Revisiting the Simplest Investing Rule

In the post Making The Simplest Investing Rule Even More Simple, I explained a rule for monitoring the S&P 500 weekly moving averages to spot buy and sell signals for long term investors.  The rule comes from Karl Denninger at Market Ticker.

When the 20 WMA passes the 50 WMA by 1%, you buy into an index fund.  When the 50 WMA exceeds the 20 WMA by 1%, you sell your positions and move into a cash position or fixed income position.

Last week, a buy signal trigger using this rule and a few people have asked me if it is time to get long.  Let me start by saying that every rule works until it doesn’t.  There is no such thing as a system that will work forever.  It is my belief now that The Simplest Investing Rule is sending a false BUY signal. I think the recent run-up in the stock market has been manipulated by traders and does not reflect economic reality.

In the post Eye of the Hurricane, I listed my 2 criteria that must be met before I believe that a recovery is possible.

1. Bad debt must be defaulted on and removed from the system.  Mathematically we can not grow from these levels of debt.Denying the true value of assets is only delaying the reality.  Japan went through a 20 year period of denial.  We are in a deflationary period. Credit is being pulled from the system at a historic rate.  We have too many houses, too many cars, too many malls and too many of about anything created via leveraged financing.  There is no growth around the corner to absorb the excesses.
2. The criminals must prosecuted.  At the height of every bull market, there are individuals that play fast and loose with the law.  Boesky and Milken in the 1980s.  Bernie Ebbers and the boys at Enron during the dot-com days.  There will be no market bottom until you start seeing old rich guys in handcuffs.  Everyone knows the financial markets have been riddled with fraud for the past few years.  Where are the arrests?  The problem with this recession is not only have we not gone after the criminals, but the bailouts have created another wave of fraud.  Until investors have their faith restored that laws will be enforced and the accounting is honest, they will not take risks, start companies and hire workers. They will sit on the sidelines.

Neither has happened.  Nathan’s Economic Edge refers to both my criteria as Rule of Law.

For capital to form and concentrate IN A HEALTHY MANNER, the rule of law must be spelled out AND FOLLOWED. If the rules change over time, then those who have capital will look elsewhere to put their money to work.

Companies that should fail are being propped up.  Consumers that make bad car purchase decisions are getting rewarded at the expense of others.  The Federal Reserve is buying US Treasuries.  Insolvent banks are keeping fictional home prices on their books.  I could go on and on.  America until recently was a country that followed Rule of Law.  Now the rules change daily.  Weak companies need to fail.  Insolvent banks need to be shutdown.   Asset prices need to be restored to pre-leverage values.  Until that happens, capital will not flow and there will be no recovery.

The stock market is now priced for a extremely robust “V-shaped” recovery.  The current P/E ratio on the S&P 500 is a staggering 145.

My thesis remains the same.  This is a credit (not inventory) based recession.  Credit recessions arrive about every 3 generations (1873, 1930, now).  Banks don’t want to lend.  Consumers don’t want to borrow.  Investors with capital are losing faith that Rule of Law is being followed.  Foreigners have stopped buying the bulk of  US Treasuries.  Tax revenue has fell off a cliff.  Monetary velocity is plummeting.  Unemployment is still rising.  Debt is exploding at all levels of government.  I could rattle off stats for another 5,000 words.  I won’t.  The economic situation is ugly and getting uglier.  And it isn’t just America.  It is everywhere.

If you believe in the “green shoots” theory and that recovery is coming, please share with me in the comments where the growth driver will be coming from.  Our economy is 70% consumer based.  The consumer is tapped out.

If you held stocks from the 666 lows on the S&P 500, I’d being selling.  You gained 50% in a few months.  Don’t be a pig chasing an extra few percent.

Then again, I could be wrong.

Disclosure:  I am invested in cash and short mutual funds (Prudent Bear and Grizzly Short).