Using Martin Zweig's Model in the Modern Era
Bill Ziemba and I co-wrote the paper at the following link on using Martin Zweig's Monetary and Momentum Models in the modern era:
https://www.tandfonline.com/doi/full/10.1080/21649502.2015.1165917
The model is from Zweig's book, "Winning on Wall Street" published in 1986.
So far, it has served me well. I am certain there are many other, far better, models, but this one is easy to use and doesn't take much time to maintain. The key point about Zweig's model is that it keeps you in touch with the market trends.
Here is a quote from our paper which I have edited slightly so that it is updated with numbers from August 5, 2019 -- a selloff day:
"Zweig suggests three crucial conditions for a bear market:
1. Extreme deflation. This is not present in 2019, but the fed just cut rates. Perhaps they fear deflation because deflation is what happened during the great depression?
2. PE ratios of 18 or above. The current PE of the S&P is around 21 [and falling], which Zweig says is bearish. However, he says the exception is when profits are low (causing high PEs) because of a business downturn. This was the case in 2016 with poor earnings when this paper was written, but it may also be true in August of 2019.
3. Inverted yield curve. An inverted yield curve last occurred in early August of 2008."
It IS inverted in 2019. The 6 month T-bill to the 30 year bond is NOT inverted, but it is growing steeper. The 3/mo to 10yr IS inverted and started to invert last May -- sell in May and go away was good advice.
Zweig writes in his book "Winning on Wall Street":
“Should the major stock indices experience a decline of, say, 10% or more with none of these negative conditions present, the odds of that decline's becoming a major bear market are quite small.
It would generally pay to begin buying stocks after a 10% decline in all three markets, assuming that the big negatives are not present. The odds of that decline's reaching 15% or more are remote, and except for a few meaningless cases in the extraordinarily volatile period from mid-1920s to the mid-1930s, it simply has not occurred in at least the last seven decades… a decline of 10% sets in motion a buying opportunity with overwhelming odds that you won't lose more than 5% before the market begins to rally once more.”
Problem is, one or more of these negative conditions are present -- Inverted Yield Curve and PE above 18.
Plus, Zweig's 4% model had a sell signal triggered today when SP closed 4% below its recent high.
Zweig also writes:
"When the yield curve is negative on a monthly basis, I consider that an extremely unfavorable condition for stocks.
Only one bear market, 1929-32, had all three extremely negative conditions, and not so coincidentally it was the worst bear market in history. Four other bear markets had two of the three conditions, and three of those bears were devastating: 1919-21, in which the Dow fell 47.6%; 1969-70, when the Dow plunged 36.1%; and 1973-74, in which the Dow collapsed 45.1%. In the other case, 1966, Dow fell a more moderate 25.2%. However, that was the beginning of a much greater long-term bear market, which took the Dow downward in real terms all the way into 1982... The average of these four bear markets showed a decline of 38.5% on the Dow, well in excess of the average of the ten bear markets that had only one of the three negative conditions and fell and average of 29.4%.
In sum, there is no guarantee that a bear market will begin when one of the three extremely bearish market conditions is first present. But the longer such a condition persists, or the more severe it becomes, or when a second or third negative condition joins the first, the odds on a bear market becomes overwhelming. On the other hand, should the major averages experience a decline of, say, 10% or more with none of these three negative conditions present, the odds of that decline's becoming a major bear market are quite small."
To calculate the yield curve, Zweig used Moody's Aaa Corporate Bond rates for long term rates and 6 month Commercial Paper rates for short term. The 6 month commercial paper rates are no longer given. If you use the 90 day commercial paper rates then the curve is inverted.
Again, the 3 month to 30 year has NOT inverted, yet, but it is getting steeper and trending toward an inversion. The shorter term rates have inverted.
So of the three negative conditions, 1. Deflation is not present, 2. the yield curve is inverted, and 3. the PE ratio is above 18. That means two out of three negative conditions of a bear market may be present. HOWEVER, I can make a case for the high PE due to low earnings because of the major business downturn that has been persistent since 2009 and has been slowly recovering. Stock prices are high due to low interest rates. Investors need to make a return on their investments. Bonds are not yielding much. So investors have to turn to the equity markets. That drives up Prices relative to Earnings and gives us high a high PE ratio, but not because of irrational exhuberance. The PE is only a few points over Zweig's cutoff of 18%. Given the low interest rates I am not convinced the current PE qualifies as a negative indicator.
Lastly, Trump's tariffs and China's currency manipulations are causing a lot of uncertainty in the markets. Also, we are coming upon the weakest months of the year -- September and October.
It might pay to lighten up on stocks given the Zweig 4% model today gave a sell signal and one or more major negative indicators for a bear market might be present.
The interest rate cut on August 1 was a good sign for the market, but it was nullified by Trump and China.
The danger with China is that if they stop buying our goods that could cause a surplus. If there is a surplus and there are no buyers that will cause deflation. If deflation happens that is the third negative indicator and there is a very real risk of a severe recession or even depression.
To summarize, Zweig's model is giving a slight buy signal. The interest rate cut was a bullish signal for buying stocks. Conversely, there are signs that a recession may be coming. Given the mixed signals, I am holding for the moment, but am prepared to buy or sell depending on what happens next.
Trump's tariffs and China's currency manipulations are causing a lot of uncertainty and was a big driver of the selling Monday, August 5, 2019. If Trump can force China to the negotiating table and resolve the tariffs and currency issues then the indicators most likely would be giving buy signals.
Given what happened to Carter, George Bush I and II at the end of their terms, if Trump wants to be re-elected he would be wise to remember James Carville's slogan that helped Clinton defeat Bush, "The economy, stupid."
Carter's economy with high interest rates, inflation, and a recession along with other crises, led to Reagan.
Bush II's faltering economy in the summer of 2007 led to Obama's election.
For these reasons, I look for Trump to resolve the issues in time for the election -- but that is still over a year away. A lot of bad stuff can happen in a year. If people get hurt badly economically that could be reflected in their votes in November 2020.
https://www.tandfonline.com/doi/full/10.1080/21649502.2015.1165917
The model is from Zweig's book, "Winning on Wall Street" published in 1986.
So far, it has served me well. I am certain there are many other, far better, models, but this one is easy to use and doesn't take much time to maintain. The key point about Zweig's model is that it keeps you in touch with the market trends.
Here is a quote from our paper which I have edited slightly so that it is updated with numbers from August 5, 2019 -- a selloff day:
"Zweig suggests three crucial conditions for a bear market:
1. Extreme deflation. This is not present in 2019, but the fed just cut rates. Perhaps they fear deflation because deflation is what happened during the great depression?
2. PE ratios of 18 or above. The current PE of the S&P is around 21 [and falling], which Zweig says is bearish. However, he says the exception is when profits are low (causing high PEs) because of a business downturn. This was the case in 2016 with poor earnings when this paper was written, but it may also be true in August of 2019.
3. Inverted yield curve. An inverted yield curve last occurred in early August of 2008."
It IS inverted in 2019. The 6 month T-bill to the 30 year bond is NOT inverted, but it is growing steeper. The 3/mo to 10yr IS inverted and started to invert last May -- sell in May and go away was good advice.
Zweig writes in his book "Winning on Wall Street":
“Should the major stock indices experience a decline of, say, 10% or more with none of these negative conditions present, the odds of that decline's becoming a major bear market are quite small.
It would generally pay to begin buying stocks after a 10% decline in all three markets, assuming that the big negatives are not present. The odds of that decline's reaching 15% or more are remote, and except for a few meaningless cases in the extraordinarily volatile period from mid-1920s to the mid-1930s, it simply has not occurred in at least the last seven decades… a decline of 10% sets in motion a buying opportunity with overwhelming odds that you won't lose more than 5% before the market begins to rally once more.”
Problem is, one or more of these negative conditions are present -- Inverted Yield Curve and PE above 18.
Plus, Zweig's 4% model had a sell signal triggered today when SP closed 4% below its recent high.
Zweig also writes:
"When the yield curve is negative on a monthly basis, I consider that an extremely unfavorable condition for stocks.
Only one bear market, 1929-32, had all three extremely negative conditions, and not so coincidentally it was the worst bear market in history. Four other bear markets had two of the three conditions, and three of those bears were devastating: 1919-21, in which the Dow fell 47.6%; 1969-70, when the Dow plunged 36.1%; and 1973-74, in which the Dow collapsed 45.1%. In the other case, 1966, Dow fell a more moderate 25.2%. However, that was the beginning of a much greater long-term bear market, which took the Dow downward in real terms all the way into 1982... The average of these four bear markets showed a decline of 38.5% on the Dow, well in excess of the average of the ten bear markets that had only one of the three negative conditions and fell and average of 29.4%.
In sum, there is no guarantee that a bear market will begin when one of the three extremely bearish market conditions is first present. But the longer such a condition persists, or the more severe it becomes, or when a second or third negative condition joins the first, the odds on a bear market becomes overwhelming. On the other hand, should the major averages experience a decline of, say, 10% or more with none of these three negative conditions present, the odds of that decline's becoming a major bear market are quite small."
To calculate the yield curve, Zweig used Moody's Aaa Corporate Bond rates for long term rates and 6 month Commercial Paper rates for short term. The 6 month commercial paper rates are no longer given. If you use the 90 day commercial paper rates then the curve is inverted.
Again, the 3 month to 30 year has NOT inverted, yet, but it is getting steeper and trending toward an inversion. The shorter term rates have inverted.
So of the three negative conditions, 1. Deflation is not present, 2. the yield curve is inverted, and 3. the PE ratio is above 18. That means two out of three negative conditions of a bear market may be present. HOWEVER, I can make a case for the high PE due to low earnings because of the major business downturn that has been persistent since 2009 and has been slowly recovering. Stock prices are high due to low interest rates. Investors need to make a return on their investments. Bonds are not yielding much. So investors have to turn to the equity markets. That drives up Prices relative to Earnings and gives us high a high PE ratio, but not because of irrational exhuberance. The PE is only a few points over Zweig's cutoff of 18%. Given the low interest rates I am not convinced the current PE qualifies as a negative indicator.
Lastly, Trump's tariffs and China's currency manipulations are causing a lot of uncertainty in the markets. Also, we are coming upon the weakest months of the year -- September and October.
It might pay to lighten up on stocks given the Zweig 4% model today gave a sell signal and one or more major negative indicators for a bear market might be present.
The interest rate cut on August 1 was a good sign for the market, but it was nullified by Trump and China.
The danger with China is that if they stop buying our goods that could cause a surplus. If there is a surplus and there are no buyers that will cause deflation. If deflation happens that is the third negative indicator and there is a very real risk of a severe recession or even depression.
To summarize, Zweig's model is giving a slight buy signal. The interest rate cut was a bullish signal for buying stocks. Conversely, there are signs that a recession may be coming. Given the mixed signals, I am holding for the moment, but am prepared to buy or sell depending on what happens next.
Trump's tariffs and China's currency manipulations are causing a lot of uncertainty and was a big driver of the selling Monday, August 5, 2019. If Trump can force China to the negotiating table and resolve the tariffs and currency issues then the indicators most likely would be giving buy signals.
Given what happened to Carter, George Bush I and II at the end of their terms, if Trump wants to be re-elected he would be wise to remember James Carville's slogan that helped Clinton defeat Bush, "The economy, stupid."
Carter's economy with high interest rates, inflation, and a recession along with other crises, led to Reagan.
Bush II's faltering economy in the summer of 2007 led to Obama's election.
For these reasons, I look for Trump to resolve the issues in time for the election -- but that is still over a year away. A lot of bad stuff can happen in a year. If people get hurt badly economically that could be reflected in their votes in November 2020.
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