Introducing the Berman’s Call PRO-EYEs Index
Early in my career when I was studying for the Chartered Market Technician’s accreditation (CMT) the level 3 requirement was to write a (Thesis) research paper. Mine was based on a combination of fundamentals and technical inputs that I created to use in evaluation the bond market. It developed into an equity-based indicator in the early 2000s when my career transitioned to focus more on equity markets than bond markets. I wrote a weekly report based on it for years that went to clients of CIBC World Markets. When I left the bank in 2006 to start ETF capital management, the indicators for bonds and stocks were combined given my global portfolio scope. Today, I’m launching the indicator I’ve named PRO-II (the Probable Return on Investment Index) or PRO-EYEs. I’ve been looking at some of the factors here in recent months.
It combines 4 equity valuation metrics, 4 business cycle influences, and 12 tactical market indicators (a few of which are in the CNN Fear Greed gauge index).
Each week we will update the data on the Berman’s Call Blog HERE.
For each factor, we look back historically. The basis for the indicators is the US stock market (S&P 500). It represents about 50% of world equity capitalization compared to Canada at less than 3%. For indicators like seasonality we go back to 1927. Others go back into the 60s-70s-80s. Others are newer like the VIX that never existed back then and has less history.
We call it a probability index because we use a statistical method (Z-Score) that normalizes the factor into a confidence interval between 0 and 100% so that we have an apples-to-apples comparison over time. How far away from average (normal) is it measured in standard deviations. The higher the reading (closer to 100%), the more extreme the factor the higher its caution level. The lower the indicator level, the more opportunity it offers towards future price movements. We use it to adjust risk levels in our portfolios. It does not select securities for us, it just suggests the overall level of opportunity and caution in equity markets.
|Enterprise Value to EBITDA||3.38||100%|
|Equity Risk Premium||1.16||88%|
|Slope of Yield Curve||0.27||61%|
|High Yield vs. Investment Grade Credit Spreads||1.31||90%|
|NY Fed Weekly Leading Indicators||-0.81||21%|
|Real Yields & Inflation Expectations||-1.20||12%|
|Total Business Cycle Factor:||46%|
|5-Day Put/Call Ratio||2.42||99%|
|Speculative Position S&P 500 Futures||-0.68||25%|
|Percentage Deviation from 200-Day Moving Average||1.70||96%|
|AAII Bull vs. Bear Sentiment Spread||0.84||80%|
|Seasonal Pattern (All Years) Since 1928||0.49||69%|
|Presidential Cycle (Current Year) Since 1928||0.33||63%|
|Current vs. Average Volatility (VIX)||0.22||59%|
|Current vs. Future Volatility (VIX)||0.41||66%|
|Percentage of S&P 500 Holdings Above 50-Day Average||0.32||63%|
|Percentage of S&P 500 Holdings Above 200-Day Average||1.18||88%|
|Breadth-McClellan Summation Index||1.13||87%|
|Overbought-Oversold 13-Week Relative Strength Index||0.61||73%|
|Total Tactical Factor:||72%|
The bottom line is that no one knows, especially in a fear of missing out (FOMO) market like we are in today where general banks have resorted to printing money and governments have had to spend massive amounts to keep the economy going during COVID, how to value equities.
Of the three segments of the overall index:
Overall valuation metrics are EXTREME. Historically, valuation is not a good timing factor, but tells us about future average returns. At current levels, they are expected to be well below average with several periods of high negative returns. Corrections tends to be deeper when the economy weakens as both earnings contract and the multiple investors are willing to pay contracts. For conservative investors, once should have less sensitivity to economic weakness.
Overall the business cycle is completely distorted by central bank QE policy supporting the economy. Without it, the world would be in a deep depression. The biggest concern is the mispricing of financial assets and high yield credit in particular. With central banks actively seeking inflation, there is a tipping point for long duration financial assets leveraged to easy money. The Fed will have to keep stepping on the gas to keep business cycle conditions balanced at the risk of a STAGFLATION outcome.
Overall the tactical factor was weaker by about 6% last week. The cooling came as markets pulled back a bit from recent highs without any broad technical weakness. The more elevated the indicator, the higher the short-term correction risk will be. Divergences are building in breadth indicators and with the weekly RSI. This sign of decay suggests once a catalyst presents (stimulus funding, rising yields?), markets may be at risk for a 5-10% correction.
Our Spring weekly Berman’s Call virtual roadshow will be back in March\April. Subscribe to my new YouTube channel LarryBermanOfficial which is the new site for all our educational content and my new weekly market recap and ETF bull and bear picks of the week. Look for a series of option based educational videos in 2021.
ETF Capital Management: www.etfcm.com