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Sunday, October 7, 2007

U.S. Market Meter Changes From Slightly Bullish to Bullish

The Covered Calls Advisor conducts weekly reviews of the five key metrics used to determine its U.S. Market Meter Indicator. The Meter was initiated on September 11, 2007 with a 'Slightly Bullish' reading. Today the indicator has been upgraded from Slightly Bullish to Bullish.

The five metrics were described in detail in a Sept 11 post -- Link.
The current readings for the five metrics are:
1. Earnings and Bond Yield Spread:
5.52%-4.64%=+.88% is Slightly Bullish.
2. Inflation: 2.1% is Bullish.
3. Current Versus Expected P/E Ratio:
(20.0-18.12)/18.12=+10.4% is Slightly Bullish.
4. Price Momentum:
(903.36-817.20)/817.20=+10.5% is Bullish.
5. Covered Calls Advisor's Gut Feel: Bullish.

Three bullish and two slightly bullish indicators. Hence, the overall weighting has shifted to a bullish outlook, which is now reflected on the 'U.S. Market Meter' Indicator at the top of the right-hand column of this blog. The meter also states the recommended investing strategy for this assessment: "The Covered Calls Advisor says: The Current Overall Stock Market Outlook is: BULLISH. The Corresponding Investing Strategy is: SELL MODERATELY OUT-OF-THE-MONEY COVERED CALLS."

By 'moderately out-of-the-money', this advisor means that the covered call positions in a portfolio of near-month covered calls should now be established on-average between 1.5% and 3.0% below the strike price.

Since this advisor's gut feeling was the deciding factor in determining that the overall rating would now change to bullish, a short explanation of this bullish gut feeling is appropriate. Previously, this advisor stated that the primary factor preventing a bullish gut feeling sentiment was "investors' discomfort regarding the current decline in the rate of economic growth and, more specifically, whether a recession can be avoided and the desired soft-landing achieved." Since that concern, the Fed made their .5% reduction and thereby demonstrated to this observer that they are committed to providing sufficient liquidity as necessary to minimize the probability of a U.S. recession. Historic studies have repeatedly demonstrated that the stock market is bullish during the first six months after an initial Fed rate cut if a recession is, in fact, avoided. This outcome now seems likely.

In addition, it is noted that we are currently in a bull market that began on 10/9/02 and in which we have so far had a 100.5% increase as measured by the S&P 500. (Note: A bull market is defined as a rally exceeding +20% after a period of a 20+% decline).

Prior to this one, there have been five bull markets since 1970. This advisor analyzed the Earnings Yield to Bond Yield Spread at the end of each of these bull markets and discovered that these bull markets did not end until the Earnings Yield was more than 1% lower than the 10-Yr Treasury Bond Yield. In fact, the actual yield differences at the end of these five bull markets were -1.29%, -2.06%, -4.27%, -3.24%, and -1.39%. In comparison, as shown in #1 above, the current yield spread is +.88%. In this advisor's opinion, this bodes well for the likelihood of a continuation of the current bull market.

Regards and Godspeed

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