Excerpt from David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service.
This is an excerpt from my April 18, 2005 newsletter in which I, along with some guest editorialists, analyzed Bob Brinker's stock market timing model. I think we hit the nail on the head. For those of you who are curious about Mr. Brinker's timing model, I think you will enjoy reading this.
BOB BRINKER AND HIS STOCK MARKET TIMING MODEL
The recent market weakness has prompted several of my subscribers to ask my opinion on whether I thought Bob's timing model has or is about to turn bearish. In my opinion, the answer to both those questions is no. I thought I would use this weekend's newsletter to provide some analysis to back up that opinion.
ROOT CAUSES OF A BEAR MARKET
Back in the days when the secular bull market was coming to an end, Bob was asked how he would know a bear market was coming. At that time, Bob discussed the five factors or "root causes" as he refers to them that foretell a bear market. Those five root causes include the following: (1) tightening monetary policy by the Federal Reserve; (2) rising interest rates (especially short-term rates); 3) rising inflation; (4) rapid economic growth; and, (5) over valuation in the market.
If you look at the foregoing five factors, there is some cause for concern. Certainly we have a tightening monetary policy by the Fed, although thus far it has been to "normalize" rates, so they haven't gone overboard yet. We do have rising short term interest rates. The remaining three factors, however, seem to be ok. Inflation (so far) remains benign, although we will get some additional data on that later this week when the Producer Price Index and Consumer Price Index are announced on Tuesday and Wednesday, respectively. We haven't seen rapid economic growth, as evidenced most pointedly by the jobs growth, and GDP. Finally, the market's valuation is not excessive, especially in light of the recent correction.
The "root causes" of a bear market is the starting point for Bob's analysis. Bob also analyzes the history of past markets to see if their is historical evidence to support a bear market. In addition, Bob examines trading volumes, the cumulative advance/declines, new highs and new lows, all of which falls in the realm of technical analysis, although Bob says he does not use "charting" to predict the future. Finally, for Bob to actually adopt a risk-averse position in equities, that decision is made according to the dictates of his "long term stock market timing model." To answer the question of how Bob's timing model might be looking right now, I consulted with SteveT, one of my charter subscribers and also a Brinker historian of sorts.
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GUEST CONTRIBUTOR
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Title: LTSMTM UPDATE
Author: SteveT (with editorial comments by David Korn)
Introduction.
SteveT: LTSMTM, what the heck is that? Any long-term Trekkie already knows - its an acronym for Bob Brinker's Long Term Stock Market Timing Model. Mr. Brinker's timing model has four major components, all with approximate equal weighting. They include: (1) Valuation; (2) Monetary policy; (3) Economic; and, (4) Sentiment. In one sense, it is a simple, yet logical model. It is designed to be bullish when the outlook for the economy and corporate profits are optimistic, and bearish when the reverse is true.
Before I discuss my current views on the individual components of the model, allow me to introduce myself and share some ideas with you about Bob's methodology.
My name is Steve and I had been listening to Bob Brinker for well over a decade. At one point, I even posting notes I took of Moneytalk on the Internet where I met other Brinker-o-philes and where I ultimately connected with DavidK and now leave the commentary up to him. In recent years, I have been somewhat disillusioned with Bob, more so over the way he has reacted toward bad recommendations and treated others than anything else; nevertheless, I remain very curious as to how history will judge him. Perhaps my curiosity stems from wanting to see whether Bob will be able to successfully time the market, or whether his LTSMTM will go the way of his short-term timing model --you know, the one that was used to identify the QQQ trade in the fall of 2000.
A while back I got to wondering what causes Bob's model to change from bullish to bearish or bearish to bullish. Is it simply his personal expectation for future market returns? Does he really have a "model" that he completely relies on? Over the years, certain things kept coming up repeatedly that led to a hunch on my part about "the model." I have looked back in time trying to identify what triggered a change in Bob's model and I believe I am on to something.
I have written in the past about how I thought Bob viewed his “model” at that particular point in time and how I believe the “model” is constructed. We all know Bob looks at numerous indicators and the “model” is quantitative and does ultimately depend on Bob making a subjective judgment at some point to alter his allocation. The “model” was originally entirely comprised of fundamental analysis indicators. After Bob made a major mis-timing move, getting out of a bull market in 1988 and not becoming fully invested again until January 1991 when the DOW was some 20% higher, he added the Technical analysis component. Technical analysis ("TA") relies on things happening a certain way because they acted that way before under the same conditions. Detractors often say TA is not reliable since things are never exactly the same as they have been in the past. In one sense, Bob’s “model” in entirely technical analysis since he is relying on things falling into place this time because they did previously. You can see how it is easy to go in circles trying to follow this stuff. I will say having a model to study does have the advantage of partially eliminating some of the emotions we all face at the tops and bottoms of the market cycle.
We all know from listening to Bob on the radio that he claims to be able to know when to be in the stock market and when not to be. I believe Bob's model is simple but logical. Everyone knows the stock market is uncomfortable with things like inflation and a tight money supply. We also know that trees don't grow to the sky, and there is a limit to how much people will pay for the prospect of future earnings. When economies grow to fast and future inflation fears arise, interest rates will increase and that has historically put pressure on share prices.
It has been said that the stock market is a discounting mechanism. It tries to anticipate what a stock or group of stocks will be worth 6-12 month down the road. In the interim, volatility can move stock prices widely, offering opportunity for both buying and selling of stocks at favorable prices. Or at least that is the theory.
Methodology.
I have always believed that Bob has a great deal of respect for valuation. Every Monday when he examines his model, I believe Bob starts by calculating the current P/E ratio of the S&P 500 -- the Index which Bob says his current timing model tracks. Determining the market's valuation can be a daunting task since there are many methods to choose from. We do know the stock market is a forward looking device. Based on Bob's past statements, I believe he looks at forward operating earnings.
In going back to look at what makes his model tick, I found it practical to use actual earnings for the period in question. This minor adjustment would cause my figures to fluctuate from the actual numbers Bob may have used.
I believe after making the initial P/E calculation, Bob compares that to the P/E of the FED model. What is that you say? Simply put, you take the yield of the ten-year Treasury bond and divide that by 1. For example, if the current yield is 4.75%, you use the formula (1/ 4.75)*100 = 21.05. If the current P/E is below 21.05 the market could be deemed undervalued and if over 21.05 it could be classified as over valued.
Throughout his history, Bob seems to be fixated with catch phases that he uses. One example, would be that his model "projects an increase of 10% to 20%" or "up to 20% or more." Do you ever recall Bob saying things along these lines? I believe when the P/E calculation Bob makes every Monday is between 80% and 120% of the FED model P/E he calls the valuation indicator neutral. When below 80%, it is bullish and when above 120% it is cautionary. Taken to the extreme, when above 150% it could trigger a sell signal no matter what the other indicators tell him.
DavidK EC: Bob has been consistent in saying that his model is "either bullish or bearish." In other words, there is no in between which suggests that he might actually assign a number based on the data points which triggers the decision to issue a buy or sell recommendation.
SteveT continued: It is important to separate historic valuation from current valuation. Bob's method allows you to stay invested in equities when valuations are high historically, provided we are in a low interest rate and low inflation environment. You might be tempted to go back to the 1988 to 1991 and check this theory. I'll save you the trouble. It doesn't jive, but remember Bob's timing model failed during that time, and he allegedly changed it after wrongly exiting a bull market in the late 1980s.
After making the first calculation, I believe Bob quickly reviews the other segments of his model. My guess is that he starts with the Monetary policy indicator, followed by the Economic indicator. Then, he finishes up with his newest indicator, Sentiment, which seems to be evolving to this day. I suspect that even if the last three indicators were in conflict with the Valuation Indicator, Bob would still be hard pressed to announce a change in his model outlook. In fact, I believe he uses these secondary indicators to confirm what the Valuation Indicator is saying. He may even look to these secondary indicators to pick a precise time to pull the trigger.
Bob often references the five root causes of bear markets. Those being; tight money, raising rates, raising inflation, rapid growth, and over valuation. As of today I don’t think anyone would claim money is tight. M-2 money supply is growing nicely and anyone desiring credit or mortgages does not need to spend much time searching. The Fed Funds rate has risen 1.75% in the past nine months while the ten-year treasury yield has barely moved. It seems we are all waiting to see where the FED stops. This is something I am sure Bob will be monitoring closely in the coming months.
Inflation is creeping back into the picture but for now is not out of control despite the pain we all feel when we fill our gas tanks. Final Fourth Quarter 2004 GDP was expected to come in at 4% but actually finished at 3.8%. This indicates an economy humming along in the sweet spot and in no danger of overheating. Valuation is certainly reasonable, with 2005 forward P/E coming in at slightly above 17 using Bob’s $69 as the earnings guess. Considering the inflation environment one could hardly make a case for over valuation. All in all, I can see why Bob’s last newsletter implied that further gains in the U.S. stock market are expected this year and he fully expects new cyclical bull market highs and his model is not anticipating becoming bearish anytime soon.
The art and science in all of this, is trying it assimilate the information and determine which indicators deserve the most weighting at any particular time. With that said, and with DavidK's help, let's look at the individual components of the model with an eye toward how they might translate today.
MODEL ANALYSIS
VALUATION INDICATOR
SteveT: Bob is still predicting S&P 500 earnings of $69. This is among the lowest predictions I’ve seen. Standard and Poor's is suggesting $75.06 as of early April. This weekend while pinch-hitting for Bob, the guest host Larry Kudlow suggested $78 in earnings! Now, we all know that Larry Kudlow tends to be terminally optimistic; however, I wonder if Bob deliberately diminishes his earnings estimates to protect him from being overly optimistic when he believes we are in a secular bear market. Considering past history in times when rates have been where they are now, a P/E in the high teens is very reasonable. Using Bob’s estimate of $69 and the S&P 500 close Friday of 1142.62, this gives us a P/E of 16.55. Using S&P estimates of $75.06, you get a P/E of 15.22. If you use the FED model you could call 23 a reasonable P/E. I believe this is the number one reason Bob is optimistic about equities this year. After a sluggish 2004 and most of the yearly gains coming after the election, it is not surprising we have had a slow start to 2005. After being range bound maybe it is time for the next upward leg of the bull market. I rate the Valuation Indicator as bullish.
DavidK EC: Bob Brinker tracks the P/E ratio of the S&P 500 when analyzing the valuation component of his timing model. Steve is right about Bob's estimate of $69 for calendar year 2005 being on the low side. Using today's closing price for the S&P 500, that would translate into a forward P/E ratio of 16.60. Bob has pointed out that the average P/E ratio for the market when we have periods of low inflation comes in around 18-1/2. Keep in mind that is a historical average during periods of low inflation. If earnings continue to improve, and inflation remains benign, the market can afford the types of valuations we presently have. I agree that the Valuation Indicator as Bob tracks it is bullish.
MONETARY POLICY
SteveT: Monetary Policy is something most of us are watching to see when Alan Greenspan and the FOMC pause on increasing short-term rates. It is widely know the short-term objective of the FED is to try to get rates closer to a normal range. This will allow them the flexibility to lower rates should it become necessary to stimulate the economy if we slow down. After lowering rates to levels most of us have never seen in the post 9-11 era, we all knew rates were going up. Right now, the unanswered question is whether the lower rates and tax cuts stimulated the economy enough to trigger inflation. So far so good; however, it remains to be seen if the FED will take a break in rate hikes this summer or inflation will become a real threat. For now the Monetary Policy Indicator is bullish.
DavidK EC: Bob follows the monetary supply to determine the necessary liquidity for continued expansion in the United States economy. Bob has referred to the M-2 money supply as "the fuel of our economic growth." You may have noticed that Bob has been discussing monetary policy more and more frequently on the shows of late. I think (like Steve pointed out), all eyes (including Brinkers) are on the Fed to see what they are going to do with interest rates after they are "normalized." The biggest fear that Bob has relative to this indicator, is that the Federal Reserve will overreact to headline inflation and raise interest rates more than they need to. For now, I think this indicator is bullish, but the scale could be tipped rather quickly if the Fed does something unwarranted.
ECONOMIC INDICATOR
Stevet: The Economic indicator is composed of the GDP, which is a measure of our economic growth. I believe Bob looks at the direction and rate of growth as a key to future earnings growth. I have a hunch he also looks at productivity as a way to see just how much growth we can enjoy without inflation becoming a problem. The goal is to keep GDP around 4% so we can enjoy maximum growth without having to worry about inflation and increasing rates. As of this moment, I think the economic or business cycle is no doubt in the bullish camp. Calendar year 2005 growth is expected to be a steady 3% to 4%. Productivity has helped even out the higher costs of energy. Housing is still decent in most regions of the nation, helped by low mortgage rates. I rate the Economic Cycle Indicator as bullish.
DavidK EC: Steve is correct in that Bob focuses on the growth of real gross domestic product in this category. At one time, Bob has also mentioned that "forward earnings momentum" and "economic momentum" comprise this indicator. What is important relative to this indicator is the rate of growth in the economy. At the beginning of this year, Bob raised his projection of GDP growth by 0.5% to a range of 3% to 4%. Fourth quarter GDP last year, rose 3.8%. On April 28th, we will get the first look at GDP for the first quarter of 2005. So far, GDP is looking like it is falling within Bob's projections which helps put this indicator in the bullish camp.
SENTIMENT INDICATOR
SteveT: Analyzing sentiment is something that Bob added to his “model” after the poor performance he suffered in the 1987 to 1991 time frame. I think he really struggles with this indicator. When I first recall him mentioning it, the primary data point was the Investors Intelligence four week moving average of Bulls/Bulls + Bears. At another time, Bob said the indicator was revealing very little useful information. Other data points are the VIX, TRIN, and volume. Bob also looks closely at market internals such as advance/decline line and new highs/new lows. Lately he has mentioned several times the Put/Call ratio, both the 10 day and 60 day moving averages. This has shown a fair amount of bearishness since New Years which is actually a bullish piece of data. To be perfectly frank, I believe David Korn has a much better handle on this indicator than Bob does. As some of you may recall David did not act immediately and buy QQQ in October 2000 and also identified some inflection points primarily using his TA skills.
DavidK EC: While I thank Steve for the compliment, I must remind people that I am not always able to identify inflection points. It is certainly a goal of mine that I give my best effort to, but certainly not a perfect science by any stretch.
DavidK EC#2: Bob views Sentiment as a contrarian indicator. As Steve accurately noted, I believe Bob began with primarily the weekly poll of investment newsletter writers done by Investors Intelligence. Bob uses the formula bulls/(bulls + bears) to yield a percentage. When the number comes in between 50% and 70%, Bob views it as a neutral sentiment data point. When the number comes in under 50%, it is viewed as a bullish indicator as it means the majority of newsletter editors are out of the market, and the only way they can affect the market is by buying back into it. If the percentage drops to under 50% (after checking the other indicators) it often in the 1990's indicated a buying opportunity or as Bob said, a "Gift Horse Buying Opportunity." Again when it drops to under 50% that means that one or more of every two newsletter writers are bearish. They are out of the market when they should be buying. Bob has referred to the newsletter writers who are in the "Correction" category as "clueless" and do not factor into his calculations. When the number is over 70%, it represents a lot of bullishness among advisors, which is a dangerous level from a contrarian standpoint. Bob attempts to smooth out the weekly bumps by looking at the 4-week moving average of this percentage. Currently, the percentage of bullish advisors in the Investors Intelligence Survey is 46.2%, with the percentage of bears at 29.0%. Using the formula [(bulls)/(bulls + bears)], the sentiment ratio is 61.43%. The four-week moving average is 63.55%. Not a really great number, but better than it was in recent weeks when the four-week moving average was above 70%.
DavidK EC#3: The put/call ratio is looking extremely healthy from a contrarian perspective. The 10-day put/call ratio is 1.01, which I am sure Bob would rank as very bullish. In addition, the 60-day put/call ratio is 0.89, and Bob has called this indicator bullish, even when it was as low as 0.78.
SteveT: I believe that as time goes by, Bob has learned more about technical analysis and added other data points to this Indicator in an attempt to diversify and avoid mistakes. During the panic of autumn 1998, Bob started talking about other indicators such as the Put/Call ratio. It was also then he seemed to key in on market internals such as new highs/new lows, advance/decline, volume, etc. He liked to see the market make a bottom and then drift higher, then retest the low on lighter volume. The theory was that those that were going to sell already did and that only left buyers left to move the market. Overall, I think it is safe to say that the Sentiment Indicator is bullish.
DavidK EC: In recent times, it appears Bob added the TRIN and the VIX to the mix and there are quite a few more. I agree with Steve in that the combined results of all these Sentiment Indicators is bullish. Every couple of months, I do an extended version of the sentiment data so look for it some time in the near future.
CONCLUSION
SteveT: At this time I don’t see anything to be alarmed at. I feel Bob would view the past six weeks as a normal health restoring correction in an on going bull market. The economy is doing fine and doesn’t look like a major slowdown will appear anytime soon. This bodes well for earnings, which should offer some protection against steep drops in the stock market. In fact it very well could result in valuations becoming very attractive and signal an out right buy for those holding stock market cash reserves. Monetary policy will be under close scrutiny by the major media and should things change drastically we all will know. For now, things are accommodative. Sentiment is bullish but keep your eyes on this one since it can change quickly. I make it 4 for 4 in the bullish camp which means time for Brinker followers to be fully invested.
Final Thoughts from SteveT: So there you have it. Use this information at your risk or not. Record the numbers and make up a spreadsheet like I did to track the model components and see what you come up with.
DavidK EC: I agree with Steve and believe Bob is still bullish on the market. I want to thank Steve very much for sharing his views on Bob's long term timing model and the market. I welcome comments from any of you concerning this discussion of Bob Brinker's long term timing model. Once again, thanks for contributing Steve!
- David Korn, editor of begininvesting.com
DISCLAIMER: I am not associated with ABC Radio Networks, Moneytalk or Bob Brinker and this service is neither sanctioned by, nor written under the auspices of ABC Radio Networks, Moneytalk or Bob Brinker. This e-mail is not a substitute for listening to Moneytalk, it is only my interpretation and commentary of some of what is discussed on Moneytalk, along with additional educational information that I include, editorial comments about the market and helpful financial links. I also provide my own stock market commentary to subscribers as part of my service and give them access to my web site, www.BeginInvesting.com. If you want to know what was said verbatim on Moneytalk, listen to the show live or subscribe to "Moneytalk on Demand" which allows you to listen to the show in case you missed it live. The web site, bobbrinker.com has all the links to the ABC Radio Network stations that broadcast the show live. The information contained in this newsletter is not intended to constitute financial advice and is not a recommendation or solicitation to buy, sell or hold any security. This newsletter is strictly informational and educational and is not to be construed as any kind of financial advice, investment advice or legal advice. Copyright David Korn, L.L.C. 2005. |
