Last year, I gave a speech to the Society of Competitive Intelligence Professionals. Until SCIP invited me I didn't even know such an organization existed. It's composed of internal corporate sleuths who seek information about their competitors, customers and suppliers.
A few members are former police and intelligence operatives and some are in marketing, but most are former librarians and other information scientists. After my speech, I gave two-fold advice. First, I recommended the information scientists get out of the office and talk to people face-to-face, since information relating to people must be experienced firsthand.
However, to the more outgoing types I advised the opposite. Field research is good, I said, but every now and then you should look for analytical tools to point your sleuthing effort in the right direction. In short, I advised each of the two types to do more of what comes harder - or seek a working partner who complements their skills.
Now, since this column so often advises to sleuth physically for investment information, once in a while I must look at the global picture to know where to sleuth.
The time has come to do so again, which I propose to do by revisiting two previously mentioned market models: the California model that looks for market extremes and Richard Farleigh's four-regimes model that looks for major trends.
As you may recall, early last year this column pointed out that an econometric model I had once used in California was saying the market was at rock bottom, with a potential of more than a 50-per-cent gain by the end of 2009. Since then, the market is up more than 60 per cent. So what is the California model saying now?
In a nutshell, the model is now a mugwump - a fence sitter. The market, the model says, can be either up or down 10 per cent by year's end, or something in between. The market may first tumble, then rise, or vice versa - the model says nothing about volatility - but it shows prospects for the full year are dim.
Here again, are the model's main components:
First, commodity prices. When these tank fast (as in 2008), they liberate cash that can make the market zoom - and vice versa. When commodity prices zoom (as in 2007), they suck cash out of the market, which is then likely to fall (as in 2008). Moderate commodities price moves - such as recent ones - don't count.
Second, real interest rates. These are triple-A (10-year) bond yields, less the one-year change in the producer price index (PPI, which measures industrial input prices). When real rates are high, it's good for the market (as happened last February). It's counterintuitive, but it works. High rates mean a strong economy and so (perhaps) strong earnings, while low producer price inflation can lead to high price-to-earnings ratios. So an extreme combo of both is often a telling market omen.
Third, unemployment insurance claims. The bigger their yearly rise, the better the market's prospects, and vice versa. (The market, as old market hands know, rises on an empty economy and falls on a full.)
Fourth, the market's real price-to-earnings ratio. This is the S&P 500's P/E, plus the yearly change in the PPI. For example, when inflation is low the market can stand a higher P/E, and vice versa.
Fifth, money supply. Its growth needs to be moderate.
This model, to reiterate, looks only for market extremes. Over the last 50 or so years it did a good job at pinpointing them. Now the model says the market is likely not at an extreme.
What of the other model?
I also mentioned this one before - it's the one used by famed Australian investor Richard Farleigh (who wrote Taming the Lion , and later appeared on the U.K.'s Dragon Den TV show). Mr. Farleigh pointed that a greatly underestimated market anomaly is the longevity of main trends. And such trends, he noted, often derive their power from the market's two main drivers - inflation and economic growth - which, depending on their level, generate four major market regimes. Here again are the four regimes, and the favoured trends in each:
1. In a strong (or strengthening) economy and high (or rising) inflation, you should buy and own resources and real estate (e.g. 2007).
2. In a strong (or strengthening) economy and low (or falling) inflation, own stocks. (e.g. the mid '80s, or 2009).
3. In a weak (or weakening) economy and high (or rising) inflation, buy gold and real-return bonds, and selectively sell stocks short.
4. In a weak (or weakening) economy and low (or falling) inflation, buy bonds and hold cash. (e.g. Japan in the 1990s).
So where are we now, based on Mr. Farleigh's model? Probably between examples 2 and 3: Inflation is currently low but may soon rise because of (a) the huge stimulus and (b) the strong economy that's boosted money velocity. As for the economy, while it's strong now, it might weaken next year once the Fed starts raising rates.
So - and this conclusion is similar to the California model's - hold on to your well-sleuthed long positions and to your gold, but start looking for selective shorts.
Looking how? Well, like a SCIP pro, first via careful analysis, then by sleuthing.