trajectory!

9 out of 10 sectors have positive trend values as you’ll see in the DATA & CHARTS workbook. FINANCIAL SERVICES has the top position… rising roughly 2% per week. That group has been in the top 5 for 16 weeks now. UTILITIES and INDUSTRIALS have moved up the list, while our perennial favourites MATERIALS and ENERGY have eased back a bit.

All in all, this is an excellent scenario and many of us have logged some excellent profits since the March bottom, but let’s look at some more good news…

SMART MONEY…  The “smart money” concept is pretty basic.  The people with the most money to invest and the best track records are the ones who “really know what’s going on”.  If we could only know what they were doing, we could buy the same stocks and other investments that they are buying. Or, at very least, if smart money is buying, we should be buying too (and the same on the downside).

The problem is that large institutional investors aren’t going to publicize what they’re doing. The net result is that many investors and analysts attempt to “read the tea leaves”.  Some argue that if you see higher than normal trading volume in a stock or the market at large while the price is rising, the smart money must be buying and you should too. I’ve even seen people argue that dumb money trades in the morning when the markets open, and smart money waits until the end of the day. So, if markets rise and trading volumes rise at the end of the day, you should join in.

This is all too far fetched for me!  I want to know what smart money is really doing!

That’s why I like to look at the State Street Investor Confidence Index.   It won’t tell me which stocks to buy, but I know that already. It just tells me whether there are major money flows into stocks… period.  It gives me the extra confidence to be buying when the so-called experts managing billions of dollars are also buying.

State Street Corporation (NYSE: STT) is the world’s leading provider of financial services to institutional investors, including investment servicing, investment management and investment research and trading. With $11.3 trillion in assets under custody and $1.4 trillion in assets under management at March 31, 2009, State Street operates in 27 countries and more than 100 geographic markets worldwide.

In short, they know where all that money is going… they don’t have to guess. This isn’t a survey about where these people might invest their money. It’s tracking actual behaviour.  So, the confidence indicator you see above is based on the level of risk institutional investors are willing to take by investing in equities as opposed to safer alternatives like cash or government bonds. A reading of 100 is considered “neutral”… above that, a bias toward equities, below that a bias to get out of equities.

The monthly data provided above are pretty clear. The numbers started climbing right from the bottom late in 2008. We’ve almost reached last summer’s high.

So, if you think that the people managing billions are smarter than you, you might consider following their example.

VOLATILITY…  Another reason that we should feel more confident about investing now is that volatility is falling. It’s been pretty much tracking lower since the spike last fall.

In the past I’ve usually used the US-based VIX index to talk about volatility. It’s based on options on the S&P500 index. The general argument is that volatility is a “fear index”.  When investors are worried that their equities will fall in value, they’ll buy put options which rise in value as their stocks fall.  Because of the leverage involved, it’s like buying fire insurance if you live in California and you’re convinced that a major drought will continue, or extra flood insurance in Florida just ahead of hurricane season.

We have a similar index in Canada, but it rarely ever gets any attention.  It’s calculated by the Montreal Exchange (where Canadian derivatives trade) and goes by the symbol MVX.  I have yet to find it reported by any other financial web site… so that’s your source if you want it.

Here’s how the Montreal Exchange web site describes the MVX…

The Montréal Exchange introduces a new Implied Volatility Index (MVX) reflecting the market’s expectation of how relatively volatile the stock market will be over the next month. MVX is calculated from current prices of at-the-money options on the iShares of the CDN S&P/TSX 60 Fund (XIU). MVX is an implied volatility index that is updated every minute of a trading day.

Since the value of XIU is derived from the S&P/TSX 60 Index - the equity benchmark in Canada - MVX is a good proxy of investor sentiment for the Canadian equity market: the higher the Index, the higher the risk of market turmoil. A rising Index therefore reflects the heightened fears of investors for the coming month. MVX also gives an indication of whether options are relatively cheap or expensive, as the higher the implied volatility, the higher options premiums become.

I’m not convinced that the MVX, or the VIX for that matter, are the “fear indexes” some interpret them to be, because volatility also rises when investors are euphoric and are driving up the prices of call options.  All the same, lower volatility is a good sign of market stability. You have less concerns that something you bought yesterday on an uptrend may fall 30% today. In the language of our relative trend analysis™ (RTA) methodology, when volatility is low, the consistency of a trend (whether up or down) is higher.  And, as we like to say… “a consistent trend is less likely to bend!”.

So, this chart too suggests that the investing environment is becoming more and more positive day by day, since March.  We’ll have set-backs for sure. That’s normal.  But it’s time to get some of that cash out of the mattress.

We’d like to see more individual stocks with strong consistent trends in the S&P/TSX Composite Index, but in the meantime there are plenty of them in the much larger Premium Serice Canadian Equities database.