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On High Alert
August is National Eye Exam Month, but this is the rare year we can confidently recommend
that you skip it. Warnings of stock market trouble have become clearer to see without thick lenses
or squinting. We can, just barely, make out the big E at the top of the eye chart, and suspect it means
to Exit. We made another move in that direction in late July, cutting net equity exposure in tactical
funds to 48%, from 55% in early July, and down from 61% six weeks ago.
The Major Trend Index (MTI), along with related disciplines we look to for substantiation and
reinforcement, are on the brink of negative signals. The table has already been set. Stock market valuations have been dangerous for at least a couple of years, and the Fed is slowly pulling away from its
reckless experimentationa good thing in the long term, but not for stocks in the intermediate term.
Current stock market breadth, leadership, and momentum are all characteristic of a very late stage bull
market. The smallest amount of additional confirmation will send us to an even more defensive posturebut we recognize the hazards of waiting for too much evidence to fall into place.
If the seasonal pattern of the past quarter century holds sway, that bearish signal should arrive this month. Yet another year well have to miss out on the Hamptons
MSCI World Index:
Average Monthy Performance, 1988 To Date
3.0
2.0
1.0
0.0
-1.0
-2.0
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
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S&P 500
2000
2000
1800
1800
Dow Jones 65
Composite
6500
6500
6000
6000
5500
5500
9000
9000
8500
8500
8000
8000
7500
7500
7000
7000
650
650
600
600
550
550
500
500
1300
1300
Russell 2000
1200
1200
1100
1100
300
460
440
460
440
420
420
400
400
380
380
46000
46000
44000
44000
42000
42000
x10
2014
M A
M J
N D
2015
M J
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Weakening Foundation
Over the last few months, weve presented a couple of simple quantitative studies meant to encapsulate the factors driving our Major Trend Index to the brink of bear territory. The chart and table
might provide the best summary yet.
Leadership (Dow Jones Transportation and Utility Averages), breadth (NYSE Weekly Advance/
Decline Line), and corporate credit (DJ Corporate Bond Index) have all staged intermediateterm breakdowns by falling below their respective 40-week moving averages. But the S&P 500
has, through early August, remained impervious to this underlying trouble, holding above its
own 40-week average and within 1-2% of a new cyclical high.
The bull market has ground on for so long that its tempting to ignore these internal warnings. After all, the chart shows several intermittent periods of weakness in Transports, Utilities,
NYSE breadth and/or corporate bonds since the 2009 low. But the past six weeks represent
the first period since 2008-2009 that all four series have simultaneously been in 40-week
downtrends. The accompanying performance table shows that average S&P 500 annualized
returns have been about zero under identical scenarios but those average returns include
significant pieces of the 1990, 2000-2002, and 2007-2009 bear markets.
2015 The Leuthold Group
2000
2000
S&P 500
(weekly)
1500
1500
1000
1000
Dow Jones
Transportation Average
5000
5000
Dow Jones
Utility Average
600
500
600
500
400
400
300
4500
300
4500
Market Status
Transports, Utilities,
NYSE Breadth & Bonds
above 40-wk moving avg.
Three of four series
above 40-wk moving
average
Two of four series
above 40-wk moving
average
One of four series
above 40-wk moving
average
None of four series
above 40-wk moving
average
S&P 500
Ann.
Gain
Pct. Of
Time
+15.3%
35%
+6.8%
22%
+7.5%
16%
-3.3%
11%
-0.1%
16%
4000
NYSE Weekly
Advance/Decline
Line
4000
120
120
110
110
Dow Jones
Corporate Bond Index
100
90
100
90
2007
2008
2009
2010
2011
2012
2013
2014
2015
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The Feds creativity during the post2008 period has been lauded, but it has undermined several fundamental relationships we once
considered reliable. (We wrote an Of Special
Interest piece on this topic in 2011 thats overdue for an update.) For example, the rate of
change in short-term interest rates explodes
when rates are at zero. This is a stock market indicator first proposed at least a hundred years
ago. Quantitative Easing compromised the
once-revered message of the money supply
measures, and a few years back, the Fed expunged a large set of valuable bank reserve data
in a manner that would make Lois Lerner blush.
These developments have increasingly forced us
to monitor Fed policy in a sort of second derivative fashioni.e., by monitoring movements in
the asset markets themselves.
700
650
650
600
2014
N D
2015
M J
600
Chart 2
Dec 29th
500
500
500
450
450
May 18th
400
400
400
Jun 23rd
350
350
600
2015 The Leuthold Group
2014
M J
N D
2015
M J
Chart 3
160
160
158
158
500
156
156
82.0
81.5
81.0
80.5
80.0
79.5
700
600
600
125
124
123
122
121
120
119
2014
82.0
81.5
81.0
80.5
80.0
79.5
400
M A
M J
N D
2015
M J
125
124
123
122
121
120
119
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Chart 1
2015 The Leuthold Group
2000
2000
S&P 500
NYSE new
52-week highs
and lows are both
at elevated levels,
a sign the stock
market has
become internally
fractured.
1500
1000
(10-Wk. Avg.)
1000
false
signals
1500
0
2007
2008
2009
2010
2011
2012
2013
2014
2015
*Index calculated as the lesser of NYSE Weekly New Highs and New Lows
as a percentage of issues traded.
Chart 2
5500
5000
4500
5500
5000
4500
NASDAQ Composite
4000
4000
3500
3500
3000
3000
2500
2500
2000
2000
1500
1500
7
6
5
4
3
2
1
0
7
6
5
4
3
99
00
01
02
03
04
05
06
07
08
010 10
11
12
13
14
2
1
0
15
*Index calculated as the lesser of NASDAQ Weekly New Highs and New
Lows as a percentage of issues traded.
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40
35
35
30
30
25
22.3x
20
20
16.9x
(World
Ex USA)
15
92
94
15
11.2x
(Emerging
Markets)
10
90
40
Foreign
Valuation Gaps Are
Still Gaping...
96
98
00
02
04
06
08
10
12
14
16
10
18
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Shanghai
Composite
5200
1.35
1.30
1.25
1.20
(weekly)
1.15
1.10
5000
1.05
1.00
4800
0.95
0.90
0.85
4600
0.80
0.75
4400
0.70
0.65
0.60
4200
4000
0.55
now at a
50% discount
0.50
0.45
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chart 3
3800
0.50
3600
0.45
0.45
0.40
0.35
3400
down almost
a third-but still a nice
gain on the
year
0.30
February
April
May
June
July
August
0.40
0.35
0.30
0.25
0.25
0.20
0.20
0.15
0.15
0.10
0.10
EM Allocation Model*
1.2
2015
LATEST
SIGNAL:
Switch into
MSCI World
Index
on February 28,
2011.
3200
3000
0.50
1.2
1.1
1.1
1.0
1.0
0.9
0.8
0.9
2015 The Leuthold Group
0.8
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
*Buy Emerging Markets when Total Return Ratio breaks above upper band, and remain positioned
there until Ratio drops below lower band, triggering a switch into the MSCI World Index.
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With Energy groups still ranking near the bottom of our GS framework (Refiners are the exception), is it
time to worry about Energy joining
the 40/40 Club (40% decline/40% underperformance)? Only the Consumer
Staples sector has achieved that status
(appropriately enough, during the
peak of baseballs steroids era from
1998 to 2000).
600
580
560
540
520
-32.8%
(August 4th)
2014
Mar Apr
500
May Jun
Jul
Mar
Apr
Chart 2
May Jun
Jul
Aug Sep
Chart 3
105
265
260
255
250
245
240
235
100
230
225
95
220
125
120
S&P 500
Health Care
115
110
1992-1993
215
90
210
205
85
200
80
-38.6%
1992 M A
N D 1992
M J
A S O
1993 M A M J
N D 1993
75
S O N
Chart 4
170
195
190
S&P 500
Consumer
Staples
185
180
175
170
1998-2000
165
160
165
155
160
155
150
-40.8%
2015 The Leuthold Group
O N D 1999
1999 M A M J
150
145
2000 M A M
J A S O N D 2000
145
140
135
S&P 500
Materials
130
125
1999-2000
120
-30.0%
1999
1999 M
M J
10
2000 M
2000
115
M
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As shown in Table 1, Health Care, Staples, and Materials sectors all reversed their 30/30 underperformance during the subsequent two years, beating the S&P 500 by an average margin of
+47.6%.
Table 1
S&P 500 Sectors To Have Declined 30% On Both An Absolute And Relative Basis
Outside Of A Cyclical Bear Market
Pct
Decline
Pct
Decline
Rel to
S&P 500
Relative
Perf.
Next
6 Mos.
Relative
Perf.
Next
12 Mos.
Relative
Perf.
Next
24 Mos.
16.3 %
57.7 %
67.7 %
Sector
Dates
Consumer Staples
-40.8 %
-55.1 %
Energy
-32.8
-39.4
Health Care
-38.6
-46.1
9.4
16.1
37.9
Materials
-30.0
-31.8
-11.3
23.1
37.3
Average
-35.5 %
-43.1 %
32.3 %
47.6 %
4.8 %
Chart 5
2000
1900
1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
-64.0%
2015 The Leuthold Group
2011
11
2012
700
(August 4th)
2013
2014
2015
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Avoiding Gold
The vast majority of recent gold commentary centers on its extremely oversold technical condition and the related washout in all sorts of sentiment indicators, ranging from trader surveys to futures
and options positioning. Maybe these conditions will produce a short-term bounce, but were going to
stand with the message of our bearish longer-term work.
Chart 1
Gold Futures
2000
(monthly)
1800
1600
Gold's 40%
decline still
looks
muted on a
logarithmic
scale...
1400
1200
1000
800
$693
Implied
target
if the
Gold/CPI
Ratio falls
to its 1970to-date
median.
600
400
2000
2010
Chart 2
200
150
200
150
100
100
50
-50
70
72
74
76
78
80
82
84
86
88
90
92
94
12
96
98
00
02
04
06
08
10
12
14
16
18
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