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A New Risk Indicator To Sidestep Market Downturns: Is It Better Than VIX?

By Chris Georgopoulos, originally published on 11/14/11

Without question the most popular model to predict market crashes is the VIX, commonly referred to as the “Fear Gauge,” a market index that measures the implied volatility of the S&P 500 index options. Its concept is quite simple, when the uncertainty and fear among investors rises, they commonly run to the S&P 500 options to either hedge or speculate. The increased interest in the options usually leads to higher premiums and as the premiums increase so does the VIX. However, predicting the future isn’t 100% accurate, most of the time it’s not even close. Every forecasting model has its flaws and the VIX is not an exception. There are many problems skeptics have found with the VIX such as; its population study is limited to only the 500 stocks of the S&P 500 and” {the} model is similar to that of plain-vanilla measures, such as simple past volatility” (Wikipedia). A blog post on sensibleinvestments.com summarized the VIX as “simply an indicator of actual volatility in the market but one that is very sensitive to changes in actual volatility particularly if it is on the downside.” Is there a better way?

An elementary statistics theory states that the larger the population size, the greater the likelihood that the sample will be represented. If markets are graded by the performance of popular indexes such as the S&P 500, why limit a forecasting model’s population to only 500 stocks? The economy has become global; interactions from every corner of the world’s businesses affect every other business. If there is a model that forecasts market direction, should it limit itself to just the largest companies? As for only using a month or two of short term option premiums to garner a prediction, as the VIX does, it seems to limit itself to only a single variable. Instead of short term options premiums and limited samples what if we could measure real-time individual stock trend alerts on thousands of domestic and foreign stocks and ETFs? Or simply what if we analyzed the micro components (every stock) to develop a macro forecast of the market based off trends and risk?

By studying the history of risk alerts from SmartStops.net, an intelligent risk management service, two proven alternatives to the VIX were found. SmartStops.net has developed their own proprietary risk model that monitors the trends and risks to over 4,000 of the most popular stocks and ETFs. If the risks grow on any individual investment SmartStops.net alert their subscribers with both long and short term exit triggers. However not only do these alerts help individual and institutional investors manage specific investment risk, the reviews of the alerts themselves have predictive capabilities. By back-testing every alert that SmartStops.net has issued from their inception versus the S&P 500 performance, there is proof of this and the results speak for themselves.


There have only been 7 days for which the amount of Long-Term Exit Triggers (stop alerts) as a percentage of every stock and ETF covered by SmartStops.net has been over 20%. The subsequent market action of the S&P 500 has averaged a negative return for the time periods of 1 week, 1 month, 3 months, 6 months and a year. The 6 month average return is over -7% and when examined from the absolute lows of the S&P 500, the returns average over -19%. If you remove the knee-jerk market reactions caused by “Flash Crash” on 5-6-2010, the returns are even lower.
Another metric offered by SmartStops.net is their SRBI(tm) (SmartStops Risk Barometer Index); this index measures the current percentage of stocks and ETFs that are in “Above Normal Risk” state (ANR) divided by the 100 day average above normal risk percent. By definition, a stock that is listed ANR experienced a risk alert as its last SmartStop alert identifying a downtrend. Conversely, a stock that is listed in a “Normal Risk State” experienced a reentry alert as its last SmartStop alert indicating trading strength and an upward trend. Back-testing historical SRBI data since inception shows that the repercussions to the market when the percentage of downtrends increases to over 40% of all stocks and ETFs covered are profound. Below you will see that there have been only five occasions where this has happened. In each case the S&P returns for the following year were all negative.

Is this a better way?

Before a concrete conclusion can be determined, the predictive capabilities of the VIX must also be analyzed. Read More…

NETFLIX Investors – Did you Protect Yourself?

NETFLIX , NFLX, drops but SmartStops keeps investors and traders from major losses.

This is why Risk Management and Protection are a must in every investor and trader’s arsenal.   SmartStops triggered its short-term protection for Netflix at $74.13 at 9:32AM.  NFLX closes at $60.28 today, 7/25/12.

In the most recent Netflix downtrend SmartStops saved its clients  $42.46 per share!  

See chart at: http://www.smartstops.net/PublicPages/SmartStopsOnDemand.aspx?symbol=NFLX

 

Hedge fund leverage in the industry – how its grown

SmartStops comment:   Who watches out for the little guy?

A chart from MIT’s Andrew Lo of the growth of assets and hedge fund leverage over the last 20 years. You can see the expanding leverage in the 2001-2005 period.  originally posted at Infectious Greed blog.

Hedge Fund Leverage how-its-grown

Hedge_Fund_Leverage how-its-grown

Chicken or Egg? Risk Tolerance as a Driver of Financial Success

SmartStops would like to draw your attention to this article’s statement:    Overall, by taking more risk Bill can expect to be significantly better off.    As SmartStops will remind you, you can take on more risk by ensuring there is constant active oversight for it.  See other articles on that subject.   

 published originally at:  Advisor One by Geoff Davey, FinaMetrica

Many studies have shown that risk tolerance correlates positively with income and wealth. The correlations are not strong, usually around 0.3, but they seem to be universal.

There is a temptation to think that higher income and/or higher wealth lead to higher risk tolerance. However, there is always a danger in trying to read a cause and effect relationship into a correlation. To know for sure we would need to conduct a longitudinal study measuring risk tolerance, income and wealth as we went along.

Failing that, we can conduct a thought experiment. Suppose that Bill and Bob have different appetites for risk. Presented with a choice between taking a certain $100 and a 50/50 gamble of winning $0 or $X, Bill will take the gamble when X is $250 but Bob won’t take the gamble until it reaches $300. Looking at any single $250 gamble choice, Bill has a 50% chance of being no worse off than Bill.  However, if Bill and Bob are presented with a series of such choices, the longer the series runs the more certain it is that Bill will finish up better off than Bob. With a series of 10, Bill has an 83% chance of being no worse off than Bob and by the time we get to a series of 100 that chance has increased to 98%.  Over 10 choices, Bill will finish with $1,000 but Bob could expect to have $1,250, though he may have nothing or $2500.

Now suppose that Bill and Bob both started with a kitty of $1,000 and that rather than the choices being framed from a base of $100, they were framed from a base of 10% of the kitty at the time. For 10 choices, Bob’s kitty grows to $2,593 but Bill’s grows to an expected average of $3,260 and 62% of the time will be greater than $2,590. At worst Bill will have $1,000 and at best $9,300.

Overall, by taking more risk Bill can expect to be significantly better off.

So how does this relate to real life? Clearly, life’s choices are rarely as simple as in our example and rather than a series of identical choices we face a series of mainly different choices where there are usually more than two alternatives—and those alternatives will often include the possibility of losses. Further, the range of outcomes is often not clear and they must be estimated rather than calculated. Finally, we may make cognitive errors in assessing the situation and in identifying and evaluating the alternatives.

As we know from experience, risky choices take many forms and occur in different contexts including employment, borrowing, insurance and investment. For the riskier alternatives to be considered there would be a commensurately greater expected reward, but this will come with the possibility of an unfavorable outcome. The more risk tolerant amongst us will need less of an incentive to take the riskier alternatives. If we continue that pattern over time, all other things being equal, we should finish up better off.

So my hypothesis is that risk tolerance is a driver of financial success rather than the converse.

Valuations in Free-Fall: S&P 500 Cheapest Since 1957!

 originally published at Kapitall, who go on to identify potential stocks to play.

The Standard and Poor’s 500 index valuation has hit 25% below the average from the last nine recessions, even as price estimates continue to fall, according to Bloomberg‘s data. These estimates provide a statistically significant outlook on analyst expectations for future growth and the degree to which stocks might be considered undervalued.

Historically, market contractions have not reached these lows since 1957 when the gauge for American equities traded at 13.7 times forecast earnings. Today’s equities trade at 10.2 times 2012 forecast earnings and earnings estimates continue to fall to their lowest level since April.

“What you’re seeing is a growth scare,” Wayne Lin, a money manager at Baltimore-based Legg Mason Inc. “The question is, how much of that is priced in. I’d say that if we don’t have a double-dip recession, if earnings just stay flat, these valuations are reasonable. The market already expects those downgrades.” (via Bloomberg)

Unlike previous market crashes or recessions, this one has been relatively slow-going. In the previous nine quarters, companies prepared for further economic volatility and managed to exceed income forecasts after cutting costs and lowering debt. With lowered analyst estimates for 2012 companies will have an easier time hitting their mark.

Whether or not lowered earnings estimates makes today’s stock prices a bargain is an ongoing debate between bears and bulls. According to Rob Arnorr, founder of Research Affiliates LLC, “the measures by which stocks are cheap today rely on continued recovery and a continued surge in already peak earnings. It relies on a very shaky foundation.”

for stock picks, go  to Kapitall.

If you can’t beat them join them, Best Buy. BBY

by  Chris Georgopoulos, SmartStops contributor

Reading financial articles can be, let’s say boring at times. This article we are going to try to spice it up, let’s play a game of role playing.  Famed speculator, Jesse Livermore once was quoted…

“If I were walking down a railroad track and saw an express train coming at me at 60 miles an hours.  I would be a damned fool not to get off the track and let the train go by. After it had passed, I could always get back on the track, if I desired.” –Reminiscences of a Stock Operator, Edwin Lefevre.  

For this game let’s rename the train, Best Buy stock (BBY: NYSE), the ““I” in walking down the track” we can call the shareholders of Best Buy and the speed of the train, the issues.  The game is scored by the costs of each decision. Whoever has the best return wins!

It is the end of summer 2005, Best Buy is approaching $80/share and the future couldn’t be brighter. The tech bubble burst is ancient history, the housing market is hot, interest rates are low and every house in America is an ATM for consumer spending.  You are on the railroad track…there isn’t a train in sight! 

It is now the beginning of fall 2008; Best Buy has fallen to the mid $40s in defiance of the market making new highs and there are rumors of problems in Mortgage backed securities.  (Note:  Sidestepping risk is now made possible with the release of SmartStops.net  which if had been available would have had you out in the $70 range in 2005).  Your friend has made a fortune flipping speculative properties in south Florida and Las Vegas, but you see he is worried. He still has five houses on the market with almost no personal income… (You know how this story ends)  You can hear a train coming and it sounds like it’s really moving!

Only a few months later, Best Buy is trading under $18/share!   The rumors are true; the housing market has crushed the stock market. It seems nobody thought housing prices would ever go down and the economy is on the verge of total failure. You can now see the train, its moving fast and finally you start to consider if you should actually get off the tracks.

(SmartStops.net   issued two Long-Term exit signals in 2008 the first January 4, 2008 at $46.80 and on September 16, 2008 at $40.68. That’s a  $22 per share savings by sidestepping risk.)

It is two years later; Best Buy is trading back in the mid $40s. Read More…

Autozone is definitely “in the Zone” but are there risks?

originally posted at Minyanville.

by Chris Georgopoulous, SmartStops contributor

Autozone (AZO: NYSE), a retailer of automotive replacement parts and accessories has seen an unprecedented appreciation in value over the past few years while most equities have been punished from an economic recession.  While the success of Autozone’s stock, management and business model are unquestionable there is still one question that needs to be answered; “Will it continue? “

Most businesses experienced negative effects from this past economic recession, Autozone triumphed.  The marketplace for new cars dried up quickly when personal income and spending dropped. With less money in the pockets of consumers, the more they had to rely on their aging autos. Aging autos need to be constantly fixed, and where did consumers go to replace those batteries, headlights and fuses? That’s right, “Get in the zone….Autozone”! 

This macroeconomic factor is the foundation of the growing demand, but it wouldn’t have propelled the stock alone. A competent management focused on using this ever growing cash flow to aggressively repurchase shares, open new stores and concentrated on maximizing same store sales figures. The stars aligned for Autozone and they took advantage of it.

 

Autozone (AZO) SmartStops Long-Term chart

Simple Moving Averages to highlight; 20=$292.10, 50=$271.55, 200=$178.82

The same success can be seen in the technical and fundamental analysis of their stock. From its lows in early December 2008 the stock has increased from the mid $80s to over $300. The Stock has not once broken its 50 day SMA, which was tested for the first time in 2 years during the most recent market correction.  Once tested the stock quickly rebounded in defiance of the overall market and broke to new highs.

Fundamentally the market may even be discounting the stock’s value.  Yahoo Finance lists the next five years growth rates at around 15%, Read More…

Listening For The Footsteps of A Pullback

With the market largely treading water over the last 10 years and investors experiencing several gut wrenching corrections over this period, it is no wonder that investment psyche has evolved from one of buy and hold to buy and protect.

Unlike a roller coaster, in investing the fun comes with the ride up, not with the nail biting ride down. Yet in the past 18 months alone buy and hold investors experienced a 30% decline in Google, a 46% decline in Ford, a 50% decline in Cisco and a 67% decline in Bank of America. Not a lot of fun here. Especially when you consider it takes a 43% gain to make up the ground on a 30% pullback.  As a result of this experience, investors find themselves asking, why ride out these storms if I don’t have to? How can I do a better job at identifying and sidestepping risk?

Traditionally, investors have turned to the VIX as a tool to help forecast market sentiment and risk levels. Unfortunately, the VIX often spikes in unison with significant market pullbacks providing little forewarning. The financial industry has responded with a slew of new and creative solutions that aim to help investors gain visibility and better listen for the footsteps of the next pullback. Following we take a quick look at three novel solutions, one which combines fundamental analysis with crowd sourcing, one which analyzes market sentiment, and a third that leverages technical analysis to identify periods of above normal risk. Read More…

Are ETFs Responsible for Rising Market Correlations?

SmartStops commentary:  Diversification alone is not going to be enough to manage risk in our 21st century markets.  Smartstops offers a superior dynamic intelligent risk management service.   Ask yourself, who is watching your back?

originally published at ETFTrends

S&P 500 stocks are moving as a herd and the increased presence of exchange traded funds in financial markets may be partly responsible for the spike in correlations, according to a report Monday.

Stocks in the S&P 500 over the past month have a correlation of 80%, higher than the peak reached during the financial crisis in late 2008, The Wall Street Journal reported.

“One potential reason is the popularity of exchange traded funds. ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000,” the newspaper said. “It’s reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.”

The three-month stock correlation in the S&P 500 is the highest in at least the past 20 years, while sector correlation is also elevated, according to a recent note from Goldman Sachs analysts.

A higher correlation means prices are moving together, rather than going their separate ways. [Sector ETF Correlations at Two-Year High: Strategist]

Correlations have spiked recently amid the so-called risk-on and risk-off trades. High correlations are not indicative of a healthy or normal market, analysts say. [Rising Correlations]

“Elevated correlation is generally considered a poor environment for long-only fundamental investors,” Goldman Sachs said.

Has Priceline’s trend broken? –A look at the stock through ancient eyes.

There are strategies that have passed the test of time, which we can refer to as “Tried & True”. “Cash is King” during economic downturns or the infamous, “catching a falling knife”, are a few examples.  I have found that the lessons of the great speculator, Jesse Livermore fall into this same category.  During times of market confusion or abnormal stock behavior, I use his “Tried & True” lessons to guide my own trading decisions.

How does Priceline (PCLN: NASDAQ) look through his eyes?

Priceline.com, the online travel discounter has undoubtedly been a market leader, a darling to momentum and growth seeking investors. PCLN has appreciated from the $50 area to over $550 since Oct of 2008. This “market-bragging” move has been attributed to stellar growth, perfect technical indicators and huge market interest. 

Read More…

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