TSX TrendWatch Weekly

‘Tis the time to not only start thinking about Christmas shopping, but also portfolio adjustments and strategies for the new year. This week we run through some more “big picture” indicators and size up what they might mean going forward.  Some suggest a market correction coming, while others anticipate a great December/January.  Of course, both perspectives could be correct. More below, but first, what happened last week?

WEEKLY REVIEW… The S&P/TSX Composite Index declined -1.0% over the past week. We’re clearly still influenced by the US markets where many investors took a 4-day Thanksgiving weekend. The US market indexes were essentially flat overall.

The anticipated panic over Dubai’s sudden announcement of a major debt problem didn’t materialize, and we’re back to business as usual.

Nine of the ten S&P/TSX sector indexes are still positive, with INFORMATION TECHNOLOGY being the laggard.  MATERIALS continues to be the best performing of the bunch.

Gold bullion rose another +2.3% last week. In fact it’s averaging +1.9% per week with 86% consistency. The only worrisome aspect is that gold stocks are not rising at the same pace (or faster). Historically, gold stocks have tended to be a leading indicator of the price of gold… so the current scenario may suggest that bullion is overbought at this point. We won’t fully acknowledge that, however, until we see gold trend and consistency values start softening.

The odds are still remarkably in our favour with the indicators we report in our chart.  73% of stocks in the S&P/TSX Composite Index have positive trend values.  The median is now 0.5%/week… still respectable, if you annualize that by multiply by 52.

LEADING, CONTRARIAN & SEASONAL RISK INDICATORS… As usual we like to look at other indicators of the health of the markets to put our own data in context.

While we have done remarkably well with our relative trend analysis™ (RTA) methodology over the years, it was never intended to be a comprehensive investment strategy. Its a screening tool to identify stocks with consistent upward trends.  From there independent investors should blend in their own favourite tools to have a closer look at the equities that appear attractive in our DATA & CHARTS workbook.

Since our approach is predominantly top-down, we like to keep an eye on macro indicators that might suggest a market top (or bottom).  We’re simply assuming that the chances to finding individual stocks that will buck the trend of a downward market are pretty slim. Consequently, we want to know when such an overall downtrend might be emerging.

The State Street Investor Confidence Index (SSICI) is one such measure that we like to revisit when the report comes out on the last Tuesday of each month. There are both global and regional versions of the index.

The global index peaked in August (at 122.5) and has begun a slow decline to 100.8 as of last Tuesday. The decline is most pronounced in Asia. European confidence rose 3.7 points over the past month and the North American figure ticked up 1.1 points.

Unfortunately, a weak point of the SSICI is that the scale isn’t explained well, so we can only look at the relative numbers over time.  What we do know, though, is that this is a measure of actual risk appetite (=confidence) of institutional investors (=the “smart money”). As such I take this as a leading indicator, and a warning flag right now.

The index is still way above it’s bottom at 82.8 near the end of 2008, but we can’t ignore the fact that it’s drifting lower.

UBS Securities also has a risk index called the Global Equity Strategy Risk Indicator. I’ll be looking more closely into how well that compares with the SSICI. For now, though,  I’ll just mention that the UBS index seems to have bounds delimiting “extreme high risk appetite” and “extreme low risk appetite”. It’s treated as a contrarian indicator, which is to say that markets should turn lower when an extreme high level is reached, and rise after an extreme low level. For the last few months the index has been hovering at the upper extreme. Another warning flag.

Another investor sentiment indicator is volatilty. One commonly mentioned volatility index is the VIX… sometimes inappropriately called “the fear indicator”.  Actually, it’s little more than an estimate of future stock price swings (up or down), based on options prices. The VIX reached an all time high of around 80 at the peak of the credit crisis, and is now much closer to it’s long-term average of 20 (in spite of the Dubai debt crisis news on Friday). What this tells us is that the general investing public is neither panicking, nor excessively elated at this time. Under these circumstances I would be inclined to go with the overall market trend, which is still positive.

Finally, let’s look at a seasonality indicator which is relevant right now… the January Effect. There are actually at least two sides to this.  The most common interpretation is that if January is an up-month, the year will be an up-year. Over 40-odd years in which share prices rose in January, stocks have been up for the year 88% of the time… price-wise, up 15% on average vs 3% for years when January was a down-month.

88% is not 100%, however, and this year has been a notable exception… with a January decline in the S&P/TSX Composite Index of about 3% and yet an outstanding year all the same. The exception that proves the rule!
The other bit of seasonal evidence is that December and January are normally great months to be invested anyway.  Only April is a better month on average based on 35-40 years of data.

Goldman-Sachs put a little icing on the cake with their recent study.  Rather than revisit the January (beginning of year) Effect, they had a look at the “end of year effect”.  How well do stock price gains from January through November predict stock price performance in December. The results are summarized below in a table we “borrowed”…

In short the better stocks do during the year, the better they do in December… so let the good times roll! We’ll worry about 2010 when the time comes!