Predictive Model Output - Dec 2, 2005

[nodoodahs]

It looks like the market is just a tidge overbought, so I'm not expecting a lot out of the S&P 500 for the upcoming week. The EPCR measures I follow are slightly more bearish than when I last reviewed them, and the last 21 day return has come down to skyscraper levels rather than the stratospheric heights it was at. Alas, this is the third week in a row with a low 2nd decile reading. Probably average to flat returns for the rest of the year. This model suggests that Santa Claus either has already come, or that he won't exactly fill our stockings. I'd be really surprised if we hit 1280. I am going to take a good look at technicals on my short position to decide if I want to hold it into next week. I'm also thinking of a short strategy that limits itself to (a) poor company fundamentals, (b) poor technicals on the company itself, and (c) poor short term output for the broader market. Shorting is still "experimental" for me.

The 13-week model for the S&P 500 has a 7th decile reading for the second week, which is average. A 7th decile reading would suggest median and average returns of 2.9% for the next quarter, with greater than 65% chance of gains, 50% chance of above-average gains, and 2% chance of ending the quarter down more than 10% from where we are today. For reference, the data period used to build the model has an average and median quarterly gain of about 2.8%.

The 52-week model for the S&P 500 has a 6th decile reading for a second week, neutral in the sense that it suggests an average 52-week return. Median and average returns for this reading exceed 11%, with 80% chance of gains, greater than 50% chance of above-average gains, and a relatively hefty 13% chance of ending the year down more than 10% from where we are today.

Last week I thought we might get a moderate correction and stay neutral at the end of the year. Despite some "excitement" that was generated over Thursday's "bull run," bottom line we are below where we were last week, after having declined a percent-and-a-half during the first three days. My risk tolerance to being long equities is high and I won't get out until the models are pretty low.

The 13-week model for the 10YT is way down in the 1st decile, and has been for five of the last six weeks including the last four in a row.

The 52-week model for the 10YT is down in the 3rd decile, and has been for eight weeks in a row. I don’t know if I believe that the yields will get below 4%, but that is the model output.

Still looking for lower yields in the medium to long term. I am considering using the IEF ETF for capitalizing on this, it has something like a 92% R-Square to the 10YT yield.

The 13-week model for the USDX has fallen back into the 4th decile, after having moved up from the 4th decile to the 5th decile on last week. Good suggestion that the dollar is topping out going into next year.

The 52-week model for the USDX has also fallen back into the 6th decile after having risen from the 6th decile, which is neutral for the USD, to the 7th decile, which is somewhat more bullish in amount of rise if not odds of rise. These models were much more bullish for the dollar a couple of months ago.
_________________
I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[victor]

Bill,

perhaps you prefer bowling.

Fed Focus
Paul McCulley | November 2005
I recently got a new bowling ball, drilled expertly with a fingertip grip. It is an absolute joy to roll. The tricky thing, however, is to actually let it roll. For those that don’t bowl, or have only bowled with a house ball, drilled for the fingers to grip to the second knuckle, a finger-tip ball is drilled shallow, with room for only the tips of the fingers, not quite to the first knuckle.
In contrast to the house ball, configured with the objective of a straight roll into the pocket between the head pin and the one next to it, a fingertip ball is designed to hook, sweeping into the pocket with a lot of spinning action, generating an explosive conflagration amongst the pins, known as “action.” There’s nothing like it when it works!
But you have got to let the ball do the work, avoiding overpowering its natural hook proclivity. [...]

From PIMCO as well.

[HenryTo]

Commitment of traders show small speculators holding a huge short position in U.S. Treasury bonds:

http://www.softwarenorth.net/cot/current/charts/US.png

Ditto with the 10-year Treasury notes:

http://www.softwarenorth.net/cot/current/charts/TY.png

[nodoodahs]

Interesting PIMCO piece, but I get tired of these guys making "golf" references. I know I'm in an industry where lots of folks play golf, but I've never picked up a club, at least, not since high school. Our fencing instructor took some time to show us the basics, but it just didn't interest me.

You know, I went to a convention a few years back in Nashville and, instead of just the usual golf tourney, they offered a choice of golf or sporting clays. It was quite a sight to see all of those agents and company folk bring their shotgun cases up to the front desk of a swanky hotel and asking them to put the guns in the safe!
_________________
I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[victor]

Hello,

Bill Gross says that "discretionary bond investors like PIMCO are comfortable in investing clients’ money at a 4½% 10-year Treasury rate instead of waiting for 6% which may have been a more “normal” yield during the investment frenzy of the dot-com years or the less than “transparent” central bank policy years of the 1980s."

Full commentary at: http://www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2005/IO+December+2005.htm

[HenryTo]

Thanks for the updates, Bill. I have been looking at long bonds for awhile but am still waiting for a more oversold situation (in terms of sentiment) before getting in. My benchmark in this regard is the Rydex Bond Ratio (- which is currently (last night's close) at around 25.

This tends to fluctuate quite a bit but I would like to see at least a daily reading of over 40 and preferably 50 before getting in.

As for the investment vehicles I am looking at, I am either going to go for the long bond futures or the TLT (but I like your idea of using the IEF since you have been focusing strictly on 10-year yields).

Best,

Henry