(LTSMTM
UPDATE
Continued)
SteveT is quite modest, but he has accumulated quite a bit of
knowledge about Bob Brinker, his timing model and methodology. I think Steve has great insights into
Brinker's operations. Quite frankly, I
know that Brinker knows about Steve's work, and I don't think he is all that
happy about it, as Steve hits the mark quite often!
SteveT: A while back I got to wondering what causes
Bob's model to change from bullish to bearish or bearish to bullish. Is it simply his personal expectation for
future market returns? Does he really
have a "model" that he completely relies on? Over the years, certain things kept coming up
repeatedly that led to a hunch on my part about "the model." I have looked back in time trying to identify
what triggered a change in Bob's model and I believe I am on to something.
I have written in the past about how I thought Bob viewed his
“model” at that particular point in time and how I believe the “model” is
constructed. We all know Bob looks at
numerous indicators and the “model” is quantitative and does ultimately depend
on Bob making a subjective judgment at some point to alter his allocation. The “model” was originally entirely comprised
of fundamental analysis indicators.
After Bob made a major mis-timing move, getting out of a bull market in
1988 and not becoming fully invested again until January 1991 when the DOW was
some 20% higher, he added the Technical analysis component. Technical analysis ("TA") relies on
things happening a certain way because they acted that way before under the
same conditions. Detractors often say TA
is not reliable since things are never exactly the same as they have been in
the past. In one sense, Bob’s “model” in
entirely technical analysis since he is relying on things falling into place
this time because they did previously.
You can see how it is easy to go in circles trying to follow this stuff.
I will say having a model to study does have the advantage of partially
eliminating some of the emotions we all face at the tops and bottoms of the
market cycle.
We all know from listening to Bob on the radio that he claims to
be able to know when to be in the stock market and when not to be. I believe Bob's model is simple but
logical. Everyone knows the stock market
is uncomfortable with things like inflation and a tight money supply. We also know that trees don't grow to the
sky, and there is a limit to how much people will pay for the prospect of
future earnings. When economies grow to
fast and future inflation fears arise, interest rates will increase and that
has historically put pressure on share prices.
It has been said that the stock market is a discounting
mechanism. It tries to anticipate what a
stock or group of stocks will be worth 6-12 month down the road. In the interim, volatility can move stock
prices widely, offering opportunity for both buying and selling of stocks at
favorable prices. Or at least that is
the theory.
|
Methodology.
I have always believed that Bob has a great deal of respect for
valuation. Every Monday when he examines
his model, I believe Bob starts by calculating the current P/E ratio of the
S&P 500 -- the Index which Bob says his current timing model tracks. Determining the market's valuation can be a
daunting task since there are many methods to choose from. We do know the stock market is a forward
looking device. Based on Bob's past
statements, I believe he looks at forward operating earnings.
In going back to look at what makes his model tick, I found it
practical to use actual earnings for the period in question. This minor adjustment would cause my figures
to fluctuate from the actual numbers Bob may have used.
I believe after making the initial P/E calculation, Bob compares
that to the P/E of the FED model. What
is that you say? Simply put, you take
the yield of the ten-year Treasury bond and divide that by 1. For example, if the current yield is 4.726%,
you use the formula (1/4.726)*100 = 21.15. If the current P/E is below 21.15
the market could be deemed undervalued and if over 21.15 it could be classified
as over valued.
DavidK EC: Bob has been consistent in saying that his
model is "either bullish or bearish."
In other words, there is no in between which suggests that he might
actually assign a number based on the data points which triggers the decision
to issue a buy or sell recommendation.
That said, Bob's own "interpretation" of his timing model has
suggested that he assigns various degrees of the bearishness or bullishness of
the model.
SteveT continued: It is important to separate historic valuation
from current valuation. Bob's method
allows you to stay invested in equities when valuations are high historically,
provided we are in a low interest rate and low inflation environment. You might be tempted to go back to the 1988
to 1991 and check this theory. I'll save
you the trouble. It doesn't jive, but remember Bob's timing model failed during
that time, and he allegedly changed it after wrongly exiting a bull market in
the late 1980s.
After making the first calculation, I believe Bob quickly reviews
the other segments of his model. My
guess is that he starts with the Monetary policy indicator, followed by the
Economic indicator. Then, he finishes up
with his newest indicator, Sentiment, which seems to be evolving to this
day. I suspect that even if the last
three indicators were in conflict with the Valuation Indicator, Bob would still
be hard pressed to announce a change in his model outlook. In fact, I believe he uses these secondary
indicators to confirm what the Valuation Indicator is saying. He may even look to these secondary
indicators to pick a precise time to pull the trigger.
The art and science in all of this, is trying it assimilate the
information and determine which indicators deserve the most weighting at any
particular time. With that said, and
with DavidK's help, let's look at the individual components of the model with
an eye toward how they might translate now.
MODEL ANALYSIS
VALUATION INDICATOR
SteveT: Bob recently upped his 2007 S&P 500
earnings estimates to $88.00. If we use
Bob's $88.00 figure, based on the March 2nd close of 1387.17, that results in a
P/E multiple of 15.76. In the past, Bob
has said that he is comfortable with a P/E range of 16-17 this year taking into
account the subdued inflation environment.
If we can manage a couple of dollar increases in earnings and reach
Bob's high end multiple of 17, then we would be in record territory for the
S&P 500. If we look to the FED model
as a valuation metric, we find a long treasury yield of 4.51% suggests a P/E of
22 would not be overvalued. This
indicator is bullish.
DavidK EC: Bob Brinker tracks the P/E ratio of the
S&P 500 when analyzing the valuation component of his timing model. Contrary to what some people think, he does
not use the Dow, nor does he use the Wilshire 5000. Earnings tracker First Call
is now forecasting year-over-year earnings growth of just 3.9% for companies in
the S&P 500 in the first quarter.
That would end a streak of 14 straight quarters of double-digit growth
and be the thinnest gain since the second quarter of 2002. As earnings come in, we can get a better
gauge on the P/E of the market. I agree
with Steve, however, that Bob's Valuation Indicator remains bullish at this
juncture.
MONETARY POLICY
SteveT: Bob looks at short term rates and real money
supply growth in connection with the Monetary Policy Indicator of his timing
model. Some feel short term rates will
fall later this year. I have yet to see
the need. Recession and persistent
inflation are a non-issue in the near term according to the ECRI. The Fed's favorite inflation measure, core
PCE came in at 2.3% year over year.
Until this drops below 2%, I see little chance of the Fed coming off
their neutral stance. That could come
later as ECRI's FIG is hinting that we have seen the peak of inflation and we
should see gradual moderation in the coming months. Real growth in seasonally adjusted M-2 money
supply is currently at 2.76%. We are
getting close to the territory where this kind of money supply growth can get
the economy moving enough to sustain growth.
For now, I am going to continue to rate Monetary as neutral, but feel we
are on the cusp of it becoming bullish.
DavidK EC: Bob follows the monetary supply to determine
the necessary liquidity for continued expansion in the United States
economy. Bob has referred to the M-2
money supply as "the fuel of our economic growth." In early December
2006, Bob was pounding on the table that
the Fed would have to cut rates early this year. At that time, the Fed Funds futures were
reflecting a 70% odds that a rate cut would be implemented in the first
quarter. Several weeks later, the
futures dropped dramatically and Bob (and all the other pundits) clammed up
about rate cuts. Recently, along with
the weakness in the stock market, the odds of a rate cut went up quickly and
now show a 76% chance that the Fed will lower its target for overnight rates to
5% (from 5.25%) by the end of its policy setting meeting in late June. This is an increase from late Thursday, when
the odds of a cut stood at 58%. I rate
this indicator as neutral right now as well.
ECONOMIC INDICATOR
SteveT: The GDP revision came in at 2.2% which was
below the 2.5% forecast and well below the advanced report of 3.5%. Revisions are to be expected since much of
the data used in making the final calculation become available after the report
is published. Keep in mind two things,
this number will be finalized on March 29th and revisions often vary widely
near times of turning points. I think as
we progress towards the end of 2007 we might see GDP top 3%. Bob sees 2007 GDP in a range from 1.5% to
2.5%. Regardless of which guess is
closer, neither of us is predicting a recession this year. We are seeing some improvement in U.S
manufacturing as witnessed by this weeks ISM report. Whether this becomes a trend is too early to
tell. It seems nothing, not even
depressed housing will rattle U.S. consumer spending. Bottom line is the backdrop is favorable for
improving global growth and sound earnings potential for U.S. multinationals in
particular. This is bullish for stock
prices.
DavidK EC: Bob has also mentioned that "forward
earnings momentum" and "economic momentum" comprise this indicator. What is important relative to this indicator
is the rate of growth in the economy. I
have a hunch he also looks at productivity as a way to see just how much growth
we can enjoy without inflation becoming a problem. The last time I did this timing model
update, I said that I was getting more concerned over the cost of borrowing and
the housing market as causing a recession in 2007. Right now, I don't see a recession this year,
but I would agree with Greenspan that there exists a probability it could
happen, albeit a very small one.
EC#2: The economic indicator is one of the toughest to
rate. The economic data we get monthly
is based on what happened in the past.
You have probably heard the famous quip that economists have forecasted
9 of the last 5 recessions. Still, when
you are a market timer forecasting is your "stock" in trade, so to
speak. That's why things like the
"yield curve" are important to track as an inverted yield curve has
often been a precursor for recessions.
One thing that I follow closely and I know Brinker does as well is
the Economic Cycle Research Institute (ECRI)'s Weekly Leading Index (WLI) which
is a gauge of future U.S. economic growth.
ECRI which claims to have accurately predicted the last three
recessions, argues that the current slowdown won't amount to much more than a
lull and that by the middle of the year, low interest rates and healthy
corporate spending will have the economy growing nicely again. Lakshman Achuthan, ECRI's managing director,
said last week that he thought the odds of a recession over the next year were
less than 20 percent. Read the article
where he is quoted saying this at the following url:
http://tinyurl.com/29g95v
All in all, the Economic Indicator is the hardest for me to rate right
now. I rate it neutral.
SENTIMENT INDICATOR
SteveT: Analyzing sentiment is something that Bob added
to his “model” after the poor performance he suffered in the 1987 to 1991 time
frame. When I first recall him
mentioning it, the primary data point was the Investors Intelligence four week
moving average of Bulls/Bulls + Bears.
The four-week moving average in that data point is currently
69.44%. That is the high end of Bob's
neutral range. The American Association
of Individual Investors weekly poll has historically been volatile and the past
three months is no exception. Their
current four week moving average reading of bulls/bulls + bears is 59.97. It seems this week's action really alarmed
AAII members as this ratio is 48.03%.
After an extended period of low numbers the VIX popped up noticeably
this week and ended the week at 18.62.
This is merely a confirmation of the volatility since Tuesday. The Put/Call ratio 10-day average is a lofty
1.19 and the 60-day is 0.94. These are
numbers often seen around correction bottoms.
Remember these are contrary indicators so all this bearishness is
frequently a sign the worst is over.
DavidK EC#1: Bob views Sentiment as a contrarian
indicator. As Steve accurately noted, I
believe Bob began with primarily the weekly poll of investment newsletter
writers done by Investors Intelligence.
Bob uses the formula bulls/(bulls + bears) to yield a percentage. When the number comes in between 50% and 70%,
Bob views it as a neutral sentiment data point. When the number comes in under 50%, it is
viewed as a bullish indicator as it means the majority of newsletter editors
are out of the market, and the only way they can affect the market is by buying
back into it. If the percentage drops to
under 50% (after checking the other indicators) it often in the 1990's
indicated a buying opportunity or as Bob said, a "Gift Horse Buying
Opportunity." Again when it drops
to under 50% that means that one or more of every two newsletter writers are
bearish. They are out of the market when
they should be buying. Bob has referred
to the newsletter writers who are in the "Correction" category as
"clueless" and do not factor into his calculations. When the number is over 70%, it represents a
lot of bullishness among advisors, which is a dangerous level from a contrarian
standpoint. Bob attempts to smooth out
the weekly bumps by looking at the 4-week moving average of this
percentage.
SteveT: I believe that as time goes by, Bob has
learned more about technical analysis and added other data points to this
Indicator in an attempt to diversify and avoid mistakes. During the panic of autumn 1998, Bob started
talking about other indicators such as the Put/Call ratio. It was also then he seemed to key in on
market internals such as new highs/new lows, advance/decline, volume, etc. He liked to see the market make a bottom and
then drift higher, then retest the low on lighter volume. The theory was that those that were going to
sell already did and that only left buyers left to move the market. To my way of thinking, the Sentiment
Indicator is BULLISH.
DavidK EC: In recent times, it appears Bob added the TRIN
and the VIX to the mix and there are quite a few more. I think the sentiment picture is bearish
enough that it lends credence (from a contrarian perspective) that the bull has
more to run. Sentiment, however, is a
lagging indicator, so just because there is a lot of bearishness, doesn't mean
that the market has bottomed.
CONCLUSION
SteveT: There hasn't been any dramatic changes since I
last checked in. I still believe the
strong fundamentals outweigh some of the short term emotions we all experienced
this week. To summarize, I believe Bob
Brinker's timing model is still bullish with three bullish indicators and one
neutral but improving indicator. No
reason to panic. Stay disciplined and carefully consider any moves you may be
contemplating As a homework assignment,
check out what was going on with economic growth coming out of the FED
tightening cycles of 1988-1989; 1994-1995; and, 1999-2000. Compare those figures to what we are seeing
now. I think in those prior tightening
cycles, the FED overshot and slowed the economy too much. To me, it looks like this time they got it
just about right. In other words, I
believe this bull still has legs.
DavidK EC:
I agree with Steve and believe Bob is still
bullish. I think Bob may actually use
the opportunity in his newsletter tomorrow to issue parameters under which he
would recommend an outright buy into the market. Just to take a guess, I think he might
recommend buying into the market when the S&P 500 is at 1350 or below. I
want to extend my thanks to SteveT for providing this guest editorial and doing
a great job as always!
|