TSX TrendWatch Weekly

While the markets bounced back up a bit last week, after a brutally over-sold week before that,  I wouldn’t be out on a buying spry just yet.  Instead I’m looking at some possible leading indicators of where we might be going next.

More on that below, but first let’s have a look at what popped up last week…

WEEKLY REVIEW… The S&P/TSX Composite Index rallied back 1.3% last week after the big -4% dip the week before. The S&P/TSX Venture Index  did even better with a +3.4% gain.

South of the border, the Nasdaq was able to manage a similar gain to the S&P/TSX Composite Index, but the Dow dropped -0.6% and the S&P500 gained just +0.2%. Volatility (as measured by VIX), dropped back from around 40 to 30… a -20% decline.

Commodities had a robust recovery last week… from gold and silver, to oil and gas, to diversified mining… whether you consider the raw commodities or the companies that produce them. All gains for last week in these areas were +3% to +6%.

Seven of the ten sectors are still on the decline trend-wise, but surprisingly CONSUMER DISCRETIONARY stocks are at the top end of the scale. If that price index represents  consumers being ready to buy big-ticket items they don’t need, this could be a sign of improving investor confidence in the market.

The chart above now shows that 36% of S&P/TSX Composite Index stocks have positive trend values… with the median being -0.3%/week. We would definitely like to see an improvement to back above 50% soon (and > 0.0% for the median), or we might be looking at a sustained decline.

The DATA & CHARTS workbook data, that backs up what I discuss here, uses 10 week exponential moving averages to determine trend and consistency. It’s also possible to look at longer-term moving averages and compare them.  Our premium service subscribers receive 20 week and 40 week moving averages on trend and consistency as well for whatever database(s) they’re receiving.

In the chart below I’m showing you the multi-timeframe numbers for the S&P/TSX Composite Index constituent companies.

In ideal conditions, where the upward momentum is high, the 10 week trend should be higher than the 20, and the 20 higher than the 40. That should be true whether considering the %-up red bars (right-scale) or the medians (the black diamonds, left scale).

I’d treat this formation as a major negative piece of evidence, if it weren’t for the fact that the TR10 numbers have only been south of zero for the past few weeks and the Tr20 numbers just reached the mid-point.  You’ll see that over 70% of S&P/TSX Composite Index companies still have longer-term (40 week) upward trends.

As I’ve been saying for a few weeks now, caution is still indicated and if individual stocks in your portfolio are losing their upward trends, selling is a good idea. Hold off new purchases for the time being.

Charts like the one above showing moving average cross-overs are one sort of indicator; but I’ll be the first to admit that this is not necessarily a good leading indicator, since we’re looking at different perspectives on the past up to the present. Let’s see what else we can find that might work better.

LEADING INDICATORS… Obviously, if there were any rock-solid leading indicators of where stock prices are going next, we’d all be on board and all making more money than we could probably have imagined. Unfortunately, it doesn’t work that way. The best that we can hope for is that the odds are in our favour with any specific leading indicator more than 50% of the time, most of the time. Most long-term successful investors are happy with a 60% success rate. Any leading indicator that might help you along the way to that goal is one to hang onto.

The next question we have to address is… are we talking about economic leading indicators or stock price leading indicators?  So many people believe that economic growth and stock market increases go hand in hand, but they’re absolutely wrong!  The reason so many believe that is because so many reporters in the business media get it wrong too, and they’re publishing the wrong message to investors.

Yes, there are times when GDP and stock prices rise in tandem and everyone’s happy; but that’s the exception, not the rule. Stock prices are the best leading indicator for the economy… not a coincident indicator, and certainly not a lagging indicator.  Stock prices rise substantially in the middle of a recession… signaling that the economy will be improving within a quarter or two.  By the time the GDP data confirm that, stock prices may continue to rise for a while, but they’ll turn down again well before we see hard evidence that GDP has peaked out.

In principle then, May’s substantial slump in stock prices could be warning us of a short-lived recovery economically.  I personally think that we’d need a little more evidence before jumping to that conclusion, but it’s something to think about.

The flip side of this is that if you’re looking at Canada’s new GDP numbers in the 6%+ range, do not use that as a reason to start investing in stocks now, especially if you’ve been out of the equities markets all of last year. Once again, GDP predicts nothing when it comes to stock market performance. Only the opposite is true (almost all of the time).

So, what should we look at as potential leading indicators of stocks? Certainly, not the economy.  After all, the economy may determine whether you have a job or not, but it’s not going to offer you any capital gains.

You’ll get lots of suggestions from technical analysts who study chart patterns, cycles and trends. I have to admit that I’m part of that camp at one level (specifically, I’m a trend follower),  but I look at the data quite differently. The stereotypical technical analyst will analyze one or a few charts and indicators to death… whether it be for a single stock or a general index like the S&P/TSX Composite Index or S&P 500.

On the other hand, I’m constantly looking at how stocks and indexes are performing relative to one another.  Moreover, you won’t find charts like the first one above that give you the rough odds of whether you might be profitable or not given overall market conditions. Most technical analysts do their best with current and past market numbers. But without relative comparisons, you’re losing a lot of valuable information.

For instance, our chart shows you the proportion of stocks with short-term trend values above zero… a rough measure of whether you’ll find a decent sized pool of stocks worth looking into further.  Another more common approach which seems very similar is to compute the percentage of companies in the S&P/TSX Composite Index that are trading above their (often 200 day-) moving average. That too is an indicator of where the future might take us relative to the past, but there is a subtle difference.  With the commonplace approach, most stocks could still be trending downward at the same time as many of the latest prices are above their moving average. It’s still a decent sign of a turnaround, but not as convincing as when the moving averages are standardized around zero.

But now, let’s look at some other potential leading indicators of future stock market gains or losses… investor confidence and dividends.

Investor confidence is most often measured by taking polls.  Investors are asked whether they intend to buy x, y or z over a certain time-frame, and/or are simply asked if they’re bullish or bearish on stocks at the moment they’re asked the question. I don’t have much faith in these.

Suppose the question was asked at the end of the day on “flash-crash” Thursday, May 6.  I’m sure the answers would be far more negative than they would have been a week or two earlier. Secondly, buying intentions don’t necessarily mean that there’s any follow through.

Beyond that, the sampling methods are often very sloppy. An investor confidence survey on positive or negative intentions to buy stocks during a certain time interval will rarely discriminate between a respondent who has never purchased a share of anything in his life, and someone who is a trading veteran of 20-30 years and has a 7-figure portfolio. Which opinion means more?

As I’ve mentioned in other editions of this report, the only investor confidence indexes I’ll pay attention to are those tracking real money and big money at that. I want to see real money flows, not state-of-the-minute opinions. That’s why I like the State Street Investor Confidence Index. It tracks institutional investors moving hundreds of millions of dollars around. If they’re moving money from bonds to stocks, that’s confidence that risk will probably be rewarded. If their money is going the other way, they want less risk and see less near-term potential with equities.  For the record the Sate Street index has been declining for the last two months… a warning flag for me.

Dividend increases (or decreases) are also a decent leading indicator from my perspective. In this case we’re talking about corporate, board of director level confidence that their company is going to be performing well enough going forward that they are happy to reward their investors with more of their excess capital than they’ve been doling out before.  A single company doing this in isolation means little, but if you aggregate companies increasing their dividends across the country, such an index means something.

I haven’t actually found a standardized index of dividend increases/decreases, but many of the latest reports on dividend issuing companies suggest that we’re currently seeing a lot of good news on that front.

That doesn’t mean that you need to buy conservative companies that pay dividends. You just take it on faith that if those companies see good times ahead, companies not paying dividends will be feeling more confident as well.

So there you have a couple leading indicators of stock price performance that are worth following. Don’t expect them to be foolproof, but there are so few reliable ones out there, that we’ll take what we can get.

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