SignalPoint Asset Management, LLC uses a proprietary combination of risk measures to come up with a composite market risk indication called the Market Assessment Model. The four component data are smoothed using exponential moving averages and combined in a near equal weighting. Each component has its own bullish, neutral and bearish range based upon bell curve analysis. During times of extreme market stress the four components tend to concur with each other as to market risk. During more average times there is less correlation.
There are four major components which make up the Market Assessment Model:
Relative Valuation is a concept first described by financial analyst, Elaine Garzarelli. She indicated that the sum of the market Price/Earnings (P/E) ratios and short term interest rates rarely varied much from about 20. Below 20 indicated that the market was undervalued and much above 20 indicated over-valuation. Our data base included these items, so it wasn't hard to verify what she was describing. While the P/E ratio gives us an indication of general stock value, combining it with current interest rates relates that value to competing low risk yield - hence the term Relative Valuation.
Speculation can be measured in many ways. We found in the early 1980s that an easy way was to look at how the best and worst performers were doing relative to each other. We use data from Value Line, a company that provides current and historical financial data, for both the larger and smaller capitalization stocks as the basis of this component. If we find the best performer is up 200% and the worst is down just 40%, we consider speculation to be rather high. On the other hand, if we find the list's best performer is up just 65% and the worst is down 80%, then we assume that the market is over-sold and speculation has been driven out.
Divergence is derived from market commentator, Norman Fosback's Hi/Low Logic Index. We've used his formula and applied it to the combined NASDAQ and NYSE data, however. This gives us more of a total market view than using either exchange alone. The method takes the smaller of the number of new highs or lows for each week on the NASDAQ and divides it by the total number of issues being traded that week. The theory is that if the market is confused, you will have lots of new highs and lows simultaneously. Confusion, or divergence of opinion about market direction, is usually a bearish sign (short term). Mr. Fosback's opinion is that if there's very little confusion about the market's direction (either up or down) that this is healthy for the market in the short term.
IPO Zeal measures a type of speculation that doesn't show up in the more established stocks of Value Line. When stock multiples are very high, there are usually lots of secondary offerings, new issues and other dilutive activities. Our measure of this is achieved by keeping track of the number of issues being traded on the NYSE and NASDAQ on a weekly basis. If the number increases rapidly (as in 1983 and 1993) historically this indicates a period of consolidation. Although the market hasn't necessarily fallen during the consolidation period, it historically will go flat for extended times. Typically the flat market will last up to 18 months.
SignalPoint Asset Management, LLC
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