Buy on the dip – Proceed with caution

As promised, I am alerting my readers to a buy signal in CRB’s stock market momentum indicator (SMMI). This is an indicator I have found useful for taking short-term positions in the market. Since 1994, the buy signals have been active for an average of 98 days, with a minimum of 52 days and maximum of 191 days. The average annualized return has been just over 45% with a minimum of 4.6% and a maximum of 161.4%.

There are a few reasons I am wary of the stock market in the medium term (2 years or so). First, the credit market problems that have surfaced this year are hardly over and while volatility has spiked sharply, the S&P 500 is still only 6.1% off its July 19 peak – hardly a catastrophic move. Further rounds of bad news concerning credit markets, which could come at an unexpected moment, would likely send the market down sharply again.

Deleveraging and volatility – The Icelandic example

It is doubtful that any level of sophistication in the use of financial instruments will ever create a new paradigm of permanently lower volatility. Complicated derivatives and securitizations are useful in creating new ways of pricing and transferring risk, however they do nothing to change basic human emotions such as greed and fear, nor do they change people’s appetites for risk.

After a prolonged period of low volatility, investors start to feel comfortable taking on greater risk, often with borrowed money. No matter what the latest risk control methods are, it is inevitable that an increase in risk-seeking behavior and use of leverage will eventually lead to a spike in volatility, as has been witnessed in the markets in recent weeks.

Getting the green light to buy

Those who are fortunate (or smart) enough to have some cash to deploy may be looking for opportunities to enter the market after the beating it has taken recently. Trying to time the market is a dangerous task and one where emotions are likely to get in the way of good decision making. I find that it helps to have a system to spot entry and exit points.

One system I have liked is the CRB stock market momentum indicator (SMMI). The SMMI is based on the ratio of S&P 500 companies which are below their 50 day moving average. A 10-day and 25-day moving average is then taken for this ratio to generate signals. A buy signal is generated when the ratio is low (below 35%) and the 10-day moving average crosses the 25-day moving average on the way up. Conversely, a sell signal is generated when the 10-day moving average crosses the 25-day moving average on the way down when the ratio is high (above 65%). Put simply, once things start to turn around after a broad decline, it has proven to be a good time to buy. The opposite can be true for selling. To read more about this indicator as well as get the data, you can check CRB´s website.

Riding the Tsakos wave

The shipping party is getting a little long in the tooth, but it seems there is still some fun to be had there. Virtually every shipping company has been benefiting from increased global economic activity and rising tanker rates. One oil tanker company that has taken advantage of the favorable economics in the industry and is strategically well positioned is Tsakos Energy Navigation Ltd. (TNP).

In an environment where tankers are in short supply, Tsakos has managed to build a modern fleet with several new ships being delivered in coming years. This has also allowed the company to realize profits from sales of older ships. Such sales have already been announced for the second and third quarters of this year, adding $31 million to the bottom line each quarter.