An Extreme Divergence

One of the most dangerous phrases for an investor is “it’s different this time.”

Every so often, though, it really is different. It was different in 2008, when a financial house of cards ran headlong into a tragically misguided Fed and a historic spike in commodities. It even was different in 2016, or at least at the beginning of that year, when the worst start ever for U.S. stocks resulted from extreme volatility in another country, China.

In those two instances, there were some advance signs that something unusual was happening that made it necessary to reassess in what direction different asset classes would be moving.

We can’t say yet whether 2017 will prove to be another juncture when things really are different. What we can say, emphatically, is that certain relationships have reached extremes that we have never seen before, which may require that we hone our indicators.

One extreme is the correlation between the big-cap S&P 500 index and the Russell index of smaller-cap stocks. Going back more than a generation, the relationship between the two has never been lower. Our S&P Indicator is so far holding its own in that it has not given a sell signal, though the low correlation with small caps is definitely a negative. In fact, the S&P indicator though still neutral has been improving, thanks to other positives such as strong Chinese stocks.

We give our S&P indicator a grade of no more than a C for missing the rally. Still, a handful of Cs in combination with a few As and few or no Fs (which would have occurred if we had shorted the S&P) is not that bad. But clearly it’s not good enough to satisfy us. Our guess is that the anomalous action can be explained by the extraordinary weighting of a few OTC stocks in the S&P. We will have an answer in the very near future.

Oil is another indicator that requires, if not a redo, at least the addition of other variables. Our oil stock indicator is currently in negative territory, and we recently closed out a short position in oil stocks for a small profit. Here the problem is not so much anomalies as the fact that our indicators are calculated on a daily basis while many important oil-related numbers such as production and inventories are calculated on a weekly basis. While being surer of our S&P indicator is a matter of simply making sure we are giving enough weight to the outlying relationship between the Russell and S&P, oil is a bit more complicated, requiring us to redo our indicators on a weekly basis and tie those results into the daily results.

In other words, we ask that you be patient as we refine our indicators further. We’ve promised you more trades, and we mean to deliver. But despite our win percentage, which would occur by chance in less than one in 1 million times, we haven’t delivered the outsized gains – unless you have been trading futures – that you deserve from us. We are very close to making the critical adjustments, among other things adding China to the mix, and are confident that with just a few more tweaks we should be off to the races.


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