Author: Hengfu Hsu, Analytic Investment LLC
Covestor models: Focus Value, Dividend, Enterprise Value, Deep Value, Opportunistic Value, Earnings Growth
With renewed European debt crisis, gloomy global growth outlook, and disappointment with Fed’s statements, S&P 500 index fell another 5.2%% in September, posting the first 5-month losing streak since 1973. (Data)
As of September 30, 2011, the US equity market condition is neutral based on the following factors we use to manage risk in our models:
(1) Equity Earning Yield Over Treasury Yield (Cheap, Balanced, or Expensive): Cheap
(2) Equity Earning Trend (Up, Sideway, or Down): Sideway
(3) Credit Risk (Low, Normal, High, or Dangerous): Normal
(4) Equity Volatility (Low, Medium, High, or Dangerous): Dangerous
(5) Equity Money Flow (Positive, Neutral, or Negative): Neutral
(6) Yearly Equity Price Trend (Up, Sideway, or Down): Down
(7) Monthly Equity Price Trend (Overbought, Sideway, or Oversold): Oversold
The crash of the global equity market over the past 5 months indicates to us we are in a recession since equity market index is one of the best leading indicators of a pending recession. But the latest US GDP, manufacturing, and construction spending data only point to a slower growth, instead of a recession. On the earnings front, S&P500 Q3 earnings estimates have only been revised down only slightly over the last three months, even with a depressed global equity market. With rising exports and production profits and tumbling energy and copper prices, we believe most investors probably have greatly underestimated actual Q3 corporate earnings. Due to volatile market conditions and never-ending bad news from Europe, investors have bid up the price for safety significantly, pushing the 10-year yield below 2% as of 10/1/11. Once the fear subsides, even flat Q3 earnings could provide a boost to the US equity market when investors start seeking better return on their investment capital.
However, October is the most volatile month for US equity market, with both the biggest percentage losses and gains were recorded in October. If Q3 corporate earnings are worse than expected or Europe melts down, we could see another crash similar to October 1987 or October 2008. On the other hand, we could see rallies similar to October 1982 or October 1974 if current pessimistic view proves to be unjustified after corporations turn in their Q3 report cards.
Models Review
In September, all our Covestor models remained fully invested based on our computer algorithms. The phrase “fully invested” means that our models use up to 100% of cash, and all our Covestor models do not use any form of leverage or margin.
Because we fully invested in September, all of our models suffered significantly drawdown again during the month. Since corporate earnings are not the problem for the current drawdown, we continue to trust our algorithms to remain fully invested. Depending on the October earnings results, our algorithms could move 50% or 100% of positions into cash.
We rely entirely on our computer algorithms to indicate buys of undervalued stocks and sell overvalued positions, to monitor market conditions, and to manage risk in all models, so that human emotion and buy-sell bias are completely eliminated from the investing process, unnecessary market timing is avoided, and continuous participation in the market is enabled in the effort to produce long-term growth.
