The Dow Jones Industrial Average and S&P 500 have been at 14,000 and 1,500 respectively twice before (2000 and 2007) over the past twelve years. In both prior instances, it was a great time to sell. In the prior instances and the current environment, investors were bullish and inflows into domestic equity funds were positive. In January 2013, equity inflows reached levels last seen in early 2000. The Investors Intelligence’s latest survey of advisory opinion shows bulls at 54.7% of all respondents versus bears at 21.1%. The American Association of Individual Investors (AAII) sentiment index is 42.8% bullish versus 29.6% bearish.
The problem with the Investors Intelligence and the AAII surveys is they are usually only good contrary indicators when they reach extreme levels. Currently, they do not provide tradable information.
For an indicator to be useful in a trading environment, it must provide a reliable guide to near-term market trends at all times. Investors want to know if the current feeling of stock optimism should be sold or bought.
The Delta Investment Market Sentiment Indicator (MSI) published in Barron’s in the Market Laboratory section is such an indicator. The key to using the MSI is understanding how to interpret what it is saying. This past Friday, the MSI was published on page M53 and showed a current reading of “BULLISH.” The MSI has risen from 80.9% to 82.8% over the past three weeks indicating the market has gained in strength technically during this time. Shown under the indicator is the recommended equity market exposure which is currently 100%. The indicator is published weekly and is also available for free every Friday by email if you sign-up to receive it at www.deltaim.com.
When the indicator is greater than 50%, it is “BULLISH” and your portfolio should have equity exposure. When the indicator is bullish and rising, your portfolio should maintain a full allocation to equities depending on your overall financial plan and risk tolerance. When the indicator is bullish and falling, you should look at the percent invested in stocks to find guidance on how to reduce your stock exposure. When the indicator is bearish, you should not have any equity exposure if you are managing your equity portfolio tactically.
The good news about this indicator is it is simple and offers a plan for exiting the stock market quickly if market conditions sour. The indicator currently advises a full allocation to equities. If it is wrong and 14,000 and 1,500 are a ceiling rather than a floor, you will know week by week every Friday. This week, we will continue to look to add long options exposure on market pullbacks.
Review of Positions
Electronic Arts (EA) – On Dec. 12, we recommended to buy to open the EA Mar 17 calls (EA 130316C000017000) for $0.55 or better. The stock was $15.35. After grinding sideways for a month and a half, the stock has broken out to the upside and traded to $17.50 on Friday. The console game market is sluggish and EA has had its own problems, but investors are buying the stock thinking the worse is past. As of Friday, these options closed at $0.94.
EMC (EMC) – On Jan. 10, we recommended to buy to open the EMC April 25 calls (EMC 130420C000025000) for $0.95 or less. As of Friday’s close, these options closed at $0.88. The stock gapped down on earnings but has quickly filled the gap. We continue to like this trade.
Lilly (Eli) & Co. (LLY) – On Jan. 9, we recommended to buy to open the LLY July 55 calls (LLY 130720C000055000) for $1.45 or less. As of Friday’s close, these options closed at $1.44. We continue to like this trade.
Thomson Reuters (TRI) – On Jan 16, we opened a position in the TRI Jul 30 calls (TRI 130720C000030000) for $1.60 or less. As of Friday’s close, this position was $1.80. We continue to like this trade.
Parting Shot: Hope in Japan
For 27 years, the Japanese stock market has been an abysmal place for investors. Shown below is a chart of the Nikkei 225, their version of the S&P 500. The Nikkei is about where it was in 1985 and still almost 70% below its all-time peak level reached in 1990. But, hope springs eternal.
We just returned from a trip to Tokyo to meet with a number of the largest institutional investors in Japan. They believe their secular bear market may be ending. During January of 2013, the Nikkei 225 had a worldwide market performance rank of 3 with a return of 7.15%. The top ranked index during January was the Dow Transportation Index, with a return of 9.37%. During the last 12 months, the Nikkei 225 was the top performing index with a return of 27%.
Many institutional Japanese investors believe their asset price bubble has been fully deflated. Stock valuations are now at attractive levels and they expect the yen will depreciate on a secular basis relative to the U.S. dollar and euro. Labor rates in Japan have been declining for decades and their labor force and advanced manufacturing capabilities are becoming increasingly competitive. On the margin, they see their more competitive labor force and declining currency as a driver of a long-term equity bull trend.
If Japan pulls out of its nearly three decade economic funk, it will certainly help the U.S. find sustained momentum in the current bull market move and help answer the question if the current S&P 500 is a new floor to a bull market or a ceiling to a bear market rally.
Have a great week trading,
Nick Atkeson and Andrew Houghton
Big Money Options