the hays advisory market trend analyzer · market. it is designed to detect if markets are...

HAYS ADVISORY: TOPICAL REPORT – AUGUST 5, 2010

The Hays Advisory Market Trend Analyzer (MTA) is a technical tool that analyzes the action of

proprietary short, medium and long-term moving averages. The MTA is designed to buffer

unforeseen, serious secular market declines not being forecasted and implemented already by the

Asset Allocation Matrix. It is not a stop loss trigger and it is not designed to catch every bear

market. It is designed to detect if markets are deteriorating beyond the normal bull/bear cycle,

into a more serious decline like we experienced in 2000 and 2008.

The Hays Advisory Market Trend Analyzer

The Hays Advisory Market Trend Analyzer incorporates two distinct sets of disciplines described as

the Investment Phase and the Trading Phase.

The Investment Phase exists in “normal” market environments. Shown below, the Investment

Phase exists when the short, medium and long-term moving averages are properly aligned. This

represents the majority of investment climates.

In other words, both the short-term moving average (purple line) and medium-term average

(brown) are above the long-term moving average (green). While in the Investment Phase, all asset

The Hays Advisory Market Trend Analyzer

By The Hays Advisory Investment Committee



allocation decisions are determined by the Hays Asset Allocation Model and our portfolio

management process proceeds as usual.

The Trading Phase begins when the price of the S&P 500 and the short and medium-term moving

averages drop through the long-term moving average (arrows below).

Chart 1

There are three basic levels or conditions that may exist when in the Trading Phase. As detailed in

chart 1, the first level occurs when both the short-term average (purple line) and medium-term

moving average (brown line) break through the long-term moving average (green line). This

officially moves us into the Trading Phase (white area). In this initial level of the Trading Phase, our

cash allocation shifts are based on the actions of the short and medium-term moving averages.

When the Trading Phase trigger initially occurs, the Hays Advisory Market Trend Analyzer

recommends that fully invested portfolios move to 35-50% cash. This is indicated by the price

chart of the S&P 500 turning bright red above.

We will stay at 35-50% cash levels until the second level of the Trading Phase occurs. As noted

below in chart 2, the second level is when the short-term moving average (purple) confirmed by

the price of the S&P 500 turns up (yellow arrow). Once the short-term average turns up and the

price is above it, the Market Trend Analyzer recommends that half of the portfolio’s cash be

reinvested into equities. This is also noted by the price chart of the S&P turning yellow. There is a

proprietary waiting period to confirm the new trend can last.


Chart 2

The final level of the Trading Phase gets us back to 0% cash or the current recommendation of the

Asset Allocation Model. If the current price or the short-term moving average moves through the

medium-term moving average, the Market Trend Analyzer recommends that the remaining cash be

invested. This is noted in chart 2 as the S&P 500 price moves above the brown line, and occurs

again when the purple line moves through the brown line. When this happens, the price chart

turns blue. At this point, we move back to the current Hays Asset Allocation Model

recommendation (up to 100% in equity), but are still in a watchful, trading mentality. If the short-

term average rolls back over during the Trading Phase, we will once again raise cash. In the Trading

phase, we can invest up to 50% of the portfolio in exchange-traded funds. ETF’s are highly liquid

and allow us to move very quickly as short-term conditions may change.

To get back to the “normal” Investment Phase (black S&P price line), the daily close of the S&P

500, its short-term moving average, and its medium-term moving average must close above the

long-term moving average as we noted in chart 1 earlier in this letter. Cash holdings would then

revert back to the levels currently being recommended by the Asset Allocation Matrix.

It is important to understand that approximately 50% of the time (as in the example above) a panic

does not occur and it is considered a false signal. But in the Trading phase, because the MTA is

focusing on the action of the short-term and medium-term moving averages, the MTA typically

reinvests quickly after the false signal has reversed. These quick moves limit the amount of missed

upside during an incorrect signal. And as our back-test results indicate, the amount of upside

missed in an incorrect signal is insignificant compared to the MTA’s huge potential to protect when

the panic does occur.


Table 1

The table above details the findings of our back-test results of the MTA going back to 1900. Over

the last 110 years, the market has had an average annualized return of a little more than 5%, not

including dividends. When the MTA is recommending 0% cash, the market has averaged a much

higher annualized return of 8.73%. But when the MTA is recommending maximum caution as

indicated by the red, the market has had an annualized return of -11.96% and has experienced a

maximum drawdown of -81.69%. Dealing with false signals is a minor inconvenience when one

considers the alternative of facing the brunt of a crisis decline.

In spite of the solid results of the MTA back-test, it is important to realize that this indicator is not

designed to trigger during normal corrections or even necessarily all bear markets.

To better understand the dynamics of the MTA, let’s review (Table 2) how much downside has

existed in the past before the MTA triggers, how much downside can occur after a trigger, and total

market downside during a bear market. Hopefully, it will give you a clearer picture of what the

MTA is and is not.


Table 2

As indicated in Table 2, the market averages a decline of 17.55% from a recent market top when

the MTA triggers. The most the S&P 500 would have been down prior to a trigger is 31.21%. After

the MTA triggers, the S&P 500 dropped on average an additional 19.56%. Finally, the maximum

drawdown of the S&P 500 after the MTA triggered was 81.69%

Though the MTA is designed to avoid the more extreme declines, it is important to remember that

is just one piece of our Asset Allocation process. When we studied market history combining the

MTA with our existing model that measures investor psychology, monetary conditions and market

valuation, we found that that they complimented each other very well during some of the major

bear markets in the last 100 years.


1929

First, let’s look at 1929.

Chart 3

Since the MTA is not a stop-loss, but based more on moving averages and their position in relation

to each other, the MTA would not have caught the first wave of the 1929 crash. But in 1929,

considering the amount of greed on the street and the overvalued condition of the stock market, if

our Asset Allocation Model had existed, it would have more than likely had us in our highest cash

level (50%) during the period circled above.

But what about after the crash of 1929? It is possible that our model would have started to get

more bullish as the fear became intense and valuations improved on the big price decline of the

market. This is where the important role of the Market Trend Analyzer is incorporated. By June of

1930, the Market Trend Analyzer would have been recommending 35 – 50% cash and except for a

couple of short-term moves back into stocks, it would have kept us defensive until around May of

1933, saving us much grief as the market continued sliding to historical levels. Again, the Hays

Market Trend Analyzer is designed to help avoid the “big ones,” while our Asset Allocation Model is

usually effective in normal bear cycles. This combination is designed to provide protection in both

normal times and when historic downturns occur. Also, since it shifts the focus on our shorter-

term moving averages in the trading phase, it should move quickly back into stocks when the

momentum returns to the market.


1974

In early 1973, the Dow had just crossed 1,000, the Yield Curve had inverted and the Nifty Fifty were

extremely overvalued. Don was in the business during this time and was extremely bearish

through October of 1974.

Chart 4

In this instance, our model (red circle) would have been very bearish in 1973 and the Market Trend

Analyzer indicator would have confirmed that bearishness when it would have recommended

raising or more than likely maintaining our maximum exposure to cash and bonds. In February of

1975 (arrow), the Market Trend Analyzer indicator would have returned to a fully invested posture

at a very good time to re-enter the market.

2000

In 2000, we were managing money at Hays Advisory using our Asset Allocation Model, so we can

show you (Chart 5) exactly how our model combined with the Market Trend Analyzer indicator

would have worked.

Going into the bear market, we had approximately 50% of our LTG portfolio in cash and bonds

based upon the recommendation of the Asset Allocation Model. After significant weakness in the

S&P and NASDAQ, by December of 2000 the Asset Allocation Model shifted to 23% cash position.

In March of 2001, if we had been using our Market Trend Analyzer it would have kicked in and

moved us back to 35 – 50% cash. The big difference is that on September 21, 2001, where our

Asset Allocation Model recommended going to 0% cash, the Market Trend Analyzer would have

continued to be fully bearish. The market rallied sharply after 9/11, but the Market Trend Analyzer

turned out to be right, as the market did not find its ultimate bottom until October of 2002.


By April of 2003, the Market Trend Analyzer would have gotten us fully invested, shortly after the

final retest in March (chart 5).

Chart 5

2008

And finally, the most recent bear market.

Chart 6


For the first time in recent history, a massive bear market occurred in the absence of excessive

greed by investors, tight monetary policy or over-valuation. So unfortunately, we would have been

fully invested in the initial phase of this most recent decline. But in June of 2008, the Market Trend

Analyzer would have taken us to 35 – 50% cash, getting defensive prior to the largest part of this

decline and then getting back fully invested by May 5, 2009.

Summary

The Market Trend Analyzer is a great compliment to our current Asset Allocation Model. It is not

perfect and will cause some false signals, but we believe history has shown that it will add

significantly to our results over the long-term. The Market Trend Analyzer strives to protect in

those dramatic downturns that can really hurt a portfolio, and move assets back in quickly when

momentum returns to the market.

Let us summarize some of the major points highlighted in this report regarding the Market Trend

Analyzer:

• The MTA is a technical tool, not a stop loss trigger, designed to detect panic declines.

• The MTA would have triggered 27 times since 1900 – approx. once every four years.

• On average the market is down 17.55% from a recent market top when the MTA triggers.

• The most the S&P 500 would have been down when the MTA triggers is 31.21%. (‘37/’38)

• After the MTA triggers, the S&P 500 dropped an additional 19.56% on average.

• The maximum drawdown of the S&P 500 after the MTA triggers was 81.69%.

And finally, let us review how it triggers:

• When the MTA triggers the trading phase by the short and medium term moving averages

breaking the long-term average, our equity portfolios will raise between 35% - 50% cash.

• When the short-term moving average turns up while in the trading phase, ½ of this cash will

be invested in Exchange Traded Funds (ETFs).

• If the current price or the short-term moving average moves through the medium-term

moving average, the MTA recommends that the remaining cash be invested.

• Once fully invested while in the Trading phase, if the short-term moving average turns back

down, our equity portfolios will raise 15 – 25% cash.

• In the trading phase, if the short-term moving average moves through medium term moving

average, our cash levels will return to 35 – 50%.

• When the daily close of the S&P 500, its short-term moving average, and its medium-term

moving average close above the long-term moving average, the MTA moves back to the

investment phase and all allocation decisions are made by the AAM.

Over the next several pages we have provided the decade-by-decade results using color coded

charts of our Market Trend back - testing beginning with the 1900’s. I suggest quickly skimming

through these charts to get a better feel for how MTA reacts in different market environments.


For the first 30 years, we tested the Market Trend Analyzer versus the Dow and then switched to

the S&P 500 January 1, 1930, just after it was created. Remember, a red line means 35 – 50% cash,

a yellow line is 15 - 25% cash, a blue line is fully invested but still in the Trading Phase and a black

line is in the Investment Phase.

As you can see, it worked really well from 1900 – 1909.

Hypothetical Investment. For Illustrative purposes only. Past performance is not indicative of future results.


It gave a couple of false alarms from 1910 – 1915, but it helped out tremendously in 1917.



We believe our existing asset allocation model would have picked up the early part of the 1929

crash due to historical accounts of investor greed and market overvaluation.



And then the Market Trend Analyzer would have activated in the early 30’s and basically stayed

defensive until May 1933.



It helped out in the early 40’s, and it was basically neutral in the late part of the decade.



The 50’s demonstrated that the MTA can go many years without a trigger. In the 50’s, the Market

Trend Analyzer triggered only once for a very brief amount of time.



In the 60’s, it gave several false signals, but the great thing about this indicator is since it switches

to the shorter-term moving averages in the Trading Phase, the MTA did not miss very much when it

gave an incorrect signal. Again, we are protecting against the “big one,” so we are willing to give a

little for the protection the Hays Market Trend Analyzer can provide.



After a mild period in the 50’s and 60’s, the Market Trend Analyzer would have paid big dividends

in the 70’s.



In the stock market glory years of the 80’s and 90’s, the Market Trend Analyzer rarely triggered

raising cash, except for a very brief time in early 1982. Notice, it did not trigger in 1987, but once

again, the market was overvalued, so our existing model should have been defensive.



We would love for the Hays Market Trend Analyzer to not trigger for the next two decades similar

to the 80’s and 90’s! In the 1990’s, the MTA never triggered, but our asset allocation model moved

us to 50% cash in March 1999.



And finally, during the last nine years it would have been extremely helpful.


Hays Advisory LLC does not guarantee the accuracy or completeness of this report, nor does Hays Advisory LLC assume any

liability for any loss that may result from reliance by any person upon any such information or opinions. Such information and

opinions are subject to change without notice and are for general information only. Hays Advisory LLC, 301 Seven Springs Way,

Suite 150, Brentwood, TN. 37027

2006 Hays Advisory, LLC. All rights reserved. The information contained in this report may not be published, broadcast,

rewritten or otherwise distributed without prior written consent from Hays Advisory LLC.

the hays advisory market trend analyzer · market. it is designed to detect if markets are...

Documents