(561) 771-8077

contact@optimistcap.com

Inverted Yield Curve

The stock market traded in a narrow range this past week as the yield curve inverted, which many on Wall Street view as a harbinger of a looming recession. Others on Wall Street sometime observe that the history of inverted yield curves is one of predicting eight of the last five recessions! An inverted yield curve is defined as long term interest rates falling below short term rates, which suggests deflationary pressures down the road, which most translate as a recession looming a few months into the future. I am in the business of objective measurements of the strength, or weakness, in the supply and demand for stocks vis-à-vis decades of history, as predicting the future is almost always an exercise in futility, which can be very expensive in the arena of the stock market.

TATY – THE BIG PICTURE STRATEGIC INDICATOR

Last week’s update mentioned that there was a subtle, but growing negative divergence in the tops of TATY, shown by the down sloping aqua line on the chart above. TATY is a strategic indicator, whose measurements of supply and demand are helpful in determining, if the investment environment is favorable, or if rising risks are beginning to cast a shadow resulting in an unfavorable environment for stocks. Obviously during periods when supply is outstripping demand, a prudent investor would want to scale back their exposure to stocks, and conversely during favorable periods an investor would want to be invested to the maximum exposure allowed by their appropriate asset allocation. Asset allocation guidelines are determined by a number of factors like age, risk tolerance, and so on. At the moment there is a persistent negative divergence growing in this indicator, which is understandable given the age of the bull trend. However, this negative divergence has not yet reached a critical level, but it is far enough along to signal the potential for a more volatile investment environment ahead.

So when will TATY flash a warning that risks have grown to a level, which would compel prudent investors to consider scaling back their equity exposure to the stock market? The wispy and gossamer like euphoria attendant at major tops is often pierced by a sharp break in the stock market, which is then followed by a last gasp rally back toward the highs. This kind of price break can happen at any price level, but in terms of the indicator it shows up as a break into the caution zone surrounding the 115-125 level. I call this the “Big Chill”, as giddy and often highly leveraged investors get touched up enough to give them a good dose of sobriety. Having been chastened by the sharp price break, these usually institutional investors trading in huge size become more cautious on the next rally. This shows up in the indicator as a rally, which is unable to levitate itself at its previous rate resulting in a weak rally in the indicator, which is destined to fail in, or near the red zone surrounding the 140 level. At this point prudent investors should take the warning that a major top may have formed, and then scale back their exposure to equities to “sleep at night” levels. Is this indicator perfect? Well certainly not, no indicator is perfect, but this one is the most consistently accurate major top indicator I’ve found in decades of searching. And, please notice that the ”Big Chill” can occur at any price level, but the indicator tends to do its same gymnastics over and over unchanged, which is its significant value.

Risk management is all about determining where the tipping point is on an objective scale of risks monitoring the lost opportunity costs of not being in stocks, versus where the market may be on the risk scale of being trapped in a devastating bear market for equities. Successful investing is all about risk management, and TATY has an outstanding record of defining when it is time to risk the costs of lost opportunity over the more significant and compelling costs of being trapped in a big bear. In an arena where “perfect” is not an option, I’ll take an outstanding record of accuracy every time. Obviously, currently no “Big Chill” event has occurred, but the growing negative divergence is a sign the next one may happen sooner rather than later?

SAMMY —  THE FAMILY OF NEXT GENERATION TACTICAL INDICATORS

SAMMY, a representative for a next generation family of supply and demand indicators, is shown above with SPXL, and below with SPXL and 3x Leverage overlaid. SAMMY excels at helping execute intermediate trades, which tend to occur 5-8 times a year, sometimes more, depending on a number of factors. I’ve determined that taking more of these intermediate types of trades makes sense in an environment of the lowest income tax rates in decades. SAMMY will likely signal more tactical trades than we actually take, because I never trade just on one indicator alone, no matter how accurate. I have confirming criteria, which must be present to complete the process necessary to execute SAMMY trades. The confirming criteria circulates around the premium/discount indicator signaling a fleeting discount to “value” exists in addition to SAMMY issuing a signal.

SAMMY issued two buy signals recently, which would have worked out fine for SPXL, but not so much for VOO, the non-leveraged S&P-500 ETF, which is more appropriate for risk adverse clients (SPXL is only traded in my personal account, and some family accounts). The slower moving VOO is best employed for client trades, when both SAMMY, and the premium/discount indicator flash daily, or even better, weekly signals. In any case, I’m glad to see SAMMY continue to issue extremely accurate signals, which any professional futures trader would execute immediately, I want to see a high level of accuracy, even if the signal is not confirmed by other indicators, and so far so good. Over time I would expect this next generation family of indicators, confirmed by other indicators, to potentially be an important factor in significantly enhancing client wealth within reasonable risk tolerances.

THE BOTTOM LINE

The bull trend is showing signs of fatigue, which has not reached a critical level according to an array of supply and demand indicators. So, for the time being we will hold our current longs, and look to add to them, if presented with a low risk entry to put excess cash to work. Note to clients with legacy stock holdings, I’ve trimmed laggard stock and mutual positions into strength recently in order to take advantage of better opportunities as they may appear.

 

DISCLAIMER: Alpha Wealth Strategies, LLC (AWS), and/ or Optimist Capital LLC, does not guarantee the accuracy and completeness of this report, nor is any liability assumed for any loss that may result from reliance by any person upon such information. The information and opinions contained herein are subject to change without notice and are for general information only. The data used for this report is from sources deemed to be reliable, but is not guaranteed for accuracy. Past performance is not a guide or guarantee of future performance. Alpha Wealth Strategies, LLC, and/or Optimist Capital LLC, and any third-party data providers, shall not have any liability for any loss sustained by anyone who relied on this publication’s contents, which is provided “as is.” AWS and Optimist Capital LLC disclaim any and all express or implied warranties, including, but not limited to, any warranties of merchantability, suitability or fitness for a particular purpose or use. Our data and opinions may not be updated as views or information change. Using any graph, chart, formula or other device to assist in deciding which securities to trade or when to trade them presents many difficulties and their effectiveness has significant limitations, including that prior patterns may not repeat themselves continuously or on any particular occasion. In addition, market participants using such devices can impact the market in a way that changes the effectiveness of such device. The information contained in this report may not be published, broadcast, re-written, or otherwise distributed without prior written consent from Alpha Wealth Strategies, LLC and/or Optimist Capital LLC.

Regards,

Gregory H. Adams

Senior Portfolio Manager

Leave a Reply