Stock Selection and The Logic Matrix

My Stock Selection Strategy

My stock selection strategy (for growth stocks, not long-term value stocks) is a hybrid of the systems described in the books that I have mentioned already, including those by William O'Neil, Martin Zweig, and Peter Navarro. In a nutshell, my philosophy of stock selection is: An outside player in a zero-sum game like the stock market, cannot afford to not use every available advantage, within the limits of legal market conduct. To that end, most of the stocks that I buy are discovered first in the Stock Scouter Top 50, on the Validea and AAII Martin Zweig Screens, and on the IBD 100. A stock must appear on one or more of my screens, and must rate well on either the IBD stock checkup or the Stock Scouter rating system (or preferably both), to be a candidate for purchase. I also have a few 'hard' requirements such as a lack of significant insider selling and a ROE of at least 12. .

I screen out most stocks from consideration because I only look at the strongest candidates at any time. I don't rely exclusively on any screen or rating system, but I run any purchase candidate through a thorough set of tests before I make a purchase.

For example, last week, although still in a defensive mind-set, I bought two stocks: SMTS and LCAV. These stocks first came to my attention on the Stock Scouter Top-Rated Technical and Stock Scouter Top-Rated Ownership screens, and also recieved very high marks from the IBD stock checkup. As an additional plus, these stocks are in the medical sector, one of those recommended for the late-bull/early-bear phase of the market (where I still believe we find ourselves) in If it's Raining in Brazil, Buy Starbucks, (Chapter 14, figure 14-1. Note that the stock and business cycle are mis-labeled in the legend in some editions).

On a less quantitative level, I like Somanetics (SMTS) because of their innovative products: brain oxygenation equipment for head injury victims, and cardiac repair patches. I like Lasik Vision Centers (LCAV) because they stand to benefit from the multitudes of baby boomers who will prefer laser-eye surgery to wearing glasses.

Another reason for purchase is that both of these stocks also appear to be undervalued, using metrics such as discounted cash flow and the Ben Graham fair P/E rule. Many traders ignore valuation, but it is my opinion that a stock with strong financial and stock price momentum is even more attractive if it is selling at a discount to its intrinsic value. I am not a stickler about valuation, but I do take it into account.

Also, I always set stop-losses on any short-term trade to ensure that my downside risk is strictly limited. A stop-loss can be frustrating if it is triggered and gets you out of a trade just before the stock rockets to new highs, but stop losses are crucial risk-management tools becuase they protect you from catastrophic losses. In many cases, you can offset your risk better by buying put options on the stock that you own to eliminate risk without the risk of being shaken out of a trade, but that is a topic for another column.

One of the best bits of advice that I have read regarding trading is that you should "enter a trade on ANDs, but exit a trade on ORs". So, to buy a stock, I must see accelerating earnings/revenue growth, a reasonable P/E, positive or neutral institutional and insider activity, an uptrending market, relative strength, etc. To exit a trade, a violation of my stop loss or deterioration of any of the primary reasons for making the buy decision is sufficient.

To trade this way, you must make some decisions and record those decisions before executing a trade. You must decide why you are buying the stock, what you will do if it drops X% from your purchase price, and what other conditions will be grounds for sale. If you do not make these plans and put them in writing, you are likely to fall prey to wishful thinking when your stock starts to fall, and you will start grasping for straws to provide a reason to hold your stock as it declines below your purchase price. I look at any trade as a complicated and inherently risky operation, which only has a probability of succeeding if I plan my operation carefully, and then execute that plan with minimal improvisation.

The Logic Matrix

Having discussed the fundamental and technical timing systems that I employ in my previous post, now I will explain how I combine these systems to determine how much market risk to expose myself to. I should note that this system changes directions fairly rarely - every few months. I combine the indicators described in my previous post to determine if the technical and fundamental indicators for the market are either weak, neutral, or strong. I then cross-index these indicators in a simple 9-cell table that I call The Logic Matrix, which dictates my target cash allocation and may also indicate certain temporary changes to my strategy. The Logic Matrix is posted at the bottom of this blog.

Between the beginning of January and the end of last week, The Logic Matrix put us in sector 4 (at the time, the weak uptrend was countering a longer-term downtrend, giving a neutral- technical rating). Now that we had a strong 4% buy signal last week on an unweighted S&P500 index, combined with other strong technical indicators, we are now in market sector 7, which indicates that I should shoot for a 20% cash position in my brokerage and 401(k) accounts.

To this end, on Monday I moved most of the cash in my 401k account into an even larger position in Fidelity Contrafund (FCNTX), and a smaller position in Artisan Midcap (ARTMX). Both funds have above average returns with average or low risk, as measured by Morningstar, and have held above their 200-day moving averages during the recent market choppiness. My strategy is to limit risk through both cash (or in the right circumstances, bond) allocation and investment vehicle selection. I consider it to be safer to concentrate funds in historically safe (good 10-year performance) funds than it to broadly diversify among funds with variable risk profiles, especially when market risk is high. Since both FCNTX and ARTMX have good long-term and short-term price stability and performance, they present the lowest risk options for increasing my exposure to market gains while keeping a leash on my exposure to market risk in these uncertain times. I have my doubts about the strength of the current rally.

FCNTX is the safest of the funds available to me, so why put any money in ARTMX? Because ARTMX is well positioned, in my opinion, to ride the leading sectors of the current rally which are tech, biotech and retail - Artisan is overweight in these sectors by a significant margin. In contrast, Rydex Low-Priced Stock fund (RYLPX) and ING International Value (NIIVX), two of my largest fund holdings last year, broke below their 200-day moving averages in the last few months and have yet to make a decisive recovery. These funds were very good to me last year, and I may purchase them again, but I am glad that I dumped them at the beginning of 2005 in favor cash and an overweight position in FCNTX. Note that I still keep a hundred dollars in each of these funds even after I "dump" them as a 'foot-in-the-door', ensuring that I have the option to re-enter these funds if they become closed to new investors. The mutual fund companies don't like this sort of activity, but they tolerate it as long as your major moves are more than a month apart.

In addition to determining my target cash allocation for my brokerage and 401k accounts, The Logic Matrix suggests certain refinements of strategy depending on the market situation. Here are a few of the important strategic and psychological considerations that come into play in each sector of The Logic Matrix:

1. Tech Weak, Fundamentals Weak: Consider shorting, buying puts on weak rallies. Guard against dispair, and look for an excess of pessimism or other signs that the market is ready to reverse direction. Remember that, by definition, a bottom will occur when it is least suspected by the largest number of market participants. Remember that when a bull market starts, it will likely 'Climb a wall of worry'
2. Tech Weak, Fundamentals Neutral: Watch closely for the fundamental picture to resolve itself as either strong or weak. Watch closely for the start of a rally.
3. Tech Weak, Fundamentals Strong: If the market P/E has fallen very low, as it usually does at the bottom of a bear market, then this is the ideal time to buy excellent companies at excellent prices, according to the method laid out in The Warren Buffett Way. These companies are often in the sector that led the rally, which is now undervalued as a result of the fear of losing money in that sector. For example, in 2001 and 2002, stocks like EBAY and AMZN actually became undervalued for a time. Remember that strong fundamentals can occur in a recession in the form of slowing earnings deceleration and bullish monetary policy. The last time the market was in this sector was 2002.
4. Tech Neutral, Fundamentals Weak: Favor defensive positions that generally weather weak fundamentals well. Dividend-paying stocks in reliable industries should be favored.
5. Tech Neutral, Fundamentals Neutral: Be on alert for any indication of shifts in the fundamental or technical picture. The market rarely stays in this sector for very long.
6. Tech Neutral, Fundamentals Strong: Favor value-and-growth strategies, and stay away from more speculative companies until the technical picture strengthens.
7. Tech Strong, Fundamentals Weak: Buy growth companies in defensive sectors, and be aware that you are skating on thin ice in this sector of the Logic Matrix.
8. Tech Strong, Fundamentals Neutral: Exercise normal caution, and favor momentum screens for stock picks. Keep a close watch on the fundamental picture.
9. Tech Strong, Fundamentals Strong: Use wider stop-losses to let profits run. Consider buying calls on low-volume market sell-offs. Consider buying stocks with weaker fundamentals that are experiencing strong momentum. Guard against euphoria, and look for an excess of optimism or other signs that the market is ready to reverse direction. Be expecially vigilant about any sign of a deterioration in the Technical or Fundamental picture, so as to avoid joining the majority of investors who are caught off-guard. Remember that when the bear market starts, it will likely 'descend a slope of hope'.

Next week, I will discuss some key points and links on the subject of behavioral finance, the field that studies the many mind-melds, nerve-pinches, and other subtle cash traps that await investors in the stock market. The existence of these traps is part of the reason that many investors achieve the best results with a buy-and-hold technique.

• Logic Matrix: Sector 7 (Technical Strong, Fundamental Weak).
• Technical Sensors: O'Neil and Zweig 4% indicators are strongly positive, though we do have some resistance ahead around the Dow 10600 level. MA analysis continues to suggest intermediate-term risk, although if the indices continue to hold above their key support/resistance levels of SPX 1180, DJIA 10400 and Nasdaq 2020, which all three indices crossed and closed above last Wednesday, then the MA analysis will switch to positive. The 4% indicator is issuing the first buy signal this year on a broad move in the unweighted SP500.
• Fundamental Sensors: "This is without a doubt the most manipulated economy in recent history." I could not have put it any better myself. Also, rational reasons to be defensive still abound. As Peter Navarro mentions in his latest weekly commentary, the market seems content to ignore serious economic issues for the moment. So the question is: are the fundamentals better than they seem, or is the market having a bout of excessive optimism? The economic reports due this week might help to answer this question.
• Evaluation of Market Sensor Readings: Cautious and 20-25% in Cash. I have increased my market exposure in response to an improving technical picture, but I am sticking with relatively defensive mutual funds to minimize market risk. For a glass-half-full take on the market, see Jon Markman's latest column.

Logical Thought of the Day:"It is illogical to change one's perspective and strategy in response to each new development. However, it is also illogical to not allow any development to change one's perspective and strategy."

A quick update... more thoughts Tuesday night

Last week's market action was sufficiently strong to trigger my 4% rule buy signal. So, while my assessment of the market fundamentals is still weak, my technical assessment is now strong - which dictates a 20-25% cash position, according to my system (which I will detail in my next log entry).

• Technical Sensors: Strong positive technical readings. O'Neil System: Buy. 4% Indicator: Buy. Moving Average and Support/Resistance Analysis: Moderate Buy.



• Fundamental Sensors: Weak market fundamental readings. Macrowave System: Sell. Zweig Monetary Model: Sell. Stein/Demuth Model: Sell.



• Evaluation of Market Sensor Readings: Increasing market exposure in response to technical data, however still cautious and 20-25% in Cash. We have had a strong technical rally that could easily rage all summer long, but the fundamental economic and growth picture continues to be troubling. I have redeployed most of my brokerage account cash into a larger position in my safest fund (FCNTX), as well as a smaller position in the mutual fund offered by my 401(k) that I believe is most likely to thrive in the current rally due to its market cap and sector weightings (ARTMX is a mid-cap fund heavily weighted toward medical, tech, and consumer descretionary sectors, which are leading this rally). While I remain very cautious, I refuse to sit out a strong technical rally in prices that offers an opportunity to reap a probable intermediate-term profit. I will remain on yellow alert as I watch how this rally plays out, and I will move more funds back to cash if the rally breaks and reverses momentum according to any of my technical sensors.
  
• Some Allegory: These are confusing times, but as logic dictates, I have redeployed more of the crew to carefully chosen areas of the surface. This may be the last chance that I have to mine dilithium crystals from the ground before another ion storm hits. The ship remains on yellow alert.

Logical Thought of the Day:"It is illogical to allow awareness of danger to blind you to the opportunity for gains. The mind that can simultaneously hold both risks and rewards, and weigh each accordingly, and not tire of the task or its inherent uncertainties, is a mind that will prevail through uncertain times."

Market Timing vs. Buy and Hold... and Book Recommendations

I'm changing my plan with this log entry. Rather than going into my timing model, stock selection, and buy/hold/sell rules, I'm going to spend some time talking about Buy and Hold vs. Market Timing. Stay tuned to this blog for updates on those other points mentioned in my first log entry.

Another point before I dive in: My success in the stock market is as much a result of putting some of my funds into bonds and cash when stock market risk is high as it is a matter of mutual fund and stock selection. My most remarkable success in the realm of investing was when I moved 90% of my 401k into a bond fund in 2000 (providing safety and growth for the next two years), and then moved my 90% of my 401k back into stock market mutual funds in early 2003. These two key moves saved me considerable financial losses. Which brings me to the primary goal of any market timing system: reducing your likelihood of being fully invested in the market when a major selloff is likely.

EMH and RWT

The Efficient Market Hypothesis (EMH) and Random Walk Theory (RWT) are widely held to be true by many investors, who are quick to ridicule technical analysis or any attempt to time market entry or pick winning stocks as exercises in futility. If these ideas are as true as most investors believe them to be, then any strategy other than buy-and-hold and dollar-cost-averaging will probably fail, or if successful, will only succeed occasionally due to chance variation. In its strongest form, the EMH implies that there is no benefit to favoring any stock over any other stock, as all stocks are efficiently priced at all times, so buying an index fund is the only way to achieve returns without excessive risk. In its strongest form, RWT means that stock prices are entirely random, so you can forget about strategic timing and technical analysis of past prices - the only way to go is to buy small numbers of shares periodically in order to buy at a low basis cost. So what you get from EMH and RWT is a stern warning not leave the buy-and-hold-dollar-cost-average-into-an-index-fund sandbox under any circumstances, because you will get hurt.

As a result of much study and some personal experience, I have come to the conclusion that neither EMH or RWT are true in their strictest sense. It is my informed opinion that markets are semi-efficient, meaning that while key market information is available to all participants, some market participants are better able to analyze information and translate that analysis into effective action. Similarly, it is my informed opinion that stock prices are semi-random, meaning that while it is impossible to predict every detail of the future fluctuations of a stock, it is possible to predict with reasonable certainty the direction that a stock will move using a wide variety of technical and fundamental systems, none of which are infallable, but several of which work quite well.

Buy and Hold vs. Market Timing

I was a bit hard on buy-and-hold in my last log entry (perhaps illogically so), so let me quickly describe the case for Buy-And-Hold, and then the case against it. First I will present the case for dollar-cost-averaging and buy-and-hold. Please forgive me as my criticisms seep into this commentary:

• Dollar-cost-averaging into an index fund (or better yet, a well managed mutual fund), as many of us do in our 401(k) accounts, is an easy way to achieve good long-term performance with minimal stress or thought, provided that the long-term trend of the fund continues to outpace inflation over the long term, which means between now and retirement in the case of the 401(k). (Note: While the assumptions that I italicised in the previous sentence are very reasonable assumptions, they are still assumptions, not the near-certainties that most investors assume them to be. The author considers any conflation of probability and certainty to be quite illogical, indeed.)
• If you try to time the market without a good system, you are very likely to sell at the bottom, and then buy back in at the top because you will percieve the greatest risk at the moment of greatest opportunity, and the greatest opportunity at the moment of greatest risk (this is classic herd psychology, and humans are herd animals). Even if you do have a good system, your emotions may overwhelm you, and you may still buy and sell at the worst possible times. You need to have a great timing system and stick with it to derive any benefit.
• If you can identify the best, safest long-term companies to own (as Buffett can), and can buy them at reasonable prices (when most others are selling, and scoff at the mention of stocks), and weather the volitility necessary to hold these companies indefinately, you can make a lot of money. Most of us are better off just buying a B Share of Berkshire Hathaway and letting Warren Buffett do this for us, though, because few of us have the knowledge or psychological strength to pull this off successfully. That, or learn to find one of the handful of mutual funds whose long-term managers have proved that they are worthy of a buy-and-hold strategy (Hint: Long manager tenure, morningstar risk: low, morningstar reward: above average, funds like FCNTX fit the bill).
• If you are managing hundreds of millons or billions of dollars, then you generally cannot time the market because any swift moves into or out of stocks will spike or sink the prices of those stocks. Mutual funds, pensions, endowments, etc. are too big to make rapid, drastic moves in most cases. However, this does not mean that customers of mutual funds cannot make quick moves into or out of those funds. The agility that comes with managing a 'small' portfolio (less than several million dollars) is one of the chief advantages that individual investors have available to them vs. the larger players.

Now I will present the case against buy-and-hold, and in favor of market timing:

• If you know what is likely to cause a bear market, and you can avoid the worst bear markets, you are unlikely to suffer a life-changing setback. For example: The interest rate yeild curve inverted in 2000, a clear sign to those in the know that a bear market was probably around the corner. Also, the S&P 500 had a much higher P/E ratio in 2000 than is typical of the market. These are two big warning signs, and Martin Zweig's Winning on Wall Street, published in 1983 for all the world to see, warned us that if you see one or both of these signs, you must be on guard.
• If you only participate in the stock market between November and April, you will get the bulk of the gains, and miss the bulk of the pain (I am considering buying QQQQ puts between May and October each year as part of my strategy... more on that later). Look at the chart hosted on The Big Picture if you are skeptical: Chart of the Week: Sell in May . . . Now that's a market inefficiency large enough to fly a Starship through...
• William O'Neil and a few others were able to dodge terrible market declines that the rest of the world didn't see coming, because of market timing. This includes the '87 and 2000 routs.
• As I touched on earlier, there is no guarantee that the long-term stock market uptrend will continue to outpace inflation in the 21st century as it did in the 20th, unless we discover another planet made entirely of oil and timber (no sign of such a planet appears on my sensors). Also, when you adjust the performance of the S&P500 over the 20th century for inflation and index delistings, the returns are much less exciting than you would think. See Ben Stein's book, Yes, You Can Time The Market for more information on the cold reality of the inflation adjusted 'real' S&P500.
• I'm skeptical about conspiracy theories as a rule, but, for a moment consider the special interests at work against the notion of market timing, and their motivations: Mutual fund managers want you to believe in efficient, completely unpredictable markets so that you will make their lives easier as they spot bargains, trends, and position themselves on the right side of the market. They also want you to believe in efficient, unpredictable markets because most of them cannot beat the market, due to the size of the portfolios they manage, and other factors, so these beliefs reduce the pressure on them to perform. Also, complacent investors keep things simple for mutual fund managers by not requiring them to deal with large inflows or outflows. Companies want you to believe in efficient, completely unpredictable markets so that you will continue to buy or hold their stocks (our stock is always a buy!), even when insiders in-the-know are selling heavily. By the way, insiders did more selling than buying in 2004... Some Academics (who come up with an army of statistics to support their belief) want to believe in efficient, unpredictable markets because it explains away their failures in the market, vs. those on Wall St. (whom academics are certain are not as smart as they are). The General Public wants to believe in efficient, unpredictable markets because it allows them to write off any success that others may find in the market as luck, which eases their feelings of envy.

So, why did I state that the strict buy-and-hold-only approach is rooted more in emotions than in logic, at least in the case of most individual investors? Individual investors want to believe in efficient, unpredictable markets because it relieves them of the knowledge that they could have avoided losing money in the past. This is a big motivator, especially now, when the memories of substantial losses in the crashing of the tech bubble are so fresh. Also, individual investors, by insisting that no matter what, you should be a buyer of stocks, are effectively presuming to know that the future looks like the past, and that the economic trend that has prevailed for the last 100 years will continue despite a radically changing world. I would like to restate that nobody knows with certainty what the future holds.

Also, individual investors are usually buy-and-hold investors to a point... until they sell at the bottom of the market in response to unbearable emotinal pain (which is the biggest mistake you can make if you are a buy-and-hold investor). And yet they remain 'buy and hold' investors, even after selling at the bottom. Why? Because emotions prevent them from taking responsibility for their losses, and these same emotions cause them to actively forget their losses and move on without learning anything. Logical? Hardly. If you want to become a logical investor or trader, which means not letting emotions hamper your performance, you must read Trading in the Zone by Mark Douglas and/or Sun Tzu. I'll expound upon the ideas presented in these books later.

Wait... I just stated that nobody knows the future, so how can I turn around and time the market, you ask? I do not try to predict the future, but I know which conditions produce the probability of near-term higher stock prices, and I know which conditions produce the probability of near-term lower stock prices, and I pay attention to those conditions and especially to changes in those conditions. I deal in probabilities, which is a safer way to operate than pinning all of your hopes on the 'pseudo-certainty' that the prices of index-listed stocks will continue to outpace inflation and provide great rewards while requiring little or no effort on the part of the individual investor (which is the implicit assumption of the buy-and-hold-dollar-cost-average-into-index-funds approach). To clarify, there are a few companies and mutual funds that are worthy of an indefinite holding period, but in my opinion, most stocks do not fit this bill.

In Summary: The Buy-And-Hold-Dollar-Cost-Averaging-into-Index-Funds approach is better than haphazard market timing, and is the most sensible choice for investors who do not want to make any choices beyond the choice to invest (which is the logical choice to make). But these investors should be sure that they are really willing to hold their shares through almost anything (and will not capitulate as so many did in 2002), and should be aware that this approach has risks and limitations which are generally under-appreciated (the chief risk being reliance on an unknown future, the chief limitation being a very slim chance of outperforming the broad market averages). Market timing is a great tool for those who want more control over their finances (particularly defensive control), and are willing to do the work required to succeed, which includes finding and adopting a sound timing system, coming to terms with the fact that it will occasionally fail, and then sticking to it. The entry and exit signals that I use to manage my 401k are triggered less than 3 times per year on average, so with just a bit of work each week, I generally beat the S&P 500 and inflation each year.

So, without going into my specific market timing model yet, let me provide you with a list of the books and systems that have informed this model. Market timing systems can be roughly divided into fundamental timing systems, which rely on economic and earnings information, and technical timing systems, which rely on statistics derived from price and volume movements. I will describe the systems that I follow, with book references for each one, below.

Fundamental:

• Macrowave Economic Indicators: Peter Navarro's book, If it's Raining in Brazil, Buy Starbucks tells you how to read macroeconomic indicators the same way the big players do.
• Zweig's Monetary Indicators: Read Martin Zweig's Winning on Wall Street to learn how to read monetary indicators, and to learn how the Fed pulls the stock market's strings.
• Ben Stein and Phil DeMuth's Valuation Indicators: Read, Yes, You Can Time the Market to find out how to tell when stocks are cheap and when they are overpriced according to historical metrics. This system gives mixed signals most of the time, but gave a crystal-clear (and correct) signal at the top in 2000.

Technical:

• Zweig's 4% Model: Read Martin Zweig's Winning on Wall Street, and then hunt for an unweighted index of stock prices to apply the 4% rule against... This is my favorite model, and it has told me to be on guard since the start of the year, with money-saving results. More on this in another log entry.
• Moving Average Analysis: Sources for analysis of 50-day and 200-day (and other) moving averages, and what it means when these moving averages converge in a Golden Cross or a Death Cross are too numerous to mention, but Tobin Smith's Changewave 2.0 provides a great explanation and methodology, as do many other books and Web sites. Suffice it to say that when the 50-day moving average crosses the 200-day moving average, this is a significant event, and usually forecasts a move in the direction that the 50-day moving average is moving.
• William O'Neil's IBD system: A great system that provides early warning on every strong rally... but one that sometimes pulls you into short-lived 'sucker rallies'. You cannot have it both ways - either an indicator gives late notice of a long-term trend, or it provides early notice of a trend that may be short-lived. Read How to Make Money In Stocks or The Successful Investor to learn his system for interpreting price and volume. Essential reading for recognizing when to exit a stock or when to watch a topping market very closely. The Successful Investor is an eye-opener for anyone who got burned in the 2000-2002 rout.

Logical Thought of the Day:

"It is illogical to choose one's beliefs about investing based on the emotional comfort that those beliefs provide, when that very comfort gives rise to complacency and exposes one to needless risk."

Descent into Allegory:

Spock's log... fundamental and technical sensor readings continue to suggest danger in the form of economic uncertainty and an intact intermediate-term down-trend... Shields remain up...

Welcome to The Spock Report

I created The Spock Report to share my quest for financial success through the application of logic and control of emotions. The quest for emotional neutrality began when I realized that my stock selection and timing of entry were usually correct, but that I sometimes failed to profit from my investments due to erratic application of selling and buying rules, and due to 'going with my gut', rather than developing sound, rational plans and sticking with them. Unless you are already a top-notch investor or trader, you must resist your instincts, as they will usually be wrong, and instead use objective systems to control your activities in the financial markets. I also believe that there are safer and riskier times to be in the markets, and that while a strong case can be made for buy-and-hold investing, the devotion to this approach among retail investors is rooted more in emotions than it is rooted in logic. Even Warren Buffett has stated that he should have sold some of Berkshire Hathaway's holdings during the 2000 market top, and he is the most successful buy-and-hold investor that the world has ever seen.

The Spock Report will describe my activities in and thoughts on the financial markets (stocks, 'forex' currency trading, etc.) as well as my thoughts on news events that move the markets. I plan to spend some time talking about common financial pitfalls that stem from irrational thinking and emotional attitudes toward money. I also plan to recommend the books that have helped me to understand trading, investing and personal finance. So, while this blog will be market-focused, it will not be exclusively concerned with the financial markets.

The inspirations for this blog include Mr. Spock from the television series Star Trek, the fictional paragon of logic and rationality, and Charles E. Kirk of The Kirk Report (http://www.kirkreport.com/). By the way, I would like to extend my condolences to Mr. Kirk for the recent passing of his father-in-law.

In my next log entry, I will describe the tools that I use for my market timing model (the system that tells me when to increase my market exposure, and when to reduce it), the rules that I use to select stocks and to enter and exit positions, and I will also refer you to some of the more useful investing books that I have read. Here is a brief description of my take on the US stock market right now, though:

• Technical Sensors: The long-term momentum of the market at this moment remains down, although the short-term momentum is more neutral than negative. An unweighted calculation of the S&P 500 index has had two weeks in which it lost ~4% of their value in the last 6 months, and no weeks in which it gained ~4% (I use a modified version of Mr. Martin Zweig's 4% rule as one of my primary technical indicators). On Tuesday, with no news to drive the US stock market, the markets sank, which indicates that the general sentiment on Wall Street is one of worry (lacking news, markets often drift with general sentiment). The DIA, SPY and QQQQ exchange traded funds (ETFs) that track the DJIA, S&P500 and Nasdaq 100 indices are all under their 50-day moving averages, and the bearish 50/200 SMA crossover that has occured recently on the QQQQ, and that look to be only days away on the SPY and DIA provide additional negative technical signals.
• Fundamental Sensors: The fundamental sensors are also picking up some troubling readings. The recent seesaw action in the market has been caused by shifting perceptions of the risks of inflation and the risks of an economic slowdown. The second deltas of earnings and GDP are also negative, meaning that corporate earnings and GDP are still growing, but no longer accelerating. Also, profit warnings from GM and IBM, the bell weathers of the automotive and technology sectors, are casting a shadow on the stock market at this moment. And Oil prices are still a concern as long as they remain above $40 and volatile - one that market speculators would do well to keep in mind. And did I mention the twin budget and trade deficits... And that there are more interest-only mortgages on the books than we have had since the 1920's...
• Evaluation of Market Sensor Readings: Cautious and over 50% in Cash. We could certainly see a strengthening of the current market... and if we get a rally that is strong enough to trigger a buy signal from my timing model, I won't argue with it - that would be illogical. But I will be very careful about taking any new long positions, and I will cut any losses very short without flinching.
• Descent into Allegory: The fundamental and technical sensors are picking up troubling signals in this sector of market space-time, so until these signals change, I will remain alert and wary. I will send only small away-teams to the better-known areas of the surface, and I will keep most of my crew safe aboard the ship. Shields up!

Logical Thought of the Day:

"It is illogical to expose yourself to significant risk, unless this exposure also creates a high probability of a significant reward."