That Darn January Effect

February 1, 2012

Bespoke has a brief article about what is commonly known as the January effect.  This year it has been quite noticeable.

No matter how you look at it, the month of January was a month where most of last year’s losers played catch up and most of last year’s winner dropped back with the pack.  The first chart below shows the performance of the S&P 500 (red dot) and each of the ten sectors in 2011 versus their performance in January.  As shown, the three sectors that were down in 2011 (Financials, Materials, and Industrials) rank in the top three in terms of performance so far this year, while the two best performing sectors last year (Utilities and Consumer Staples) are two of only three sectors down so far this year.

Losers playing catch up and winners lagging is obviously not a formula for good performance by relative strength!  January is typically the worst month for relative strength, but it usually gives way to better performance for the rest of the year.

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Revisionist History

February 1, 2012

In certain regimes, political figures who fell into disfavor were expunged from the history books.  The Conference Board is somehat better, in that the old and the new indicators can be compared.  Specifically, the Conference Board has changed the composition of the US Leading Economic Indicator.  Ed Yardeni comments:

The Conference Board has made the first major overhaul of the components of the LEI since it assumed responsibility of the index in 1996. It replaced real money supply with its proprietary leading credit index, and the ISM supplier delivery index with the new orders index. In place of the Thomson Reuters/University of Michigan consumer expectations measure, it will now use an equally weighted average of its own consumer expectations index and the current measure. Also, the nondefense capital goods gauge was tweaked to exclude commercial aircraft.

The impact of these changes has been shocking, and really questions the credibility of constructing LEIs. The old LEI rose to a new record high in November, exceeding the previous cyclical peak (where it hovered during 2006 and 2007) by 12.7%. The new LEI edged back up in December to its previous high for the year during July, but that’s 13.1% below the previous cyclical peak!

I added the bold, but you can see why economists are shocked when you see the visual difference in the chart reproduced below (I think Dr. Yardeni included the ECRI leading indicator for good measure):

LEIoldandnew Revisionist History
Source: Ed Yardeni/Conference Board/Haver Analytics (click on chart to enlarge)

The old LEI is blasting off into the stratosphere, but the new LEI is still way, way below the old highs.  In addition, the old LEI showed a very modest decline from the 2006 peak, while the new version shows a bloodbath that took out the 2000-2002 recession lows!

Mr. Yardeni has a very apt comment on the problems with indicators that are revised:

These man-made indexes combine a bunch of indicators that purportedly lead the business cycle. When they fail to do so, the men and women who made these indexes recall them, retool them, and send them back out for all of us to marvel at how well these new improved versions would have worked in the past. I can accurately predict that when they fail in the future, they will be recalled and redesigned yet again.

Of course, it’s not just the US LEI that economists revise.  They revise GDP, CPI, employment data, and virtually everything else.  Analysts revise earnings estimates with regularity, which I suppose is a good way to avoid saying “Our old estimate turned out to be wrong.”

Here we see one of the benefits of using relative strength: since it uses only market prices, it is not subject to revisionPrices reflect true supply and demand.  No one can come back to you and say, “You know those IBM shares you sold in 2010 for $141?  We’ve revised the data and it was really only $123, so you need to send us a check.  Of course, we might revise it again later, so keep your address current.”  It is difficult to make good investment decisions even when using good data!  It’s got to be near impossible using data that turns out to have been completely wrong.

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From the Archives: Supply & Demand is Everywhere

February 1, 2012

NPR has a great story about monkey economics and how special skills in short supply translate into higher monkey income.  I first saw this on Greg Mankiw’s blog.  Even monkeys bow down to supply and demand!

—-this article was originally published 11/12/2009.  Human economics and monkey economics are exactly the same–scarcity creates value.  The story is quite funny too.

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High RS Diffusion Index

February 1, 2012

The chart below measures the percentage of high relative strength stocks that are trading above their 50-day moving average (universe of mid and large cap stocks.)  As of 1/31/12.

diffusion2112 High RS Diffusion Index

The 10-day moving average of this indicator is 88% and the one-day reading is 84%.

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