AAII Investor Update: Death Crosses and Negative Yields

Thursday, July 19, 2012
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

An Intro to Moving Averages
Moving averages show the trend of a stock’s price movement.

Ins and Outs of Bond Yields
Learn how yields are calculated and what they mean.

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What are the charts telling you about the market?

Most Popular AAII Articles

  1. “The Good Investor Rule: Focus on How Not to Lose Money”
  2. “Finding the Right Withdrawal Rate: One Key to Portfolio Sustainability”
  3. “Quantitative Strategies for Selecting Stocks”

Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 22.2%, down 8.0 points
  Neutral: 36.0%, up 1.0 points
  Bearish: 41.8%, up 7.1 points

Long-term averages:
  Bullish: 39%
  Neutral: 31%
  Bearish: 30%

Take the AAII Sentiment Survey »

Scary-sounding descriptions of the market’s state never cease to surface during periods of uncertainty. The latest term I’ve heard is the “ultimate death cross.” This chart formation, used by Societe Generale strategist Albert Edwards, occurs when a 50-month moving average falls below a 200-month moving average. According to news reports about the market pessimist’s recent research note, this ominous-sounding indicator is close to appearing on the long-term S&P 500 chart and is a warning of a major bear market.

Among the major global indexes, it is apparently rare to see this indicator. Edwards said that the S&P 500 came close to forming an utimate death cross in 1978. The indicator did appear on charts of the Nikkei in 1988. Edwards points out that the Japanese market has been in the “embrace of the bear” ever since.

A regular (as opposed to ultimate) death cross formed on S&P 500 charts last year. On August 18, 2011, I wrote about how the 50-day moving average crossed below the 200-day moving average earlier that week. Since I wrote about the indicator, the S&P 500 has risen by more than 20%.

The indicator’s failure to predict a bear market is not surprising. Last year, Mark Hulbert looked at 20 years’ worth of data on the death cross. He found the indicator to have no statistical significance. In other words, despite its ominous name, the death cross is all bark and no bite.

Presently, a short-term bullish formation is appearing (as shown below). Since bottoming in early June, the S&P 500 has been experiencing a series of higher lows and higher highs. The index has also risen above its 50-day moving average. Though the chart pattern suggests more volatility could occur, it does point to rising stock prices.

Click on image to enlarge

Keep in mind that a trend only exists until it doesn’t. This is why it is important to consider a variety of indicators before making a market call.

Negative Yields in Europe

Speaking of charts, I want to call your attention to a set of charts published by the Financial Times on Tuesday. Yields on two-year notes turned negative in six European countries: Switzerland, Austria, Denmark, The Netherlands, Germany and Finland. This means investors will get back less money in two years than they paid for the notes earlier this week.

Why buy an investment that is priced to lose money? Investors would rather risk taking a known, small loss than incurring an unknown, but potentially far larger loss by purchasing short-term debt issued by other European countries. Plus, if fears about the European sovereign debt crisis intensify, it is possible that yields on the notes issued by the six aforementioned countries could fall even further, thereby creating a short-term profit for this week’s buyers.

More on AAII.com

Major Changes Made to the Model Fund Portfolio

Major changes have been made to the Model Fund Portfolio.

The experimental Model ETF Portfolio has been discontinued and select exchange-traded funds are being integrated into the Model Fund Portfolio. The combined portfolio is designed to take advantage of the unique strengths of mutual funds and ETFs.

In conjunction with this change, five mutual funds were sold from the Model Fund Portfolio: Madison Mosaic MidCap (GTSGX), Manning & Napier Pro Blend Extended Term (MNBAX), Meridian Value (MVALX), Northern Small Cap Value (NOSGX) and Royce Pennsylvania Mutual Investment (PENNX). Added to the Model Fund Portfolio were Guggenheim S&P 500 Equal Weight ETF (RSP), Guggenheim S&P MidCap 400 Pure Value ETF (RFV), Guggenheim S&P SmallCap 600 Pure Value ETF (RZV) and WisdomTree Emerging Markets SmallCap Dividend ETF (DGS). For further commentary and rationale behind the changes, read James Cloonan’s latest Model Fund Portfolio commentary.

No changes were made to the Model Shadow Stock portfolio last month. Updated performance information for the Model Fund Portfolio and the Model Shadow Stock portfolio can be viewed in the Model Portfolio section of AAII.com.

The Week Ahead

Approximately 160 members of the S&P 500 will report earnings next week. Included in this group are Dow components McDonald’s Corp. (MCD) on Monday; AT&T (T) on Tuesday; Boeing (BA) and Caterpillar (CAT) on Wednesday; 3M (MMM), Exxon Mobil (XOM) and United Technologies (UTX) on Thursday; and Chevron (CVX) and Merck & Co. (MRK) on Friday.

The week’s first economic report of note will be June new home sales, published on Wednesday. Thursday will feature June durable goods orders and June pending home sales. The first estimate of second-quarter GDP growth and the final July University of Michigan consumer confidence survey will be published on Friday.

The Treasury Department will auction $35 billion of two-year notes on Tuesday, $35 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.

No Federal Reserve officials are currently scheduled to speak.

AAII Sentiment Survey

Bullish sentiment fell to nearly a two-year low in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, plunged 8.0 percentage points to 22.2%. This is the lowest that optimism has been since August 26, 2010. It is also the 68th lowest bullish sentiment reading out of more than 1,300 weekly readings in the survey's history. Optimism has now been below its historical average of 39% for 16 consecutive weeks.

Neutral sentiment, expectations that stock prices will stay essentially flat over the next six months, rose 1.0 percentage point to 36.0%. This is an 11-week high for neutral sentiment. It is also the fourth time in five weeks that neutral sentiment is above its historical average of 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 7.1 percentage points to 41.8%. This is the 11th consecutive week and the 14th out of the last 15 weeks that bearish sentiment has been above its historical average of 30%.

The last time bullish sentiment was lower, August 26, 2010, the market reached a short-term bottom. Though very low bullish readings have been correlated with short-term term market rebounds, optimism among individual investors can stay at low levels for a period of time.

For example, bullish sentiment fell to 18.0% on August 17, 1990. Six months later on January 25, 1991, bullish sentiment was still low at 25.0%. Over that time period, the S&P 500 rose a mere 2.5%. Thus, while our survey has been correlated with market reversals, low bullish (or bearish) readings are not causal events.

This week's special question asked AAII members whether they thought the stock market overall is presently fairly valued, undervalued or overvalued. The votes were very close, with those describing the market as overvalued only slightly exceeding the number who said the market was undervalued or fairly valued. AAII members are split about whether fears about slowing economic growth and sovereign debt problems have been fully priced into the market.

Here is a sampling of the responses:

  • “Overvalued, because of sluggish U.S. economic growth, S&P earnings estimates are too high, reduced demand from Europe and China and the drag of federal debt.”
  • “Overvalued, since earnings will be depressed going forward due to the trend in the worldwide economy.”
  • “Fairly valued, given the overreactions to the fears about European debt and national and international economic growth.”
  • “Fairly valued. While price-earning ratios are a little low, the election and European weakness provide increased uncertainty and fear.”
  • “Undervalued based on historical price-earnings ratios.”
  • “Undervalued. Everybody is scared to death.”

» Take the sentiment survey