Stockradar Stock Pick count versus the ASX/200 normalised - 4/9/10

 
       

The Stock Pick Count Overview (June 2009).

The Stock Pick count represents the number of qualified Stock Picks that are trending higher from a defined pool of stocks. i.e. A bull market may drive the Stock Pick count to levels of 140+ out of 200 stocks or alternatively a bear market may hold no Stock Picks. The Stock Pick count peaked in February 2007 at 141 and declined to only 10 Stock Picks by late 2007. The ASX/200 climbed to a new high in late 2007 polarised around a small base of high capitalisation stocks demonstrating poor market breadth which ultimately led to the calamatous market decline. For the ASX/200 to begin rising again it must be driven by more qualified up trends and thus the Stock Pick count will begin rising before the ASX/200.

The Stock Pick Count

Where is the stock market heading at any point in time and how much does it really matter? Simply by qualifying stocks on a consistent and defined basis from a pool of stocks we can get a simple, reliable, and valuable measure as to where portfolio weightings should be that will reasonably accurately reflect market conditions. Let me explain….

JBH is a stock that recently began trending strongly higher again, as is KCN and MND, so too has RIV, PDN, MCG, PNA, WES, FLX, DOW, IFN and in fact by Stockradar’s reckoning at the beginning of June 2009 there were 70 stocks beginning or already exhibiting compelling trending qualities from our defined stock pool which is currently at 173 stocks, made up primarily from stocks in the top 200. All stocks with qualified up trends as per my definition are called Stock Picks*.

That ratio of Stock Picks to our stock pool size thus sets our current exposure ratio at 32% equities and 68% cash (70 Stock Picks, 103 neutral). This is reflective of a tentative recovery but as we delve deeper into the list of qualified Stock Picks we find 50% of those Stock Picks come from the Energy, and Metals and Mining Industry Groups.

A bear market doesn’t become a bull market overnight or at a particular spot and there is an overbearing obsession with this question as at any point in time it is often an unknown like her in the middle of June 2009 for example. It happens over time as sentiment shifts the balance from a supply controlled environment to a demand controlled one and that is what we are constantly assessing. Often at times it is uncertain and that in itself is a common sense indicator.

We can make statements of value based on certain criteria (usually historical) to help us take a valid and sensible route through the mire.

To enable us to accurately respond to the market opportunities without being overly reckless we use a defined trend tool as our historical measure and we use the stock market as our instrument of choice as it naturally trends higher. Stocks will trend and fall out of trends and the ratio we use simply reflects the number of trending stocks as a percentage of the total pool. Whether we are returning to bull market status or not is endlessly debatable and there are many definitions we can use but this is a very simple way that, regardless of bull or bear status by any definition, we can gain a very useful measure into the probabilities of an uptrend or down trend phase occurring and to more importantly have the balance our portfolio to cash appropriately matched with the condition of the market.

The Stock Pick Count to stock pool ratio has moved the cash balance up from around 90% cash to 10% equity levels where it has been for more than two years as the Stock Pick count bounces along it lows. (See chart above).

February 2007 is when the bear hit and you can see by the end of 2007 there was close to nil stocks trending by following this defined trend process and although the balance changes from week to week you can see the cash weighting has remained stubbornly high for some time as a dearth of stocks qualify for (up) trending status.

Unlike the “buy and hope” funds under management 2yr to 5yr returns our returns are not affected as all stocks were sold out of that we held back in 2007 and thus we have maximised the opportunity the bull market presented us with. Unlike the poor old buy and hold group who have seen at least 5 years of growth shredded.  

Using this more aggressive, but very simple and effective approach, there are thus no losses to carry from those years such. The majority of Long Equity funds in Australia who are now back to 2004/5 share valuation levels and this effect flows directly through their 2yr to 5yr returns in a debilitating way. Our simple strategy does not allow that to happen, and that is all wrapped up in how many stocks have valid trends and the “double whammy” effect from that style of trading is that we have the benefit of the capital growth from that period between 2003-2007 and now we can start reinvesting that growth at much lower levels as some trends return and get the leverage of investing at these vastly reduced bargain prices! And the cycle goes on once again.

By being primarily in cash at the right time positive returns are achievable even in the tough years. Cash is sweet safe in times of doubt and this is often knowledge we gain in hindsight so to have a measure that warns of heightened uncertainty is very useful and although cash returns looked paltry compared to some at the time when they disappeared so did the cash attraction suddenly grow, and at least you weren’t losing money. A very accurate perspective during emotional times is needed and this offers just such a measure.

It is important to start weighing back into cash at the right times and often we know too late just like when bull turns to bear or visa-versa. Hard to see at the time but in hindsight it’s easy and obvious – but that simply doesn’t help us make money which is our primary aim. Exactly the right time is a near impossibility but using a common sense value or a market edge approach it is amazing how perceptions can change and just as we couldn’t get enough of the Banks and other high flyers two years ago at stratospheric prices as greed drove the market now the brokers are struggling for ideas as to how to attract the buying back at these lowly fear driven levels and look at how fragile the advances are. We need to be able to look through that “market noise” and disruptive influences with the sound guidance to base it on.

The current Stock Pick Count (70) to stock pool (173) ratio is near the highest it’s has been for some time as is the ASX/200 Accumulation Index, which we benchmark our results against to assess our success, and that is consistent outperformance of that index. That gives us hope but the ratio is probably not high enough or broad enough to confirm the return of a sustainable bull phase especially with the polarisation around resources, but then this not our aim. Our only aim it is to ensure our stock / cash balance is right and reflective of market conditions and risk.

I don’t know, you don’t know, the knowing experts don’t know, neither do the professing media commentators know at what point a bull market returns, or by whose definition, nor do we need to know.

So what do we know?

Firstly when it comes down to it, it doesn’t necessarily matter if we are in a bull or bear market as our approach calls for us to analyse stocks only on a stock specific basis from a price and odds perspective. In fact it is a fundamental truth of trading that you don’t have to know what is going to happen next to make money or at least it’s a very good starting assumption to make to seriously progress a trading career. However it is this ground swell of qualified Stock Picks that offers this invaluable guiding benefit of market breadth. So rather than a top down assessment this is bottom up.

Because we trade stocks and not indices and the fact is you need more individual stocks to exhibit up trends to in turn drive a solidly based rise in the indices and this clearly was not happening as the ASX/200 drove to its last 2007 peak and neither is it decisive now as we recover from plumbing the depths of this market clean out. Thus our cash / equity balance is reflective of that.

Let’s travel back in time to early 2007 and see what the Stock Pick count message was. It was sending a clear warning of an impending danger and clients were availed of this high alert signal then and many thus escaped the wrath of the market collapse. The Stock Pick count reached a maximum of 129 stocks in February 2007 of the then 198 stocks in the stock pool. Ratio: 34% Cash and 66% Equities. For us that’s high but as our trading returns are consistently above the market average it makes up for any shortfall from the safety of the extra cash balance of which we can now clearly see the benefits of. This ratio tells me of 198 stocks covered, 129 have qualified up trends and this is an ample amount of up trends to drive the indices higher and sustain a bull market advance. If not we have a warning divergence as happened in 2007

A bull market must contain a weight of stock up trends to provide market breadth and to drive indices soundly and sustainably higher. When a weight of stocks begin to fall out of trends and the Stock Pick count begins to fall significantly it warns us of imminent danger. But not just by falling by one, two, or 10 stocks in this instance but between February 2007 and August 2007 we lost over 110 of those 129 Stock Picks and during that time the ASX/200 made a very divergent bull market high.

Why? A nervous polarisation around high capitalisation stocks disguised what was going on in the “body” of the market and if you only focus on indices that’s a big danger. Greed was what really diverted most investors from reality as is what happens at every bull market peak.

As the market tries to recover I look for guidance as to its stability and likelihood of sustainability and a building ground swell of trending stocks to underpin a revival in the market as a whole, and thus the indices will then begin to track higher. For the market to start rising on a sustainable basis more stocks from our pool must start to trend up. The more stocks that develop qualified trends the stronger the odds are of moving sustainably higher.

We are at a crux. The ASX/200 has hit a recent high at 4000. The Stock Pick count has reached its highest level since late 2007. To drive the ASX/200 higher we need more stocks to hit the Stock Pick Count and it is getting interesting as things have definitely warming up.

By comparing the Stock Pick Count to the defined stock pool that ratio naturally reflects our exposure. It allows for an active trading base that is balanced by the safety of a cash quotient reflective of current market risk which in turn quickly responds to changing market conditions as it did in 2007. A simple, reliable, and valuable tool.

To take this concept one step further we can then drill down again to the next level which is allows us to have weightings within the Stock Pick group set on an industry group basis.

Energy of the 25% weighting        71% are Stock Picks            29% is Cash
Metals and Mining  18%                65%                                        35%
Retail 8%                                          100%                                      0%
Diversified Financials 6%              38%                                        62%
Capital Goods 6%                            31%                                        69%
Software and Services 5%             60%                                        40%
C.S&S 3%                                         33%                                        67%
Precious Metals 3%                         18%                                        82%
Banks 3%                                          33%                                        67%
Chemicals 3%                                  37%                                        63%
Consumer Services 4%                  50%                                        50%
Transport 3%                                    20%                                        80%
Utilites 3%                                         33%                                        67%
E&S 3%                                             16%                                        84%
Pharm and Bio 3%                          33%                                        67%
Media 2%                                          10%                                        90%
Telecoms 2%                                    33%                                        67%
Insurance 0                                       0%                                          100%
Food and Drug 0                              0%                                          100%
Hardware and Equipment 1%       100%                                      0%
Consumer Durables 0                    0%                                          100%

*Stock Pick
 What is a Stock Pick?

It is a stock that completes one of four market edge entry signals
1. Trend Reversal, or
2. New High,
3. Key Low
4. Spike Reversal

which is then confirmed by a qualifying Trend Intensity rating of 4, or greater. More information on Trend Intensity