Wednesday, December 21, 2011

A Bullish Composite Indicator

There are numerous indicators of the stock market, many of which have tended to work well over time.  Unfortunately, they don't work all of the time, and they often conflict with one another.  That is why investing is so challenging.

One of the most reliable indicators over the years was the dividend yield on the U.S. stock market.  When the dividend yield on U.S. stocks was 6% or higher, it was a buy signal.  When it fell to 3% or less, it was a sell signal.  Successful market technician Edson Gould called this his market "sentimeter."  But in the 1990's, the dividend yield on stocks fell to 3%--and kept on falling, as the technology stock mania rolled on.   I admit to having relied  too heavily on this indicator at the time and becoming too cautious.  Since then, I've tried to take each indicator on its own with a grain of salt and instead emphasize the weight of the evidence.

Today I came across a composite indicator by a prominent investment research firm.  This indicator includes monetary, economic, sentiment, and valuation components.  Its record using more than 40 years of data would have outperformed the S & P 500 by nearly 600 basis points annually.  Aside from a major faulty signal late in 2000 when it turned bullish before a big drop in stock prices, its record since then is particularly good.

This indicator now is in bullish territory, which has returned 15% annually on the S & P 500 since 1965 when at its current level.  That is interesting, but I remain neutral on equities for various reasons, including the investor complacency that is indicated by a VIX Index (of option volatility) reading of only 21.

Steve Lehman

S & P 500:  1244

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