After the first 30 or so responses, the established pattern was simply magnified, so we are comfortable about the statistical validity of our sample. Most of the responses were from the U.S., but we also had multiple advisors respond from at least four other countries.  Let’s get down to an analysis of the data! Note: You can click on any of the charts to enlarge them.

Even during the correction of the past couple of weeks, the RS Spread has continued to rise—a potentially good sign for RS going forward.

Despite strong U.S. equity market returns in early 2012 that sent the Dow back above 13,000 by the end of February, indications are that many Americans remain investment spectators, reluctant to participate in the equity market rally, a Franklin Templeton global poll has found.

Investor skepticism appears to be tied to the extreme volatility witnessed in 2011, in which the Dow Jones Industrial Average had 104 days of triple-digit swings-representing a significant portion of the 252 total trading days last year. Indeed, when asked about the importance of various market scenarios when deciding to purchase an equity investment, market stability was most frequently identified by U.S. respondents as an important factor.

“The market volatility that has persisted since 2008 is keeping many investors on the sidelines, and their ability to view positive equity market performance constructively has been thwarted by the market ups and downs that are at odds with the stability they are seeking,” John Greer, executive vice president of corporate marketing and advertising at Franklin Templeton Investments, said in a statement. “But the reality is that investors who have been waiting for ‘the right time’ to get back into the equity market have been missing out on the market rally we’ve witnessed over the past few years.”

This is sadly typical of retail investors.  Volatility tends to be greatest at market bottoms, and volatility tends to be what investors most avoid.  As a result, investors often avoid returns as well!

This period strikes me as psychologically reminiscent of the late 1970s, when Business Week famously published a cover announcing the death of equities.  Consider what investors had been through: in the late 1960s, the speculative names had gotten torched.  By 1973-74 even the bluest of the blue chips had gotten ripped.  By the late 1970s, 20% annual corrections were the norm.  The economy was a mess and investors simply opted out.  The Business Week cover just reflected the spirit of the time.

The late 1970s are not so different from now.  The speculative names collapsed in 2000-2002, followed by a bear market in 2008-2009 that got everything.  The last couple of summers have been punctuated by scary 15-20% corrections.  The economy is still a mess.  Psychologically, investors are in the same spot they were when the original cover came out.  Based on fund flows, “anything but stocks” seems to be the battle cry.

Yet, consider how things unfolded subsequently.  Only a few years later both the market and the economy were booming.  (High relative strength stocks began to perform very well several years ahead of the 1982 bottom, by the way.)  The Business Week cover is now famous as a contrary indicator.  It wouldn’t shock me if the current investor disdain for stocks has a similar outcome down the road.

Business Week: the famous "Death of Equities" cover

Source: Horan Capital Advisors  (click on image to enlarge)

Their observation is that ratios near one are often lows.  There’s no way to know if the same thing will happen this time, but it fits in with the generally negative sentiment we see in our client behavior survey as well.

via Abnormal Returns

A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.

We’re in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.

We will also need fiscal stimulation by the government, which of course, is very classic. Governments have to spend more when sales and tax revenue go down and as unemployment and other social benefits kick in and there is a redistribution of wealth. That’s why there is going to be more taxation on the wealthy and more social tension. A deleveraging is not an easy time. But when you are approaching balance again, that’s a good thing.

What makes all the difference between the ugly and the beautiful?

The key is to keep nominal interest rates below the nominal growth rate in the economy, without printing so much money that they cause an inflationary spiral. The way to do that is to be printing money at the same time there is austerity and debt restructurings going on.

It’s interesting that he seems pretty satisfied with the process the US has taken so far, in the sense that we may avoid significant inflation or deflation.  The deleveraging process won’t be easy socially or economically, but it’s certainly preferable to a Japan-type scenario.  His opinion is interesting to me because so many other commentators are falling into the doomsday camp, although half are expecting Japan-style deflation and the other half are counting on Weimar-style inflation.

I suppose it is human nature to worry about the worst thing that can happen, but Mr. Dalio suggests a middle path might be the most realistic.

Last week’s performance (5/14/12 – 5/18/12) is as follows:

The worst performance for the week actually came from the bottom quartile of the ranks (laggards).

We’ve written before about beanbag economics, the essence of which is that when you smush in one part of a beanbag, it just poofs out somewhere else.  Relative strength is a simple and effective way to see where trends are underway.

Consider a typical bad news lead in this Reuters article:

Worries about a run on Greek banks has rattled Athens this week, after savers withdrew at least 700 million euros on Monday alone…

That sounds quite scary.  However, buried deep in the article, at the very end, is the beanbag economics section:

Deposits shifted around Europe dramatically last year, analysis of data from more than 120 listed European banks show.

More than 120 billion euros was taken from two banks in Belgium alone, including an exodus of customer deposits from Dexia (DEXI.BR) which had to be bailed out and restructured. KBC (KBC.BR) also saw a big outflow.

Some 90 billion euros was taken from France’s banks, including around 30 billion each from Credit Agricole (CAGR.PA) and BNP Paribas (BNPP.PA). French banks were hit last year by their heavy exposure to Greece and concerns about their liquidity that forced them to accelerate plans to shrink.

Worries the euro zone crisis would spread also saw about 30 billion euros in deposits leave Italian banks, although inflows to BBVA (BBVA.MC) helped limit the net outflow from Spain.

Cash flooded into Britain; more than 140 billion euros was deposited in four big banks alone. The UK benefits from its position outside the euro zone and its Asia-focused banks HSBC (HSBA.L) and Standard Chartered (STAN.L) are seen as particular safe-havens.

Other banks to see big inflows included Barclays (BARC.L), Germany’s Deutsche Bank (DBKGn.DE), Switzerland’s Credit Suisse (CSGN.VX) and UBS (UBSN.VX) and Russia’s Sberbank (SBER.MM) and VTB (VTBR.MM).

Banks that were in trouble had deposits leave, but they didn’t vanish into thin air.  Other banks saw massive inflows at their expense.  And—think about it—the Greek and French banks had the money in the first place because depositors saw them as relatively more attractive than European stocks or their mattresses, or whatever, at the time.  Times have now changed and the flow of money is being directed somewhere else.  It’s not the end of the world when some asset class implodes, unless, of course, you have 100% of your assets in it.  That implosion works to the benefit of another asset class somewhere else.

There are always relative winners and losers; things are rarely completely one-sided.  This is the primary attraction of using relative strength for tactical asset allocation.  It is able to identify shifts in supply and demand by measuring what assets are strong and what assets are weak.   Markets all over the world operate and interact in this same way.

Beanbag Economist: Someone has to get those asset flows!

Source: www.indyagenda.com

via The Big Picture  (click on image to enlarge)

You can see that relative strength did not crack the top ten.  On the bigger chart, which you can see in the article, relative strength came in at #11.  Of course, there are many formulations of relative strength, so even that ranking probably covers a lot of different methods.

A number of the popular factors are value-related and some are based on profitability.  All of these factors ultimately interact in complicated ways, but you don’t have to worry about a crowded trade in relative strength.

Value, quality, and risk-related factors are all much more popular than relative strength.

via The Big Picture     (click on image to enlarge)