iBankCoin
Joined Nov 11, 2007
1,458 Blog Posts

S&P, Treasury Bond Relationship: Bear Market Continues

What happens when 1-3 year Treasury Bonds and the S&P 500 are both stretched above and below their 20 day moving averages?

It is hard to miss the persistent news pieces about Treasury bonds rising, and even harder to miss the news about the S&P 500 falling. Is there a relationship between Treasury bonds and the S&P 500, and if so, what does it portend for the future? Let’s develop a simple model of the relationship…

Treasury bonds, as measured by SHY ( iShares Barclays 1-3 Years Treasury Bond ETF), is extended above its 20 day moving average. As of Friday’s close it was 0.16% above the MA20.

SPY is stretched beneath its 20 day moving average. As of Friday’s close it was -8.43% beneath the MA20.

The Rules:

Buy SPY at the Close If:

  1. SPY is stretched more than -5% beneath its 20 day moving average
  2. SHY is stretched more than 0.10% above its 20 day moving average

No commissions or slippage included. All SPY and SHY history used.

The Results:

I isolated SPY performance after it was more than -5% beneath its MA20.  I also isolated SPY performance after SHY was more than  0.10% above its MA20. Separately, each event is neutral to bullish over the intermediate term. However, when combined, they are bearish.

Sample size is a possible issue. These events tend to cluster so that the longer each trade is held, fewer samples are available. Let me know if that concept is confusing. There were 47 occurrences of the setup if each trade was held only 1 day, but only 7 if each trade was held for the full 100 days.

Still, since there were plenty of samples of the isolated variables, I’m inclined to consider that we might be in the early days of another protracted bear market. If you pay attention to nothing else, pay attention to the volatility shown by the setup results (blue line). I’ve been highlighting for weeks now that we have to be prepared for large, volatile swings, in either direction. This study does nothing but confirm that volatility will be a key feature, going forward.

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Volatility is Screaming BUY!

Do you feel lucky, punk? Do you? Ranked volatility is suggesting that now is the time to be buying, for long-term buyers. The setup has been right 72% of the time. The problem: Is it different this time?

One of David Varadi’s premium indicators ranks volatility. It looks back in time and compares current volatility to volatility in the past, and ranks the result on a scale of 0 to 1. Looking back over the past 252 trading days (one calendar year) , we see that ranked volatility is higher than it has been in over a year. Hat to Jeff Pietsch over at ETF Prophet for directing my attention to this.

So what happens when we buy such extreme volatility?

The Rules:

  • Yesterday, Ranked Volatility = 1. Today, Ranked Volatility < 1. Buy SPY at the Close.
  • Sell X Days Later (from 1-100 days).
  • No commissions or slippage included
  • All SPY history used.

The Results:

Obviously, buying when volatility is high, relative to the last 252 days, works. However, during a true Bear Market, buying volatility can lead to disaster. (See spreadsheet below, noting 2008 results). There is likely a method to mitigate the disaster, but I do not intend to write about that tonight.

What I’d like to highlight is how the results above suggest a change in the character of the market. These returns are generated by holding the trade for 100 trading days.

From 1994 to 2000, there were 6 trades that generated double-digit gains. (Yes, I’m aware there was huge Bull Market). From 2001 to 2007, there was only 1 trade generating double-digit gains. Despite a huge bull run of almost 100%, there have been no double-digit gains generated from 2008 to the present day.

I’m not sure what this all means. I just think it is significant. Perhaps the old adage about buying when there is blood in the streets has run its course. Maybe even Warren Buffett, who is famous for buying panic and disaster, has so thoroughly popularized the methodology as to render it impotent.

Are You Feeling Lucky?

Past history shows that we have arrived at a significant buying opportunity for long-term holders. More recent history suggests the edge is wearing thin.

The market always seeks to remove money from the naive, and the naive are much more likely to be swayed by emotion. Since high volatility is very likely to increase the influence of emotion and increase investor anxiety, I personally have difficulty believing that buying when there is blood in the streets is losing its edge.

Therefore, I’m Nibbling Tomorrow

Look, I’ve been saying for weeks, if not months, that we will be trading in a volatile range. A re-test of the current bottom is very likely. While swing-trading high volatility markets can be very, very profitable, short-term trading in these environments is best left to professionals. For everyone else, this is the time to deploy a small amount of cash in accounts that run long-term trades. Make sure the amount of cash deployed is small enough not to cause extreme angst should the market continue tanking but large enough to contribute to the long-term success of the account. In other words, don’t bet enough to cause you to sell at the bottom if the market trades much lower, but do bet enough to ensure you are rewarded for buying such a challenging (but potentially very rewarding) market.

BONUS!

Here is a graph of all the trades made based on the setup, over the last 7 years. Green arrows show the buys, and red arrows show the sells 100 days later. The lower pane displays the indicator. Finding the bottom looks easy with this indicator. Knowing when to sell, as always, is the hard part.

 

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I Don’t Much Care for Yankees

But I love NYC.

Mrs. Woodshedder and I are headed to Yankee Land for the annual iBC equity partners meeting.

Unfortunately Senator Gint will not be meeting with us. I understand that he was intimidated by my ghetto workout last year. He believes that I might challenge him to a push-up contest. As not to embarrass himself, he will not be attending. He and his lovely wife will seriously be missed.

I believe the rest of the gang will be with us, including Chuck Bennett, Jeremy, and Cronkite.

As I type, Chess and Cajun are painting the town purple and gold.

I understand that Fly has procured the most opulent of establishments for our repast, complete with gilded curtains and silver-plated ceramic tiles. The lint generated from the 14k gold fabric on the chair backs would fund a medium sized Mexican drug cartel, if it were not removed and recycled prior to exiting the establishment. Restrictions on pipe smoking have been suspended and the finest of southern Whiskey has already been delivered. A gallon of blueberry shine awaits those who wish to sample Virginia’s finest export. We left the possum at home in the freezer.

Do not let the epicurean nature of our meeting dissuade you from believing the important nature of our true business. Indeud, at the close of our covert assemblage, we will have planned and implemented said plan to ensure the continued domination of iBankCoin over the financial blogosphere. For you, dear reader, this is a win-win.

Many of you have recently left me some great comments. Unfortunately, due to work and getting ready for a trip to NYC, I’ve been busier than a one-armed man in a wallpaper hanging contest. I hope to be able to respond over the next few days. Should I not, just know that I very much appreciate the input.

As for the markets, take the weekend to re-group. As I’ve mentioned recently, a large increase in volatility will affect the markets over the intermediate term. Even if volatility slowly decreases, there will still be large swings. They will just get smaller and smaller.

At today’s close we completed a Death Cross, which is a cross of the 50 day moving average beneath the 200 day moving average. I have written previously about the Death Cross. Below is the link to a post which should go a long way towards covering everything you need to know about the Death Cross.

What you NEED to know about the Death Cross

Have a good weekend…

 

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New 200 Day Lows Makes for an Ugly, Volatile Future

On 8.8.11, SPY made a new 200 day low. As the results will show, a market making new 200 day lows remains volatile and prone to failure for many months going forward.

I’m still struggling with the best way to model an abnormal market that is making history daily with unprecedented action. The idea is to get enough sample sizes to feel confident about the results. The SPY’s recent 200 day low may offer just what we need: decent sample size and objective criteria to help avoid curve fitting.

The Rules:

  • Buy SPY at the Close When It Makes a New 200 Day Low (on a closing basis)
  • Sell at the Close X Days Later
  • No Commissions or Slippage Included
  • All SPY History Used

The Results:

There have been 74 occurrences of new 200 day lows. As the graph shows, once a new 200 day low is made, SPY tends to want to revisit that low.

I stretched out the results over 100 trading days as I think it is important to understand the long-term effect of a new 200 day low on the market. Based on these results, a new 200 day low seems to continue to produce a volatile, somewhat range-bound market, for many months following the occurrence.

And indeud, we have been experiencing the volatility first-hand. The blue line shows that after a new 200 day low is made, the market spasms periodically, producing wild up and down swings of 2% or more.

To demonstrate the difference in volatility, I added the results of buying SPY after it makes a new 200 day high. Newton would be proud to see his first law demonstrated so simply. In fact, this illustrates how we should be thinking about a market making new 200 day lows. It is constantly being bombarded by outside forces, whether they be economic, or psychological. In contrast to the market making new 200 day highs, almost every force is stronger than the market itself, and it is constantly buffeted by the changing winds of the economy and investor fear and uncertainty.

The market making new 200 day highs is carried by its own momentum. The momentum allows the market to shrug off bad data and investor fear and uncertainty.

A few posts ago I made the remark that this market was going to eat people alive, if they were not very careful. Looking at the blue line, I’d say the market has a voracious appetite and will be hungry for some time. Discipline is the key. One must face this market without emotion, if he wants to avoid being eaten.

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Modeling the Devils Bottom: Will We Revisit the Crack?

The market put in an incredible reversal today with a huge intraday swing which was even larger than yesterday’s -6.66% loss. Not surprisingly, the extreme down and back up volatility has not happened very often in the past. However, there have been similar instances, and they have all led to a re-test of the bottom.

Unfortunately, I tried exactly modeling the past two day’s market action, and there are only several comparable instances. I had to loosen the criteria a bit, and even then, I have only come up with 5 other occurrences. Describing recent market action as unprecedented would not be inappropriate.

Anyway, here is what I used to model the Devil’s Bottom.

Buy Rules:

  • Buy SPY if Yesterday Closed Down More than -2% and the Close was a 100 Day Low AND Today Closed Up More than 2% and Today’s Volume was More than Yesterday’s Volume
  • Sell X Days Later
  • No Commissions or Slippage Included
  • All SPY History Used

A quick word about my methodology: Yesterday’s volume was incredible, but if I get too specific trying to get a near match of yesterday’s volume, it limits the sample size. Therefore, I just required today’s volume to be more than yesterday’s. It seems to work as anytime the market is putting in new 100 day lows, volume is swelling.

I also tried requiring a new 200 day low (yesterday was a new 200 day low) but that limited sample size. Again, I sufficed for the less restrictive 100 day low.

I also tried messing around with the relationships between yesterday’s and today’s opens and closes. Again, it was just too restrictive. As it stands, even with the less restrictive buy rules above, there were only 5 samples, not including today.

The Results:

Bottom Line:

Every instance saw a re-test of lows.

I’m not at all confident that these results are generalizable due to the small sample size.

What I do know is that the market is still in an abnormal state in a climate of high volatility with a 200 day moving average that is rolling over. An abnormal market will do abnormal things, and even if volatility starts to decline, it will decline with ever smaller spikes and waves.

My money is on a re-test. As I am writing this, I am working through some possibly more effective and generalizable ways of determining whether a re-test is likely. Stay tuned!

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The Devil’s Bottom

It was noted last night that yesterday’s loss on the S&P 500 was -6.66%. Also noted was the Bear Market end in 2009, where the S&P 500 bottomed at 666. This led longtime friend of the blog Redshark to christen the yet-to-be-formed-possible-future-bottom “The Devil’s Bottom.” As much as I like Fly and especially Chuck Bennett, his nomenclature is trumped as my blog is proof that the bottom was already named, yesterday evening.

Until it fails (more on that in future posts), let it be known that today will live in infamy as The Devil’s Bottom.

 

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