Monday, April 25, 2011

Smart Model, Stupid Operator

I began developing the Model T in 2006 as an attempt to predict cyclical highs and lows in the stock market. The model is built on factors and indexes connected to the commercial transportation industry.

I started sharing the results of the model in early 2007 with financial experts who specialize in the transportation industry. These people are “heavyweights” who invest millions of dollars of other people’s money. At that time, they thought I was very amusing. After all I was just a marketing person working at a component supplier. To establish “street cred”, that would be Wall Street cred, I not only had to tell them the market was going down, but how far. To be a playa, you gotta talk like a playa, you gotta dress like a playa. (Okay so I draw the line at the wardrobe. To be a financial guy you have to wear “tie shoes”. You can tell the difference between a marketing guy and a financial guy, because the financial guy will be the one with the shoelaces.) So at that point, the Model T predictions became more about numbers than trends.

In 2009 I was downsized. In September 2009, I started this blog. The main purpose of the blog was to help me find a new job. It would give me a forum to display my analysis and writing abilities and keep my name active in the marketplace.

There was some risk however. The Model T was unproven and it was going to be tested publically, not privately. If it turned out to be worthless, then I would look like a fool. (“Charts on the ground, charts on the ground, lookin’ like a fool, with your charts on the ground”).

However, I believed in the Model T. My fantasy was that the Model T would correctly predict the bottom of the stock market and that I would instantly become an overnight celebrity. I would be interviewed on CNBC by a hot econo-babe. You know the type, short skirt, plunging neckline, high ratings. When the cameras stopped rolling, she would invite me to continue the conversation over dinner. Job offers would then come rolling in from all over the world. “I’m sorry, $1.4 million is a nice offer, but the stock options in the package are a little weak”.

Yes, unemployment does cause you to think irrationally. On a more practical level, I did include a local newspaper columnist on my mailing list just in case the model was spot on. Interestingly enough, the blog did not help me in landing my job. I did however turn down the opportunity (generated on a recommendation from one of my “tie-shoe” connections) to interview with a Wall Street investment firm. (Because New York’s Not My Home)

I have written before that the Model T was predicting an S & P bottom of 580 and the market bottomed at 666 (you could call it a demon drop). Yes close, but if you waited for the 580 and didn’t get back into the market until later, you gave up some money.

But studying the latest update to the model reminded of something I had long forgotten. It’s not about the numbers, it’s about the trends, and the Model T is effective at predicting the trends. In short: The model works, and problems were due to operator error. Stupid, stupid, idiot operator!

Responding to model trends results in not selling at the highest point and not buying at the lowest point, but there is the potential to achieve some significant gains. If the model works, you should be able to get out of the market before a significant drop and get back in before a big upswing. Let’s see what investing according to the Model T would have produced over the last two major cycles.

Test #1 (One Cycle)

Say you invested $10,000 in a fund perfectly indexed to the S&P 500 at the beginning of 2006. The Model T would have said to sell in October 2007. Your money would have been worth around $11,970. Using the trend analysis, the Model T would have indicated to get back into the market in April 2010 (it actually says March, but you wouldn’t have the data until April). Your investment today would be worth $13,500. This is a 35% return on your investment. Not great under normal conditions, but not many 401-K accounts are up 35% since 2006. If you found a safe investment to park your money in 2009 and 2010, your return would be over 40% for the time period.

Test #2 (Two Cycles)

Let’s run this through two cycles. Say you invested $10,000 in January 1998. The model says to sell in October 2000. Your money is worth around $14,370. The model tells you to invest back in September 2002. You then cash out $27,000 in October 2007. You buy back in April 2010 and have around $30,400 today. Again, you get even more if you invest in a money market fund during the trough.

What the Model T Says Today

The Model T continues to indicate steady stock growth in 2011, leading to a bodacious 2012. Please remember however that the Model T is only useful for long-term cycles. It does not predict mid-term corrections. We will be fortunate if there is not some type of drawback this year. If there is a correction, the Model T would suggest getting some more money in the market before the 2012 upswing.

Underwear Check

A recent article reported that men’s underwear sales are having a strong year. It said that an improving economy and pent up demand were the reasons. It also stated that men were being more modest in their purchases, buying more basic brands instead of the higher priced products. This was correctly predicted in my March 18, 2010 post: “The Economics of Underwear”.

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