The Indicator That Nobody Believes, But It Works!

By Dr. Steve Sjuggerud
Friday, November 21, 2008

What I'm writing to you today may seem incredibly naïve... and downright foolish to believe in.

It shouldn't work. It should not be a useful moneymaking indicator. It drives academics nuts. But I don't care... It works.

When this indicator says "buy," stocks significantly outperform their long-term average... earning double-digit annual returns. And when this indicator says "sell," stocks lose money.

It's based on a mountain of historical evidence... using weekly data going back to the 1920s.

It's incredibly simple too. This indicator only has two modes: buy or sell. The indicator is simply whether we're in an uptrend or a downtrend.

That's it. I'll explain it in just a minute. But before I do, just look at this chart. Think about it. What do you see here?

I see an uptrend to 2000, a downtrend to 2003, an uptrend to 2007, and a downtrend today. Don't you? The blue line spells it out pretty clearly.

Going back to the 1920s (as far as we have data), this indicator was in "buy" mode just under two-thirds of the time. When it was in "buy" mode, you'd have made double-digit annual gains, which beats buy-and-hold by a wide margin.

The first academic to "admit" that a simple uptrend works was Professor Jeremy Siegel of the esteemed Wharton School of Business. In his classic 1998 book Stocks for the Long Run, Siegel tested an uptrend strategy. Using the Dow and going all the way back to the 1800s, this strategy thrashes buy-and-hold.

Siegel used the 200-day moving average – about 40 weeks, with five trading days a week. I prefer a 45-week moving average, because it does a better job calling the uptrends. But either way, the major gain of the strategy is a reduction in risk: "Since you are in the market less than two-thirds of the time, the standard deviation of returns [the volatility] is reduced by about one-quarter."

So the uptrend strategy is particularly helpful in crazy times like now...

Siegel found this strategy "had its greatest triumph during the boom and crash of the 1920s and early 1930s... Except for a brief period in 1930, the strategy would have kept investors out of stocks through the worst bear market in history." Great stuff.

Fast-forwarding to today, it would have worked again... The last signal this indicator gave was "sell" in December 2007 – when the S&P 500 was just under 1,500. As I write, the S&P 500 is sitting below 800... It's lost nearly half its value since this simple indicator last flashed "sell."

Call it dumb. Call it foolish. But history shows it's worked.

Good investing,

Steve

P.S. I don't use this indicator by itself of course. If you want to invest with maximum potential upside and minimum risk, buy stocks when they're cheap, hated, and in an uptrend.

Stocks are cheap and hated... but as the chart shows, we're not there yet – not even close – on the uptrend. To minimize your risk, wait for the green light from this simple signal.

Further Reading:

Will Stocks Soar after This Carnage?

What's Gonna Happen Next?

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THE BIGGEST RED FLAG RIGHT NOW

Today's chart is the world's most shocking chart: the past three years' trading in the iShares Real Estate Fund (IYR).

IYR is comprised of America's largest commercial property owners and operators. Major holdings include ProLogis (largest warehouse operator), Simon Property (largest retail-space owner), Boston Properties (largest office-space owner), and Equity Residential (largest apartment owner).

From 2000 to 2007, this fund was a wonderful investment. Real estate prices were buoyant. Financing for new construction and expansion was available everywhere. Demand for retail, office, and warehouse space was healthy. But like all good parties, folks got carried away with this one... so we"sounded the bell" on commercial real estate over a year ago.

As you can see from today's chart, these companies are in total freefall right now... down 58% in just the past two months. This is an absolutely stupendous drop for the bluest of the blue-chip property owners. As our colleague Porter Stansberry has been saying for months now, "If you're looking to bet on companies headed for bankruptcy, look at commercial real estate."

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