Standard Deviation, Price Momentum, Birds, Bonds and Oil
Standard deviation is one of many terms often used to describe the pendulum swing of volatility in the stock market. This measurement-term can give an indication of how close the market is to being overbought or oversold. Standard deviation can aggregate any number of intelligence behaviors. Birds, for example, tweet at certain times of the day. They tweet in patterns for certain lengths of time and even dream about their tweet patterns. But, birds only tweet during certain times of the day. To describe a full range of this behavior, a standard deviation of one explains some 68% of daily tweeting activity. A standard deviation of two explains some 95% of daily bird tweeting behavior. So a positive or negative standard deviation of two can be used to estimate when tweeting begins or ends. Estimates of human behavior such as when to expect the buying or selling of stocks can be measured in the same way.
In late June, price momentum in the stock market, as measured by the US MSCI price momentum index, became more than two standard deviations overbought for the first time since the summer of 2008. According to Credit Suisse (CS) analysts, this standard deviation reading has led to 5-10% corrections in price momentum, but not stock prices, on many occasions. So at least we have an indicator of the expansion in price momentum recently. Moreover, since the technology sector makes up nearly 50% of the price momentum index this raises the question, what might this mean for the technology sector? We have seen an increase in the flattening out of price momentum in technology stocks (a correction in momentum) lately.
Therefore, a high standard deviation reading in the price momentum index may be significant in predicting the end of dramatic price momentum. It also may allow analysts to remain positive on the technology sector. To illustrate, in the first week of June the technology heavy NASDAQ market index reached a new all-time high, after which it began an orderly sell off, taking the index down some 4.4%. In fact, the technology sector has already sold off more than the price momentum index indicates. The standard deviation for overbought/oversold measures is now less than .8 standard deviations overbought relative to the 10-year average of this index.
So, as we enter the first part of July, the technology index has fallen, but very little (some 4%); suggesting price momentum has, in fact, peaked and should be much more subdued going forward. If so, this would coincide with a hopeful, yet unrewarded policy landscape as it relates to tax relief and infrastructure.
In the interim, the bond market has soft economic data to digest, lulled inflation risk takers to sleep. Credit Suisse analysts expect surprises for the bond market soon. They believe a number of inflation indicators will show up soon. This contrarian perspective is based upon what analysts refer to as “hard data surprises” in the coming months. Meanwhile, implied volatility in bonds is close to an all-time low. Bond valuation models estimate that bonds are two standard deviations overvalued. This suggests that investors should be long financials and sell expensive proxies to bonds such as consumer staples and regulated utilities.
Finally, the price of oil is oversold, according to Credit Suisse analysts. The risk in this sector for investors has now moved to upside risk. Short positions in the oil market are at a two-year high. Fourth of July holiday short sellers are selling their positions before the holiday causing the price of oil to hold up. We shall see if this continues into the third quarter, a period in which supply is expected to outstrip demand.
Again, thank you for your continued trust and support. Referrals are also greatly appreciated. You can refer people to me by email or phone. It’s time to remind all that we may be moving into that portion of the economic cycle requiring enhanced professional and experienced oversight. This is particularly true of people holding large positions of inflation sensitive bonds, utilities and some annuities.
Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.
Credit Suisse, Global Equity Strategy, Price Momentum and Bonds, A. Garthwaite, et al., 6/26/17
Context: A Neuroeconomic Solution Set for the Integration of Intelligence Models, Vaughn L Woods, 2007