Use high yield bond fund to time market and economy

As you might know, stock indexes are like chained pets walking with owners, sometimes they go too far, sometimes they stay too close, but they will stay in the course of their owner, which in investment cases are moving averages or trend lines.  So the day-to-day movement of stock indexes are mostly noise controlled by animal spirit, not driven by economic forces, so is there such a rational trading vehicle that moves slowly daily, has minimal day-to-day animal spirit driven noise, and sticks to ecnonmic force driven trend? The answer is yes, and they are high yield bond funds (HYBF).

Due to the fact the HYBF are more rational, they usually are good warning signals for stock market, as in good times, animal spirit tend to be overly optimistic, driving stock indexes to new highs as economic conditions starts to deteriot; while in bad times, animal spirit tend to be overly pessimistic, making stock indexes stay low for too long as economic conditions already starts to recover.

As HYBF day-to-day price actions are more rational than those of stock indexes, HYBF's moving averages are more reliable indicators in terms of avoiding day-to-day noises, and following underlying economic trends.  Such events as short term moving average, such as 50 day moving average, crossing over long term ones, such as 200 day moving average, usually indicate economic turning points.

Let's backtest our model, using JP Morgan High Yield Bond Fund (OGHBX), looking at 2007-2009 time frame.  In early June 2007, OGHBX topped at 6.31, 4 months earlier than stock market top in October, its 50D MA moved under 200D MA in Aug 2007, confirming economic deterioration; In mid Dec 2008, OGHBX bottomed at 4.39, 4 months earlier than stock market bottom in March 2009, its 50D MA moved over 200D MA in May 2009, confirming economic recovery was starting.

OGHBX chart from 2007-2009

Using this model, if we look at OGHBX chart now, although we are not certain whether 8.22 high in May 2011 was the near term top or not, 50D MA did move under 200D MA in August 2011, confirming economic weakness.

OGHBX chart from 2009-2011

Based on the above information, the following 4 scenarios are layed out:

• Scenario 1: OGHBX will make a lower high in next 4-6 months before heading down to lower low, at the same time stock index will make a higher high.  Probability: 40%.  Reason: this round of stock index correction is sharp, yet is still within 20% bull market correction range, therefore possibility of making a higher high remains.
• Scenario 2: OGHBX will make a lower high in next 4-6 months before heading down to lower low, at the same time stock index will make a lower high.  Probability: 30%
• Scenario 3: OGHBX will make a higher high in next 4-6 months (true top), stock market index will make a higher high.  Probability: 25%
• Scenario 4: OGHBX will make a higher high in next 4-6 months (true top), stock market index will make a lower high.  Probability: 5%

Monthly Intraday Charts for SPY and SSEC: 2011-08

This is a monthly series of intra-day charts for S&P 500 (SPY) and Shanghai Index (SSEC) for July 2011.  


SPY

SSEC

How to parse jobless claims message

WSJ ran a educational piece on 8/11/2011 on how to interpret jobless claims messages:

Perhaps the most important data release this week is Thursday's report on jobless claims. These Labor Department figures have a remarkable track record for pegging economic turning points.
They also can signal where stocks are headed.
Lately, claims have sent a mixed message. The outright level of jobless claims remains uncomfortably high; the four-week average stood at 407,750 as of July 30.
By contrast, two years into the last economic recovery, claims had fallen to about 360,000.
Still, the pace of newly filed claims has slowed a bit lately. The four-week average actually peaked in mid-May at about 440,000, and its improvement since did foreshadow the better tone of July's employment report.
There are a host of reasons now to suspect that the improvement may not last. First is the jump in layoff announcements of late. These hit a 16-month high in July, according to Challenger, Gray & Christmas, thanks to major cuts from large companies like Cisco Systems and Merck & Co.
Second is the sharp selloff in stocks, which has undermined confidence and deepened concerns about economic growth.
Third, Japan-related disruptions to typical auto-plant shutdowns this summer may keep claims artificially low.
All this may put upward pressure in the weeks ahead on jobless claims. The key, though, is whether they surpass year-earlier levels.
As John Lonski of Moody's Analytics notes, the last three recessions occurred after jobless claims posted significant year-on-year gains. For now, their level stands about 10% below where it was at this time last year.
"It is imperative for financial markets and for the economy that we avoid another upward trend," Mr. Lonski says.
There are glimmers of hope: The number of U.S. job openings edged higher in June, as separate Labor Department figures showed Wednesday. The ratio of unemployed to openings has now fallen from a high of over 6 to 1 to about 4.6 to 1.
Even so, it will be a long wait before openings, currently about 3.1 million, return to the 5 million level seen before the recession started in December 2007.
The labor market's rebound has so far been halting. It will need to take more than baby steps for the U.S. to get up and running again.

True Capitulation? 80%, Bottom to be revisited? 50%

From April 29's high 1370 to yesterday's low of 1119.28, S&P 500 index retraced more than 18%, a severe correction, on the verge of 20% definition of bear market.  This magnitude is greater than 17% correction in summer of 2010.

According to Investopedia.com, Capitulation happens:

When investors give up any previous gains in stock price by selling equities in an effort to get out of the market and into less risky investments. True capitulation involves extremely high volume and sharp declines. It usually is indicated by panic selling.  

The term is a derived from a military term which refers to surrender. 

After capitulation selling, it is thought that there are great bargains to be had. The belief is that everyone who wants to get out of a stock, for any reason (including forced selling due to margin calls), has sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that true capitulation is the sign of a bottom.

Some other investor professionals also require more than 10% drop in major company's stock price or better, major indexes, yesterday Bank of America's price dropped more than 20%, Financial ETF (XLF) dropped more than 9%, S&P 500 itself dropped 6.66%, Nasdaq dropped 6.9%.  All these factors plus the fact that S&P is on the verge of 20% edge that distinguishes bull market correction from bear market.  It's very likely yesterday was the true capitulation i.e. the bottom, the likelihood is 80%.

Now the next question is will that bottom be revisited in the near future?  I give it a 50% chance right now.

Monthly Intraday Charts for SPY and SSEC: 2011-07

This is a monthly series of intra-day charts for S&P 500 (SPY) and Shanghai Index (SSEC) for July 2011.  

SPY

SSEC

US Stock Index Update

Even though last week was dubbed the best week in 2 years, the following charts show that the major indexes were just on track to get back to the upward trending channel dated back to September last year, and in fact, Dow is already in the channel, NASDAQ has touched the lower end and reversed, and S&P has not yet touched the lower end of channel yet.

DOW

NASDAQ

S&P 500

Monthly Intraday Charts for SPY and SSEC: 2011-06

This is a monthly series of intra-day charts for S&P 500 (SPY) and Shanghai Index (SSEC) for June 2011.  

SPY

SSEC