I know some of you had hoped that I have some sort of crystal ball or system that will tell when me the market is going to go up or down. Well that is half true. What I have is a strategy that tells me the when the odds favor the market going up, down or sideways. That doesn't mean the market will cooperate, as we have seen.
Some would say playing blackjack or poker is gambling. But what if the odds are in your favor? Let's say you are playing blackjack. You have a 14 and the dealer's up card is a 10. You have been counting the cards and you know that there are 12 cards left, 8 that will improve your hand and only 4 that will bust you. That's a nice 2 to 1 advantage that your hand will improve. Does that mean you will improve your hand? No. Like the market, there are no guarantees. But if you had this same situation over and over, in the long run you would improve your hand 67% of the time and you would bust the hand 33% of the time. The best play is to take the card even though you could bust.
Don't play blackjack? How about flipping a coin. If you flip a coin 10,000 times you are likely to have close to 5,000 heads and 5,000 tails come up. If tails comes up 9 times in the row, what are the chances the next flip will be tails? Of course it is still 50/50. You have no advantage no matter what happened in the past. Odds are odds.
So when my indicators are telling me there is a high probability that the market is going to go higher (or lower), what are the chances that it will happen today? Same deal. It can go either way. But if you ask me what are the chances it will be higher one to three months from now, I feel a lot better about my indicators being correct. But like the coin or the cards, it may not go your way in the short run.
I can list 8 or 10 indicators that tell me that stocks will go higher soon, but they said that last week as well. Not much comfort there for you. So what is the market trying to do? If you look at the chart of the S&P 500 below, you will see some repeating patterns. Based on the indicators, I was hoping we would see 1163 hold. Since it did not, we have to determine what it might do next. Last summer we had a similar formation in that a prior low's support held (point #2) and a small rally ensued. That rally was short lived and the next test a week or so later failed. Now we are seeing a very similar situation.
Charts provided courtesy of www.decisionpoint.com
In early August it continued to waffle around for a few days after the break of support, before a rally started. That sounds reasonable but of course anything can happen. I'm just playing the odds my indicators are giving me.
Someone had asked about bonds versus stocks right now. Although there are other options, for the most part people are either invested in stocks or bonds, whichever may give the best return. Some people like to use price / earnings ratios (P/E's) to determine if stocks are over or under valued. I like to use the yield of 10 year treasury note versus the forward earnings yield of the S&P 500. With the 10 year T-note currently at 4.37%, and S&P earnings yielding over 6.5%, it actually makes stocks 32% undervalued.
To keep their accounts allocated "correctly", many diversified investors and money managers sell stocks to when they go up and distort their desired stock/bond ratio, and vice-versa. Right now that ratio is at a point where they might be lightening up on bonds and buying some stock.
Chart provided courtesy of www.sentimentrader.com
The scale on the Stock/Bond Ratio is the number of standard deviations the ratio is from its mean value. The lower the ratio, the more stocks are undervalued against bonds.
Will the market crash? I sure hope not. I just don't know for sure. Right now it is time to hit that 14 against the dealer's 10. Odds are your hand will improve. If we bust, we just have to move on to the next hand.
That's all for today. Currently 60% C, 40% S fund. See you tomorrow.
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