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Risk Assessment - Are You Listening?

Opening Whisper

The sweet spot in the economy appears to be eroding before our very eyes. No matter how GOOD Uncle Larry says that the economy is, we still cannot accurately predict just how BAD the labor market can become. The March Non-Farm payroll numbers came in at 110,000. This is just half of what was predicted. No Larry, the economy is not great! The jobs we are getting are not the significant types of jobs that our economy requires. During this business cycle, we have not had sufficient job growth and quality and now many are suggesting that this recovery cycle is over. I am no economist (thankfully), but it appears to me that something is broke, or at the very least not sufficient to give us stable and consistent earnings, jobs and personal savings growth.

There are several economic and financial factors that are at all-time extremes. You have read about these factors on SafeHaven.com and other sources in recent months. Low personal savings rates, high debt-to-GDP ratio, highly leveraged real estate markets as well as the cosmic extremes in the derivatives markets. The probability of any of these factors seeing a collapse may be small. However, we need to ask ourselves, "What is the risk assessment should one of these factors see a tremor or collapse." If you do the math, a small probability of potential collapse multiplied by the dramatic damages associated with that event could leave us with a sizeable probability of an unwanted outcome. Here's the kind of math that we engineers use to estimate the risk of and unwanted hazard in a system design;

Risk Factor (for event) = P x D (P - probability of event, D - damage from event)

If P = 0.001 (Not bad), and D = 1,000,000 (Bad); then Risk Factor = 1,000 (Not Good!)

OK, OK. Now don't hold me to any absolute numbers here. I am just making a very generic point. An unlikely event, when associated with a severe outcome increases the risk such that an unlikely outcome may produce an unacceptable risk.

Here's another way to show it;

 4  Bad Hurts Ouch! Ouch!
 3  OK Bad Hurts Ouch!
 2  Good OK Bad Hurts
 1  Best Good OK Bad
  1 2 3 4

The result of our macro risk assessment of the economy should lead us to the conclusion that the economy, and therefore the equity and real estate markets, have a greater potential downside than upside. There are several unacceptable (and maybe unpreventable) risks lurking in the core of our financial system. Just how big is that Greenspan put?

Our Trading System - What The Numbers Are Telling Us

The contra-trend rally may be sputtering. The Put/Call spike of March 18 prompted us to look for a short-term rally in the markets. However, even end-of-quarter positioning and the new quarter opening could not seem to spark any buying interest. The NDX was down 0.04% for the week. No rally there! The other indices were basically flat on the week as well.

Our sell signal is maturing, but may also be picking up some strength. Our temporary and partial move to cash my have been without foundation since at week's end none of our indicators have moved to initiate a Buy signal and the ROC is losing momentum quickly. We will get back to a fully short position in the next few trading days.

Below I have included a 2 year chart of our NDX model. In the big picture, it appears that the next down-side support for the NDX would be at the August 2004 lows of 1300. But before we get there however, we may see a pause in the decline as the Dow Industrials approach the 4-digit 9,999 level.

NDX - 2 yr. Chart Model - Friday April 1, 2005

What Is The Current Sentiment?

The markets finished the week on a weak note. The VIX broke down briefly today in a fit of irrational greed but ended the day with a whimper of trepidation. We will need to see the VIX break above 16 before we can get a significant rally.

VIX Volatility Index - 6 months

Below is the GLD chart. The Gold ETF MACD is still rolling over on the weekly chart. Watch for a turn up in the MACD in the next few weeks.

3 Year Chart for Gold ETF - GLD

Let's take a look this week at the Semiconductor sentiment ratio chart -
$SOX/$SPX. (The relative strength between semiconductor sector and S&P 500)

The weekly MACD on this chart and the ratio Stochastics seem to indicate that the Semiconductors may start losing ground relative to the SPX after holding their own for several months.

Where Do We Go From Here and How To Listen For the Next Signal?

Listener Summary for the Week

We have apparently avoided both the rally and the fall off of the cliff this week. We are looking at a potential for more downside before we get a bounce. However, the talking faces on CNBC seem to be getting more bearish. Wow, that must be a contrarian sign that we are oversold and ready for a bounce! Keep watching our indicators and let's be ready to move to a cash neutral position if any significant rally develops next week. Other than that, we should stick with our SELL signal. The upcoming earnings announcement season may bring some surprises since there are a lot of insiders selling their shares and stock options awards at a frenetic pace.

The Market is whispering now, but may be getting ready to shout!

Are you listening?

The Market Listener Indicators

Week Ending Slo. Stoch. StochRSI MACD ROC Signal
Apr 01, 2005 Sell Sell Sell Sell Sell
Mar 24, 2005 Sell Sell Sell Sell Sell
Mar 18, 2005 Sell Sell Sell Sell Sell
Mar 11, 2005 Sell Sell Sell Sell Sell
Mar 04, 2005 Sell Sell Sell Sell+ Sell
Feb 25, 2005 Sell Sell Sell Sell Sell
Feb 18, 2005 Sell Sell Sell Sell Sell
Feb 11, 2005 Sell Sell Sell Sell Sell
Feb 04, 2005 Sell Cash Sell Sell Cash
Jan 28, 2005 Sell Sell Sell Sell Sell
Jan 21, 2005 Sell Sell Buy- Sell Sell
Jan 14, 2005 Sell Sell Buy Sell Sell
Jan 07, 2005 Buy Sell Buy Sell Sell
Dec 31, 2004 Buy Buy Buy Sell Cash
Dec 23, 2004 Buy Buy Buy Buy- Buy
Dec 17, 2004 Buy Buy Buy Buy Buy
Dec 10, 2004 Buy Buy Buy Buy Buy
Dec 03, 2004 Buy Buy Buy Buy Buy
Nov 26, 2004 Buy Buy Buy Buy- Buy
Nov 19, 2004 Buy Buy Buy Buy Buy
Nov 12, 2004 Buy Buy Buy Buy Buy
Nov 05, 2004 Buy Buy Buy Buy Buy
Oct 29, 2004 Buy Buy Buy Buy Buy
Oct 22, 2004 Buy Buy Buy Buy- Buy
Oct 15, 2004 Buy Buy Buy Buy- Buy
Oct 08, 2004 Buy Buy Sell+ Buy Buy
Oct 01, 2004 Buy Buy Sell+ Buy Buy
Sep 24, 2004 Buy Buy Sell+ Buy- Buy
Sep 17, 2004 Buy Buy Sell+ Buy Buy
Sep 10, 2004 Buy Buy Sell Buy Buy
Sep 03, 2004 Buy Buy Sell Sell+ Buy
Aug 27, 2004 Buy Buy Sell Sell Buy
Aug 20, 2004 Sell Buy Sell Sell+ Cash
Aug 13, 2004 Sell Sell Sell Sell Sell
Aug 06, 2004 Sell Sell Sell Sell Sell

* Note - You should not base your trading on this or any other single indicator. With Rydex I can trade 10 minutes prior to the close on Fridays (or other days during the week) when I see that one or more of the signal indicators have changed signals. This is particularly important if I am going to a CASH position in order to preserve capital. The above table shows the results of the WEEKLY - FRIDAY SIGNALS with the exception of the latest week, which only shows the END-OF-DAY THURSDAY SIGNAL POSITIONS. The latest signal position may change in next week's newsletter due to a dramatic move on Friday after the Newsletter is issued.

Listen To What He Says
From 1 Cor. 15:51-57 (NASB):

"Behold, I tell you a mystery; we will not all sleep, but we will all be changed, in a moment, in the twinkling of an eye, at the last trumpet; for the trumpet will sound, and the dead will be raised imperishable, and we will be changed. For this perishable must put on the imperishable, and this mortal must put on immortality. But when this perishable will have put on the imperishable, and this mortal will have put on immortality, then will come about the saying that is written, "DEATH IS SWALLOWED UP in victory. "O DEATH, WHERE IS YOUR VICTORY? O DEATH, WHERE IS YOUR STING?" The sting of death is sin, and the power of sin is the law; but thanks be to God, who gives us the victory through our Lord Jesus Christ."

I am still working on the Art of Listening, and hope that you are also!

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