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International Market by Martin Pring’s InterMarket Review (December 2014)

This month we introduce our revised Stock Barometer. It uses the same indicators as the previous one, but Jim Kopas, our ace spreadsheet expert from Pring Turner, has improved the previous model by tightening up a couple of moving average relationships and substituting end of month, as opposed to monthly average data, for some of the S&P Components.

Tables I and II compare the results of the two models. As you can see, the monthly annualized average return between 1955 and 2014 improves from 10.45% to 12.11% yet the standard deviation (risk) is slightly lower at 12.37% versus 12.71%. The return for the S&P in that same period was 7.68% with a 13.7% standard deviation. Since 2000, the return for the S&P was 3.76% compared to 11.03% for the new Barometer, up from 9.17%. Sell signals also caught more downside action, thereby reducing drawdowns in both periods.

This new barometer has been deteriorating for the last few months and sports a current reading of 58.3%. A review of the various components indicates that an outright bear signal is not likely unless the S&P falls back towards the 1925 area on a month-end basis.

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Chart 9 features the ratio between the Shiller P/E and government bond yields, which is a rough and ready way of comparing current returns between stocks and bonds. Between 1880 and 1998, every time the ratio moved to an overvalued state for equities by crossing through the .7 area, the market experienced a primary bear trend. In the 1990/2000 cycle and more recent cycle, the indicator triggered some false negatives as signaled by the dashed vertical lines. Its current reading of 7.4 ties the 1929 high. We are all aware of the fallout from that one! There is, of course, no reason why this relationship cannot move further in the direction of overvaluation. However, the higher it moves, the tighter the psychological elastic, and therefore the greater the vulnerability when it does turn. Remember, trend trumps everything, so the key is to see when the S&P responds to this situation by penetrating a long-term MA or its 2009/14 up trendline.

In that respect, Chart 10 shows that in the last 50 years or so, joint trendline breaks by our Combo Momentum and the S&P Composite have successfully signaled six primary bear markets. In the current situation, the trendline for Combo Momentum has seriously been violated but it continues to await confi rmation by the S&P itself in the form of its 9- or 12-month MA. At the end of December, they will be around 1980 and 1945, respectively.

Equities and the Economy

Most of the time there is a strong connection between the stock market and the economy. In that respect, Chart 11 compares the progress of the S&P to that of the ECRI Weekly Leading Indicator. The arrows show that with the exception of the 2004 and 2010 experiences, a declining ECRI KST has typically been followed by a stock market decline or extended trading range; the KST recently triggered a sell signal. Also, the indicator itself confi rmed with a trendline break of its own, suggesting economic momentum is slowing. Falling commodity prices are also indicative of a weakening economy. So far so good, but it is important to note that other leading indicators, such as those published by the Conference Board, are still fi rming up and at this time are offering no hints of a recession. The overall impression S&P Composite and Two Indicators that we get from the economic indicators is that its trajectory remains an upward one, but recent ECRI weakness is pointing out that it is probably more delicately balanced than the consensus would have us believe.

The bottom line is that if the S&P were to drop below its 12-month MA, investors should pay close attention because it would likely be the market's way of fl ashing an economic warning sign. Since such action would likely push our Stock Barometer into bearish territory, greater caution would most defi nitely be called for.

Russell 2000

One area we are watching closely is the progress of small caps in the form of the Russell 2000 ETF (IWM). This section of the market peaked for all intents and purposes in March, although the actual high was registered in July. Earlier this year, the RS line violated an 11-year up trendline and its RS KST, in the bottom panel of Chart 12, peaked out. Since the absolute KST is bearish and the price itself has violated its bull market trendline, the IWM appears to be a leading indicator on the downside. Having said that, the situation could be saved if the relative KST reverses and the RS line moves back above the trendline. Moreover, should the price itself break to new highs, it would indicate a reversal in fortunes for the IWM and probably signal a signifi cant new up leg for the overall market. None of that has, of course, yet happened. Consequently, a cautious stance is recommended until it does.

Another likely pointer to higher prices would be an upside breakout in the stock/bond ratio, shown in Chart 13. This series completed and broke down from a top in October - action which was supported by a bearish long-term KST. However, the ratio has since moved back above the breakdown point hinting that the whole move may have been a whipsaw. That would be confi rmed with a convincing move above the green down trendline, say with a Friday close above 18.2. We are not predicting this will happen, merely suggesting that if it does, it would strongly suggest that stocks had begun to take advantage of the three bullish seasonals about to kick in. They are: the end of the year tendency to rally, the very positive third year of the presidential cycle and the strongest year of the decennial cycle. In this respect, since 1865, every year ending in a "5" has been positive!

Nevertheless, we would be remiss if we did not point out some current discrepancies of the type that have often preceded important market peaks. They are featured in Charts 14 and 15. Chart 14 compares the Hamilton Bolton Weekly A/D Line with the S&P. Net new weekly highs are featured in the bottom window of the chart. Note that the A/D Line was in gear with the S&P up until July of this year at which point it began to trace out a series of declining peaks and troughs. Note the number of issues reaching net new highs has been a pretty low one. Both series therefore suggest that breadth has been lagging in the most recent part of the advance. Perhaps most telling of all is the fact that the A/D Line has violated its bull market trendline in a pretty decisive way.

Chart 15 compares the S&P to a ratio between government and corporate BAA yields. Most of the time the ratio rises in tandem with equities as bond and equity investors both grow in confi - dence as the economic recovery takes hold. It is when stocks rally and the ratio does not that it warns of trouble. Unfortunately, this is not a precise timing device as the long period of negative divergent action between 1995 and 2000 points out. It is therefore quite possible that the current discrepancy will continue for a while. That is why it is so important to make sure that the S&P is responding with a trend break of its own, again, trend trumps everything.

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