Aug 24, 2012

Next NASDAQ target

Seasonally repeated NASDAQ100 patterns proved to generate useful buy and sell signals for the last three years. This post is continuation and update of the “NASDAQ target reached! Now what?” post. 

On the chart I have used simple analysis which follows the strength of the recent bull markets and the range of the bear ones as a base for building projection for the next NASDAQ target. As chart shows for the last three years there is clear seasonal relationship – autumn spring bull period followed by summer corrective zig-zag. 

NASDAQ cyclical pattern
NASDAQ cyclical pattern
Currently we are at the end of the summer and using the logic of the previous two cycles we should enter new bull phase of the cycle. The foundation of the projection is the summer bottom of 2439 registered on 1st of June. Adding the average gain for the previous two cycles (around 750 points) gives a target level of 3200. This target seems quite optimistic. Probably it is, however, one should consider the relatively big share of Apple in the index compared to the other companies. As a big influencer of the index if the target range of 800-900 for the iPhone maker prove to be true than 3200 for NASDAQ could be completely reasonable target.

Still unclear is whether the consolidation has finished yet. It is possible to see moderate pullback before the market rally unfolds. Again Apple could be major driver as iPhone 5 release is knocking on the door and as history proved new product announcements has been bearish for the stock, at least in the short run (see “The correlation between Apple product launch and stock price”).

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Gold vs. stock market: Can we use gold to preserve our assets from market crash?

Gold has always been considered to be one of the few hard assets which successfully store value through the time. Proof of that fact is the long term performance of the precious metal. 

Probably most of the investors have faced the question “Can we use gold to preserve our assets from market crash?” In that regard is observation of the 6 year performance chart of gold, represented by (GLD), and S&P500 index (SPX) which lead to the following conclusions:
  • For the last three years Gold (GLD) followed SPY corrections with certain lag
  • Market corrections tend to be more severe compared to gold corrections
  • For the last 6 years GLD outperformed SPY with 153% return vs. 10% for the index

S&P500 corrections vs. Gold corrections
S&P500 vs. Gold corrections
*Note that the chart is in log scale.

As numbers show all of the registered corrections for the period tend to be more severe for SPY compared to GLD. The reason for that could be found in the statute of the gold as a safe heaven. Just imagine where you could put your money in time when every asset price drops. The logical answer is hard assets with good historical price performance. Since in long term GLD clearly outperforms SPY it is rational that after the initial selloff most of the investors jump back in the gold and prevent its price form huge drop.  This fact again is supported by the perception of gold as save heaven asset good to be invested in long run.     

The lag

Most recent bear market which triggered recent economic turmoil started at the end of 2007. During that year when the broad market (SPY) started falling still the gold continued its rise until March 2008. That is 4 months lag. Consequent market corrections in 2010 and in 2011 had the same occurrence – the gold made its peak soon after the market hit the roof. Thus selling gold in the middle of the market correction sounds reasonable.

The correlation

There is wide known that the gold has negative correlation with the dollar and the positive with the global markets. However note that those correlations are not perfect i.e. not always for example as dollar falls the gold appreciates with the same margin. In its “Gold investment statistics commentary” the World Gold Council stated:

Looking back to Q1 2012, gold had a higher correlation to global equities, emerging markets and commodities than the long-run average; however, this correlation was not indicative of a direct economic relationship.

Gold correlation to global assets
Gold correlation to global assets

The correlation coefficient changes over time influenced by numerous factors but the relation is the same – positive with the markets and negative with the dollar. What does it means for the investor? Simply that one can use the gold as dollar hedge while using it as a market hedge is a bit tricky. That is because, as observation results showed, in short term you cannot avoid drop in the price of gold when everything is melting down, however in long term compared with the stock’s performance the winner is the metal. Thus you can boost your performance and add value if you have wide gold investment horizon.

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Aug 20, 2012

The correlation between Apple product launch and stock price

The highly anticipated iPhone 5 release has pumped Apple price to new records as investors jump in the strongly desired stock. Still, the release date of the company’s expected to be-most profitable and famous product, is not yet clear, thus additionally fueling speculations.

For investors, it is logical that the price behaves in such a way during a pre-product release period, as everyone is full of expectations and trilled about the new features. It is interesting to see, however, how the price performs post product release date. In Chart 1, I have labeled the exact dates of the product releases of iPhone (started 2007) and iPad (started 2010). Please note that Chart 1 price scale is logarithmic.

There are some common price patterns repeated almost around every product release date:
  • The price peaks few days before release date and falls one to three months afterwards 
  • The correction after the release date is between 9 and 16% 
  • The correction is usually zig-zag shaped 

Chart 1. Apple product release dates and stock price move
As seen from the Chart 1, with the first iPhone released on 29 Jun 2007, the stock price traded in consolidation followed by a sharp rally. All following iPhone releases tend to show the same consolidating pattern in the period surrounding the release. The iPhone 3GS (released 19 Jun 2009), iPhone 4 (released 24 June 2010) and iPhone 4S (released 14 Oct 2011), have shown price drop post release days. After the iPhone 4 release, the stock lost 10% in a week, while the iPhone 4S release pushed the price with 14% in a month (see Chart 2). The optimistic thing here is that both corrections consequently triggered extremely strong bull market in which ironically no product release was announced.

Examining the iPad release date, patterns show slightly different picture. One should note that larger share of Apple’s earnings (48%) and income comes from iPhone sales thus the impact of the phone release is higher than that of the tablet. The announcement of the first and third iPad proved to be bullish for the stock, while the second was followed by correction, which again triggered major rally for the stock. On Chart 2 (daily bars) you can follow the picture in detail.

Chart 2. Apple product releases are followed by correction
Based on the observation findings and combining them with the seasonal patterns of the Apple stock (Apple seasonal patterns with strong predictability power) we would expect the price will continue rising until the iPhone 5 release date (expected mid September). This is to be followed by a correction in the following month. Based on the experience from previous corrections, the pull back should not be deeper than 16%. The support level is determined by the 200 day moving average, which projected to that date gives $565. Thus the area falling between 590 and 565 could present a good buying opportunity.

It is clear that no one can predict the future, however, there is a strong logic in stock price moves based on a product release cycle and on seasonal basis. This could be used during the process of an investor decision making. Several times, Apple investors have followed a “buy the rumor sell the fact” strategy. Whether they will repeat it again we are about to see in coming months.

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Aug 16, 2012

The connection between stock market and US president cycle

The connection between US president cycle and stock market cycle has always been a debated issue. With US elections approaching, the topic is receiving even more attention. In the paper entitled “Presidential Elections and Stock Market Cycles” by Marshall Nickles, EDD thoroughly explains the evidence for such a connection. This is done by analyzing15 stock market cycles (from April 1942 to October 2002) and presidential elections for the same period. Here, I intend to use that methodology to review the last two stock market cycles and find out how they fit to the broader picture.

Briefly stated findings of Mr. Nickles research show that:
  • Average bull market duration for the mentioned period was 3.08 years
  • The average bear market duration was 0.94 years
  • The bull/bear market duration depend on the measures undertaken from officials to tackle the crisis and stimulate growth, thus deviation of the average number exists
  • There is significant probability market trough to occur in the second year of the presidential term  (12 out of 16 terms for the observed period)
  • There was not major market correction during the election years for all election years within the observed period

Based on the findings, the author suggests investment strategy buying on 1st of Oct of the second year of the presidential term and selling 31th of December of the fourth (the election year). According to the calculations this strategy could gain annualized return of 9% for observed 60 years.

Those findings seem quite convincing and one might decide to build his investment strategy based on them. Let us examine the latest two cycles from 2000 to date and apply mentioned strategy for this period.

The chart gives us information about the relationship between presidential and stock market (S&P500) cycles for the suggested period. The index is in log scale.

S&P500 and presidential elections
S&P500 and presidential elections

Last two bull cycles (2002-2007 and 2009- to date) tend to be more extended than the average mentioned in the paper. This could be explained with the magnitude of the crash proceeding each of the bull phases. As the chart shows, during both years- 2000 and 2008, downturns were severe. Average bear markets for the period 1940-2002 tend to last one year, the recent two are exceptions from that rule and are  longer. Dot com bubble, for example, busted in 25 months while recent mortgage burst lasted 16 months.

Take a look at the last two market cycles – the Dotcom bubble (2000) and Housing bubble (2008). What they have in common with presidential election cycle is that election year coincided with severe bear market – the exact burst of the bubble. Moreover, the duration of the last two market cycles was longer than the average for all previous cycles between 1944 and 2000. Dot com boom and burst lasted 99 months (8.25 years) while housing bubble and consequent melt down lasted 77 months (6.4 years) compared to 4 year average. As the author noted, cycle duration depends on unforeseen events such as monetary or government stimulus actions, which influence the cycles, indicating that those events have intensified recently.

The strategy

In the paper, the author suggested interesting investment strategy. Buy on the second year of the presidential term and sell on 31 Dec on the next election year. As calculations showed, this kind of investing could have preserved you from most severe bear markets and brought to you annualized return for the period 1952-2000 of 9.3%. Sounds good, doesn’t it? However, if you have followed it you would have missed some of the great bull market runs, like 2002-2007. If you have waited two years after 2004 elections and entered the market in 2006, you would have missed 16% S&P500 rally, which is significant. By applying this strategy for the 2004-2008 president cycle, i.e. buy in Oct 2006 and sell 31 Dec 2008 you would have counted with a  loss of almost 20% as year 2008 is one of the few presidential years, which ended with loss. Thus, buying in presidential year does not always work, however the probability for stock market gain in the election year is high. Since year 1928, only 4 out of 22 president election years finished with negative gains. The table below shows market returns for each election year. Data below are taken from  Dimensional Funds Matrix Book 2011 (“Presidential Elections and Stock Market Cycles” Marshall Nickles, EDD)

S&P 500 Stock Market Returns During Election Years

Year      Return   Candidates
1928      43.6%     Hoover vs. Smith
1932      -8.2%      Roosevelt vs. Hoover
1936      33.9%     Roosevelt vs. Landon
1940      -9.8%      Roosevelt vs. Willkie
1944      19.7%     Roosevelt vs. Dewey
1948        5.5%     Truman vs. Dewey
1952      18.4%     Eisenhower vs. Stevenson
1956        6.6%     Eisenhower vs. Stevenson
1960       0.5%      Kennedy vs. Nixon
1964      16.5%     Johnson vs. Goldwater
1968      11.1%     Nixon vs. Humphrey
1972      19.0%     Nixon vs. McGovern
1976      23.8%     Carter vs. Ford
1980      32.4%     Reagan vs. Carter
1984        6.3%     Reagan vs. Mondale
1988      16.8%     Bush vs. Dukakis
1992        7.6%     Clinton vs. Bush
1996      23.0%     Clinton vs. Dole
2000      -9.1%      Bush vs. Gore
2004      10.9%     Bush vs. Kerry
2008      -37.0%   Obama vs. McCain
2012      ?             Obama vs. ?

How to avoid presidential election year with negative stock market return?

Presidential election cycles alone do not give us the necessary information for taking investment decision. Combining the stock market cycle with the presidential cycle gives us the ability to time the market. It is a statistical fact that it is more likely to see market trough during the second or first year of presidential term. Keeping in mind that average duration of a bull cycle is 3 years, we could expect that if presidential election comes during the bull market or first two years of the market cycle than there is no point of waiting two years to enter the market as expected correction should be mild. If election years, however, coincide with the third, fourth year of the bull phase or even with bear stock market then you should follow the suggested strategy.

The 2012 elections and the stock market

Currently we are in the fourth year of the president cycle, the election year, and in the fourth year of the bull cycle (started with the 2009- low). The logic of the cycle sequence suggests that applying the presidential year cycle strategy we could wait with investments until mid presidential term - Oct 2014. However, there are presidential elections years followed by strong bull market. Are we in a such one? Considering the fact that currently we are in the 42th month (3.5 year) of the bull market, we have to be cautious. Markets might be close to the bull cycle end as the average one from 1944-2004 is 3.08 years and 2012 is the fourth year of rising stock prices. 

Many state that history does not repeat itself and it is impossible to predict future events. However, it is possible to time the market cycles, at least to some extent, and with relative accuracy. No one can predict the future but knowing the big picture and major trend of the phase of the cycle could save you some financial headaches. Even for the critics it is obvious that repeated patterns do exist. Just look at the chart. Whether you agree or disagree with the cyclical relations it is up to you, however it is always better to know some important repeating patterns and to be ready to use them in your favor.

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