Affecting the Primary Trend?

The Primary Trend System^® is a strategy I have been offering to clients since 1999.   The Primary Trend referred to in the name is the trend of money flows into the stock market.  Money is the raw material of supply and demand, and without money to carry demand into the markets the markets will not go up.  I use money flows to generate a signal as to when to be invested in stocks and when to be out of the market.

These money flows in the financial markets have an annual cycle, and tracking and using this cycle is what gives the Primary Trend System^® an edge over normal buy-and-hold investing. 

During winter, the economic activity that accompanies Christmas ripples through the economy as factory workers, store clerks and delivery people all get more hours, bigger 401k deposits and the like.  Profit sharing and mutual fund distributions often occur in the winter months, also.   Some of this extra money becomes savings and finds it’s way into the financial markets.

These cold-weather money flows taper off just as people begin to buy more homes in warmer weather.  Perhaps you have heard that many more homes are sold in summer than in winter?  So where do you think much of the house purchase money is saved?  Right, in the financial markets  (stocks, bonds, CDs, etc.).  So the winter flow of money into stocks and bonds reverses as investments are liquidated to buy houses.

How powerful is this cycle? 

Dow Jones Industrial Index, 1/1/1956 to 12/31/2005

$100,000 becomes

• $2,206,846 if bought and held

• $2,879,124 if held during 6 colder months only.

• $     76,815 if held during 6 warmer months only

 (assumes no interest when out of the market.)

What this means to you as an investor is that over the long term, most earnings come from the colder months.  Furthermore, an investor is not compensated for the risk of holding through the unfavorable warmer months, so why do it?  

However, as with most things investment-wise, it is not as simple as it sounds.  The markets don’t follow a calendar.  So the Autumn entry signal can occur anywhere during a 60 day window, and the Spring exit signal can occur as early as April 1 or as late as the end of June.

The May drop in the stock markets was the type of event that often marks the annual sea-change in the markets.  During the Spring, the market seemed like it was trying to set records for tameness as it rose very steadily.  In May the bottom dropped out in one of the sharpest reversals in recent memory.  Since the slowdown of money flows into the markets normally reach their tipping-point about this time, I was expecting more stock market declines to follow during the summer. But they didn’t happen. 

So, the question becomes what is really happening, and what does this mean for future stock market activity?

I have the words of successful hedge fund manager Michael Price in my head, saying when the market is doing something different than you expect it simply means that there is something bigger going on that is not yet evident and it is time to back away and reassess things.  So in September I made changes in our portfolios to reflect the market conditions as they were, not as I expected them to be, and I proceeded to scratch my head about the meaning of it all.

Many times over the past few years, while discussing real estate with friends and clients, I suggested that one of the reasons the real estate market was so strong was all of the folks that got burned in the stock market a few years back began looking for something other than stocks to invest in - anything but stocks!

Contributing to today’s unexpected strength in the stock markets may be that some money from today’s real estate sales are not going back into real estate and have to find another home.  Stocks may now be getting the benefit of the dynamic that helped real estate a few years ago, and this increased money flow into the stock markets greatly reduces the chances of any large scale sell off in stocks this fall as some of my earlier work called for.  Remember, you heard it here first!

Please don’t take this as a recommendation to jump into the market with both feet, because there can still be market declines.  Especially in an election year, the likelihood of a political ambush creating uncertainty in the markets is something to be wary of.  Money flows can change as quickly as investor sentiment can.  But if my analysis is correct, the severity of any near term decline may be muted by the extra real estate money entering the stock market.