Today you’ll hear the term ‘triple witching’ a lot in the media — it refers to four Fridays a year when stock index futures, stock index options, and stock options all expire on the same day. The expiration can lead to unusual volatility in markets as traders scramble to offset positions. This could make things quite bumpy, but I think there may be a more important triple witch – one that has provided the catalyst for a deep correction in U.S. markets.
In the world of technical analysis, the symmetrical triangle represents a battle between bulls and bears. Neither side gains ground while the market forms this pattern, and the result over time is lower highs and higher lows. However, the direction of the next major move can be determined following a valid breakout of the pattern.
Over the past few weeks our proprietary quantitative model has experienced a significant decline, falling from an almost unequivocally bullish reading of 7.45/10 to a lower neutral reading of 4.33/10. The deterioration in the overall score was caused by a broad-based decline in several important variables including, among others, the relative momentum in early cyclical, late cyclical, and defensive sectors, the steepening of the yield curve, the growth-sensitive Australian dollar to Canadian dollar exchange rate, and implied volatility.
The overdue market correction analysts and pundits have been waiting for may have arrived with the breakdown of the S&P. It has been a two stage process, with Japan breaking first and the U.S. and the rest of the world following suit. One of the interesting aspects of this correction is that bond yields are moving higher as stock prices have been moving lower. In Japan the focus has been on a bond yield rising in a nation with very high debt levels. In the U.S. yields have been going up too, and the buzz has been that the Federal Reserve may start “tapering” down their $85 billion bond buying spree (known as QE Infinity).
So far in 2013, U.S. investors have enjoyed a steady climb in stocks, with the major market averages surging into record-high territory. There’s been a near absence of any sort of market volatility, with the CBOE Volatility Index (VIX) sliding to multi-year lows. Whatever the reasons behind the rally, it’s been gradually bringing back positive vibes on the part of market participants. In other parts of the world, however, the story is different: There’s been a greater degree of volatility in many international markets, and in general, international stocks have lagged behind the U.S.
There is an entire school of investing that would have you screening for stocks that are making new lows in price on the assumption that the best values can be found in that group. I recently wrote about the strange psychological wiring of value investors who believe that they can outsmart Mr. Market and find investment ideas that are mispriced by the crowd. They are supported in their belief by the study of momentum and crowd psychology which shows that investors often over react to bad news and sell securities at prices well below their intrinsic value. With steely nerves and an ability to see value that the rest of the market doesn’t see, value investors are the heroes of the professional investment universe (foremost among them, of course, is Warren Buffett).
One concept that is common in the investment world is the idea that assets will typically revert to the mean or mean reversion (the average). This may seem a bit contrarian since it essentially means that when an asset price returns in excess of its long term average return profile, over time it will likely reverse course and return to that long term average. Imagine a rubber band that gets stretched…. and then eventually snaps back to its normal size.
One of the hot investment phrases streaming through the investment media lately is “currency wars.” This refers to the idea that governments around the globe are fostering weak currency policies in order to export their way to prosperity at a time when world aggregate demand is weak. Japan is the latest country to weaken its currency, as new leadership has recently diluted the value of the Yen materially in an attempt to jumpstart their way out of deflation. So with all these countries racing their currencies to the bottom, shouldn’t gold be the store of value that we can all depend on? One look at the chart below tells you that gold has not received the memo.
How to determine the proper time horizon to evaluate portfolio performance is always a subject for an interesting conversation. In a recent client survey on investment issues, we asked our clients “What time horizon do you feel is the best time frame to evaluate portfolio returns?” The results varied: 16% said “Monthly,” 43% said “Quarterly,” 37% said “Annually,” and 4% said “Over a complete market cycle.” (As an investment professional, I would have selected the last option.)