The weakness in the markets since last week has been unmistakable. With the S&P 500 down about 3%, pundits have begun asking when investors will lose hope for a near-term resolution of the international debt crisis. On the other hand, some long term investors say that the likelihood of a large market decline leading into 2012 is fairly low given certain positive economic data surfacing recently. This, however, presumes they are correct in two assumptions: First, that estimates for potential growth in the economy are sound. Second, that the markets will react “in-line” with expectations. The problem with forecasting is that the markets rarely behave the way one might predict. This is why Stadion doesn’t make predictions. We react to what ‘is’, not what ‘might be’.
As a reminder, Stadion’s market reactions are driven by the market’s ‘internals’, a set of measures including price indicators and breadth indicators that are tracked within our Stadion Investment model. Price indicators help determine the direction, or trend, of the markets. Stadion’s price trend indicators consider various time frames and calculation methodologies in an effort to identify the market’s trends. The goal is to establish whether the market is weakening or strengthening and the likelihood that the current trend will continue over time. Market breadth is also important as we “look under the hood” of the market. It helps us to determine the driving force in the price movement. Are small caps outperforming large caps? Are growth issues outperforming value issues? Does volume in top performing stocks and indexes outweigh the volume in underperforming investments? These are all questions that our market breadth indicators try to answer as they help us determine risk levels in the market, which in turn help determine our willingness to participate.
What makes 2011 a tough year for trend following? Simple: this year there has yet to be an established long term trend, up or down. However, there have been many short and medium term trends, including some in which our tactical, trend-following strategy has attempted to participate. But they have been inconsistent. In fact, the S&P 500 has seen twenty swings of at least 5%, positive or negative, since mid-February. Each of these price swings have lasted, on average, only 10 days. In other words, the market has been very volatile! Will this “trendless” market go on forever? In the last 15 years, the longest sideways market lasted a little more than a year. It’s easy to think a sideways market will continue forever, but this is historically—and practically—not true. The market has always broken out, ultimately moving either up or down. Until it does, we will continue doing what we do, reacting to movements according to the dictates of our model. When the market eventually begins to trend again, we will react to capture that trend if prices are rising, and avoid it if markets are falling.
While sometimes it may not seem so, Stadion’s model internals are doing exactly what they are designed to do. Don’t let the market’s inconsistency make it seem otherwise. For nearly 16 years Stadion’s model has demonstrated its ability to track and respond to market conditions.
By Danny Mack – Senior Analyst, Portfolio Management
The S&P Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock prices. It is not possible to invest directly in indexes (like the S&P 500) which are unmanaged and do not incur fees and charges.
