NEW HOME SPRING 2017



Schwartz is Bullish
From Note 4, Sent 1/28/18

Marvin Schwartz, one of Neuberger Berman’s leading lights since joining the firm’s research department in 1961 at an hourly wage of $1.25, told Barron’s this weekend that no other country is shrinking its equity base as much as we are:

“We’re now in our ninth year of share buybacks equal to 3% of the market value of all S&P 500 stocks, based on Laszlo Birinyi’s work. For 2017, he estimates buybacks of $630B and for 2018, $750B.”

On top of that bullish factor, he’s not worried about valuation:

“For 20 years, the average price/earnings ratio has been 19.3. If you go back 50 years, it’s 15.6 times. In periods where inflation grew 3% or less—which is 22 of the past 50 years—the P/E of the market was 19.7. Now, at 17 for 2019 and 15.9 for 2020, P/Es don’t look particularly stretched.

“If earnings are rising 16% this year and a minimum of 8% next year, and if companies buy back 3% of shares, and M&A reduces them by another 4%, then I don’t see why the market can’t rise 10% to 15% this year and another 10% or so next year.”

From Note 37, Sent 10/8/17

One bit of bearish evidence on parade is the VIX reaching a 24-year low.

Off the top of your head, when would have been one of the best years in recent decades to have invested everything you had in the stock market? How about before the tech boom of the 1990s, say, 1993?

That would have put you in with the S&P 500 at about 440, before it took off in 1995 to its peak at around 1,500 in August 2000, for a 241% gain before dividends.

Yet, 1993 was 24 years ago and the last time the market saw a VIX as low as it is now. Why don’t analysts and journalists notice such obvious evidence that the measures they fixate upon are unreliable? The VIX is a sideshow.

From Note 26, Sent 7/9/17

It’s encouraging to see Gluskin-Sheff’s David Rosenberg (bearish and wrong for the past nine years running) remaining stubbornly bearish, warning that he sees rain clouds and asking, “When do you want to make sure you’ve got an umbrella? When rain is in the forecast or after it’s already started pouring?”

Never mind he’s been forecasting a financial downpour throughout one of the best recoveries on record, and that anybody hiding under his umbrella for the past nine years has missed enough sunlight to power Vegas for days, he’s still handing out umbrellas: “I can’t tell you when it is going to happen,” he said last week, “but the economic cycle has not been abolished, and the chances of a recession are rising.”

Sure thing, Dave.

From Note 14, Sent 4/7/17

Pundit warnings of bond-fund trouble in the face of rising interest rates were wrong. According to Morningstar’s first-quarter recap: “Although the Fed hiked rates for only the second time in more than 10 years, all fixed-income Morningstar Categories were in positive territory over the first quarter.” Yes, all.

Low inflation and a low neutral real rate of interest have created a near-zero world. Probably the last thing to worry about is a bond crash due to soaring inflation and interest rates.


The Effectiveness of my Signal System

In this video, you’ll see the effectiveness of my Signal system.

Starting with $10,000 in 2001 and making employee contributions to a 401(k) account, The 3% Signal system (3Sig) returned far more than dollar-cost averaging into the S&P 500 (SPY), and dollar-cost averaging into a portfolio of Morningstar medalist actively-managed funds, as follows by year-end 2016 balance:

$332,091 in 3Sig
$263,874 in DCA SPY
$209,070 in DCA Medalists

This shows 3Sig beating both the unmanaged stock market and top-quality managed funds…

Week 6 to 2/9/18
Year-to-Date Performance

S&P 500 -1.8% | Kelly Letter -3.5%
3Sig -3.3% | 6Sig -6.2% | 9Sig -0.7%

The string of 5% losses across the indexes represents the biggest one-week downdraft for stock prices since early 2016.

As usual, explanations are narrative fallacy. The truth is probably this simple: the market went 15 months and 34% higher without so much as a sniffle, and was due for a correction.

So the correction everybody knew was coming someday, just not when, came. That’s all, but it triggered an outpouring of pent-up frustrations bigger than usual because it had been longer than usual in coming and smoother than usual in the run-up.

It’s not true that we haven’t seen anything like last week in recent times. Just two years ago, exactly, in February 2016, the market fell 15% on worries that China’s economy was slowing and heading for a hard landing. It wasn’t, and stocks got back to rising.

We never have cause for concern in our Sig systems, which it’s worth repeating are built for the express purpose of exploiting volatility. They take surpluses off the table for safekeeping, as they just did at the beginning of January. They redeploy them into shortfalls, as we hope they’re able to do at the beginning of April.

We’re sitting on $725,150 of bond balance. Our shortfalls this weekend would draw in just $255,558 of it. We could use another round of bargainizing.

Kelly Letter Learn More

Week 5 to 2/2/18
Year-to-Date Performance

S&P 500 +3.4% | Kelly Letter +3.0%
3Sig +0.5% | 6Sig +0.7% | 9Sig +9.4%

The market reversal moved all three of our Sig plans back into shortfall territory for the quarter. A week ago, they sat on a collective surplus of $34,264. Today, they’re at a shortfall of $94,886.

(Note: This shortfall refers to the plans falling short of their quarterly growth targets, not into negative territory for the year. As you can see above, all remained above zero percent performance at the time of this writing.)

This is what we wanted, a price decline, as mentioned over the last few months. After another round of selling at the beginning of January, we maintain buying power of $669,774. That’s after last week’s 1% drop in bond prices.

Ideally, we would be moving the last of it in near the bottom of whatever stock-market slide is underway, although this would only be possible if it were to coincide with our pre-determined trading dates. Luckily, close enough is good enough in our system.

Isn’t it nice not needing to care what happens next?

Week 4 to 1/26/18
Year-to-Date Performance

S&P 500 +7.6% | Kelly Letter +8.4%
3Sig +3.9% | 6Sig +6.8% | 9Sig +17.4%

Our Signal system continues performing well. Last week saw all three permutations make it into the surplus zone for the quarter, just four weeks in.

The star of the lineup is 9Sig, which has performed so powerfully since its debut a year ago that it’s almost ready to overtake 6Sig in size, as the summaries below make plain.

Balances on 12/30/16:

3Sig $948,018
6Sig $644,074
9Sig $465,417

Balances on 1/26/18:

3Sig $1,100,057 (+16.0%)
6Sig $836,942 (+30.0%)
9Sig $798,895 (+71.7%)

Just last week saw 9Sig’s balance increase by $35,639. Its balance is now only $38,047 shy of 6Sig’s balance, so we could well reach the mid-point of this quarter with a 9Sig balance larger than our 6Sig balance. This is astonishing.

Kelly Letter Learn More

Week 3 to 1/19/18
Year-to-Date Performance

S&P 500 +5.2% | Kelly Letter +6.5%
3Sig +3.5% | 6Sig +5.6% | 9Sig +12.1%

Just three weeks into the new year, 9Sig is once again outshining its less aggressive senior partners in 3Sig and 6Sig. It uses 3x leverage, therefore by definition it will have an edge in a rising market, and all one ever reads about anymore is the relentlessly rising market, hence the shining spotlight on 9Sig.

And, oh, what a light! At the three-week mark, and just two weeks after its quarterly rebalance that robbed it of $98K of exposure to the Nasdaq 100 at 3x, it’s only 0.8% below its balance target for this quarter. So far this year, 9Sig is up 12%.

Week 2 to 1/12/18
Year-to-Date Performance

S&P 500 +4.3% | Kelly Letter +5.6%
3Sig +3.0% | 6Sig +4.8% | 9Sig +10.3%

The S&P 500 is off to its strongest start to a year since 2003. Despite our selling into strength last week and currently holding 28% of our capital in bonds, we’re staying ahead of the big index.

However, it’s getting harder for us to do so. Counterintuitive though it may be, we need a correction or a crash one of these quarters to achieve greater benefit from our price reactive system. An always-rising market is the hardest kind for us to beat, and this one’s been on fire for quite some time.

Week 52 December 29, 2017
S&P 500 +21.8% | Kelly Letter +22.6%

In 2017, we grew our balance from $2,057,509 to $2,523,385 with a quarter of our capital in safe bonds.

Other key metrics for us:

NO charts consulted
NO pundit warnings heeded
NO market forecasts offered
NO stop-loss or other specialized orders used

Simplicity and rational reaction won again. Over time, they always do.

Older Performance Notes

I’m Jason Kelly.

You probably know me through one of my books, such as The Neatest Little Guide to Stock Market Investing or The 3% Signal. I also write The Kelly Letter for subscribers every Sunday morning. It runs an automated portfolio that reacts to stock price changes alone using my 3Sig, 6Sig, and 9Sig plans. It beats the market with no stress from indecision.

This page collects excerpts from letters, along with helpful information. For more from me, join the free list at the top left of this page. To turn your portfolio into an efficient quarterly machine running my 3Sig, 6Sig, and 9Sig plans, join The Kelly Letter.


How My Signal
System Works

In this video, you’ll learn how my signal system works to change the way you see the stock market.

Instead of listening to pundits commit the narrative fallacy of weaving news into a story explaining why the market went where it went or, worse, why they think it will go a certain way in the future, you’ll come to see the market as a meaningless series of changing numbers.

This controls emotion and allows for rational reaction to price changes. You won’t care why the numbers went up or went down, you’ll just react in a predetermined manner to the change by selling fluctuations above a signal line and buying fluctuations below it.

In this manner, you will beat the market with no stress from indecision and no more time wasted listening to pundits make up stories from the news.


From Note 37, Sent 10/8/17

Bears love pointing to market sentiment, usually to warn that retail investors are getting too greedy, setting the market up for a crash. But like all the other metrics they love, this one is an unreliable timing indicator.

Sentiment is an oscillator, fluctuating in a wave pattern between fear and greed through long price cycles. In most time frames, the S&P 500 rises along a line from lower left to upper right on a chart. If you put a sentiment oscillator at the bottom of the chart, you’ll see it going through its waves the whole time, exerting inconsistent influence on the rising price line above.

Zeroing in on CNN’s Fear & Greed Index, we find the following over the past two years, defining greed as a measure of 80 or higher and fear as one of 20 or lower:

2015: Greed > Fear > Almost Greed
2016: Fear > Greed > Fear > Greed
2017: Greed > Almost Fear > Greed > Fear > Greed

Through the emotional turmoil, the S&P 500 rose 24% from 2058 on 12/29/14 to 2549 now.


From Note 14, Sent 4/7/17

Almost all market movement is clustered around the no-change line. The media and our collective psyche are fixated on famous moments of short, sharp price change, but they are not the norm.

We will experience them again, though, and our plans will manage them as specified. Both 6Sig and 9Sig will do their jobs when run correctly.

The biggest risk to their performance is not from the market or their predefined responses to it. The biggest risk is an emotional mistake, such as abandoning them at the very moment they’re about to deliver their greatest over-performance. When is this? From the bottoms of crashes.


From Note 44, Sent 11/26/17

I’ve been pleased to see small caps reenter the competition from their low in August, just about when people had all but forgotten their fabulous performance in last year’s fourth quarter and were ready to abandon them for other asset classes.

This is par for the course. I’ve found from watching investors over the years that “patience” means two quarters. Somewhere during the third quarter of lagging performance, in the eighth month in this case, they start feeling like the current trend has lasted forever and get antsy. This explains why two-year bear markets leave such a deep scar in the emotional make-up of investors. Even the more rational variety, such as ones who run my Signal plans, fairly quickly begin second-guessing what’s known to work. We are emotionally ill-equipped for this business.

At least in this case, few people made moves before the historical strength of small caps reasserted itself. For the year through August 21, [our small-cap ETF] returned -2.4%. Since August 21, it’s returned 13.5%. During the lackluster first half, our 3Sig plan took advantage of the appealing prices to move capital from bonds to small caps, and it’s paying off. Nobody’s tired of small caps anymore.

Bestselling Financial Author