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Shaky Foundation

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The S&P 500 Index (SPX) is starting to paint a pattern that often leads to instability and a quick drop lower. Look at the chart below and you’ll see wide quick swings going in both directions. This indicates uncertainty by market participants. It is a pattern we haven’t seen for a very long time which makes it more important. Another thing I’m seeing is perceptions of risk rising. Three of four components of our market risk indicator are warning at the moment. We still have one hold out, but it is dropping rapidly. As I’ve mentioned over and over again I don’t think the market can have a substantial correction until breadth breaks down. One measure that is getting close to warning is the percent of stocks above their 200 day moving average. I get concerned when it falls below 60%. Add it all together and we’ve got a market with a shaky foundation. Caution is warranted.

 
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Market Health Bounces from Oversold Conditions

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This past week almost all of our indicators turned up from oversold conditions. So far the turns are slight. This indicates that the market is still under pressure even though price spiked higher. What I’m seeing looks like extreme uncertainty. Longer term market participants appear to be standing aside while traders are chasing. This adds a bit of volatility that will create larger range days both up and down on any news. One thing of note is that due to the oversold conditions and the distance our indicators need to travel to get above zero it is likely that it will be several weeks before we’ll make any changes to our portfolio allocations. The one exception is our core measure of risk. It could move higher over the next few weeks if the market gets to new highs and sustains the move. Bottom line, we’re still waiting for clear conditions before taking any risk in the market.

 
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Dow Theory Best Indicator Since 2009

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Out of the lows in 2009 there has only been one of the indicators that I follow that hasn’t had whipsaws or bad signals somewhere along the way. That “indicator” is Dow Theory. It has continued to confirm  a long term bull market for the entire period from its bullish trend change in July 2009. This is due to time being an important factor in Dow Theory. The system outlined by Charles Dow and William Peter Hamilton waited for roughly three weeks of trend before declaring a secondary reaction point. The lack of secondary lows that subsequently failed has kept Dow Theory bullish. On the chart below I’ve annotated the secondary low and high points from the last several years. In addition there is a Dow Theory line during the first several months in 2012. We’re now approaching a month long decline in the Transportation average (DJTA). The industrial average (DJIA) will need to break below the December lows to pass the three week mark. At this point we’ll need

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Risk on the Rise and Core Indicators Oversold

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Over the past week our core measures of risk fell into negative territory. It was the last category to go negative. Our other measures of market health started going negative in early September and haven’t recovered. In fact, they have continued to deteriorate to the point where several of our indicators are now oversold. Our measures of market quality and strength are at points that have often marked lows similar to May 2012 and April 2013. The only recent occurrence of oversold conditions when the market was close to all time highs came in early 2008 and persisted into July/August of 2008. This puts the market in a position where it could go either way. Until conditions clear our Long / Cash portfolios will be 100% in cash. Our Long / Short hedged portfolio will be 50% long stock that we believe will outperform in an uptrend (high beta stocks) and 50% short the S&P 500 Index (using SH or a short of SPY). Our Market Risk Indicator has only

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Risk Rising

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Once again our core measures of risk are negative. They’ve been there all week long. I suspect that it will take a close above 2050 on the S&P 500 Index (SPX) by Friday to get the category positive. That’s about the point where SPX has been when the risk measures flip. If they are negative on Friday the Long / Cash portfolios will go 100% to cash. The hedged (Long / Short) portfolio will be 50% long high beta stocks and 50% short SPX. Our market risk indicator has three of four components warning at the moment. The fourth component continues to slowly fall, but hasn’t gone negative yet. The volatility hedge is still 100% long and will stay that way unless the fourth component falls by the end of the week. One thing I’m seeing is a lot of mixed signals…I’ll post more about them on Friday, but here are a few examples. NYAD advance / declines are acting well, but the percent of stocks above their 200 day

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Gold Stocks and the Market

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I did a write up on Trade Followers about a buy signal for gold stocks generated from Twitter momentum / sentiment. It’s time to watch the trade closely for signs that it might turn into a long term trend change for gold and gold stocks (GDX). Here’s the associated chart…as a teaser. In addition, there are some interesting things happening with small cap stocks (RUT) and the NASDAQ 100 (NDX) that will likely tell us which way the market will break. Those two indexes will likely tell the tale. The short story is if sentiment for RUT breaks lower the market will likely follow. If sentiment for NDX breaks higher then odds favor new all time highs. Here’s a link to the post.

 
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Weak Internals Near All Time Highs

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Over the past week the majority of our core market health indicators fell. Most significantly was our core measure of risk. It bounced back and forth between positive and negative, but managed to eek out a win and stay above zero near the close on Friday. As a result, there are no changes to our portfolio allocations this week. Our core measure of risk has been positive for eight weeks now, but the other indicators are refusing to follow. The only other time since January 2000 that one indicator cleared and the others didn’t follow within two months started in June of 2000. It took nearly three months (until late August) before two other categories cleared. Those signals ended up being whip saws and the market turned over in early September. Those of you who lived through it know what came next. I’m not making a prediction that the same results will follow now. I’m merely highlighting the one occurrence I have recorded of a similar situation. Nevertheless, internal indicators

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Possible Allocation Change on Friday

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Our core measures of risk have been bouncing back and forth across the zero line this week. The category closed today barely above. A weekly close below zero will cause us to change our allocations in the long / cash portfolios to 100% cash. The long / short hedge portfolio will go 50% long and 50% short the S&P 500 Index (using SH or an outright short of SPY). Our market risk indicator has two of four components warning at the moment. Two are deep in negative territory. One has been moving back and forth across zero over the past several weeks. The fourth component is still a good bit away from turning negative so it appears that the market risk indicator won’t signal this week. As a result, the Volatility Hedge will most likely stay 100% long. A sharp move lower between now and Friday would be required to trigger a hedge signal in that portfolio. One chart I’m watching at the moment for clues to which way we

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2014 Hedged Portfolio Performance

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During 2014 all of our portfolios lagged the market. Most of them by a significant margin. You’d think this would concern me, but it doesn’t. The purpose of a hedge is to position a portfolio for more than one outcome when market conditions are uncertain.This means a hedged portfolio will not track the market…by design. This is the reason that most people can’t hedge. They want to participate in every uptick in the market. The hedging strategies here at Downside Hedge are designed to track the market over very long time frames. They do so by avoiding losses during severe downturns at the expense of lagging during market rallies. The performance charts below provide some good examples. Our Volatility Hedge performed the best this year. It was up up 6.5%. It is our most aggressive portfolio because it only uses our Market Risk Indicator as a signal. It is 100% long when risk is low and 50% long and 50% hedged using a volatility product such as the iPath® S&P

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Still Not Believing

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Over the past week the majority of our market health indicators improved. None of them improved enough to change our core portfolio allocations. Unfortunately, the indicators still aren’t believers in this rally. They continue to show underlying weakness. Happy New Year everyone!

 
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