In late September I showed a chart that I use for general clues about the market. It compares a short of the S&P 500 Index (SH), an actively managed short fund (HDGE), and mid-term volatility (VXZ). In that post I mentioned that even though SH wasn’t showing any concern, HDGE and VXZ were. HDGE was telling us that traders were shorting stocks and their shorts were working. VXZ was telling us that investors were getting concerned about performance of the market going into year end. That same chart is now telling me that this bounce is merely short covering by traders so far. HDGE is falling while SH is still rising. This indicates the worst stocks are being bought during this dip while big caps (S&P 500 Index – SPX) are still being sold. In addition, mid-term volatility (VXZ) is still holding up which tells us that investors are still worried about a decline going into year end. I’m seeing the same condition expressed by traders and investors on Twitter.
After seeing our core portfolios taking the most cautious stance they can last Friday I’m guessing you’re surprised that I’m writing a post telling you that according to Dow Theory the long term bullish trend is still intact. I’m also guessing that somewhere in the next few days you’ll read or hear people saying a Dow Theory sell signal has just been triggered. Those misinformed people will cite the fact that today both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) have closed below their previous lows. There are two problems with people calling a Dow Theory sell signal today. The first is that there is no such thing as a Dow Theory sell signal. The second problem (which is moot because the first problem negates it…but I’ll keep writing for those of you who still aren’t convinced) is that although both averages closed below their previous lows today, they didn’t close below their previous secondary low points. One of the major requirements for a
The volatility in the market over the past week was accompanied by a deterioration in all of our core market health indicators. Every category is now negative. As a result, our long/cash portfolio allocations are now 100% cash. Our hedged portfolio allocation is 50% long stocks we believe will out perform the market in an uptrend and 50% short the S&P 500 Index (ticker symbol SH). Please note that this isn’t a prediction of a market decline. Instead it is simply acknowledgement that enough things are wrong with our underlying indicators that I feel it prudent to step aside until the indicators give clear positive signs. UPDATE 3:32 PM Eastern – OUR MARKET RISK INDICATOR SIGNALED AFTER THIS INITIAL POST. AS A RESULT, OUR HEDGED PORTFOLIO WILL USE AN AGGRESSIVE HEDGE. Our Market Risk Indicator is very close to a warning, but it hasn’t yet (2 PM Eastern). It will take a steep sell off in today’s remaining trading session to create a signal. If it signals before the close
I’ve stated several times over the past year that breadth must deteriorate for the market to fall substantially. In mid July I pointed out the weakness in the ratio between the S&P 500 index (SPX) and SPX equal weighted (SPXEW). When it falls below its 20 week moving average it is often a sign of choppy markets to come. The market rallied after SPXEW’s initial failure, but during that rally SPXEW only made it back to the underside of its 20 week moving average then turned back over again taking the market with it. This is a great example of how tops are a process, not a single event. I’m not suggesting that we’ve seen the top, but wanted to point out how much time it takes for one indicator after another to weaken, then fail, before a top is actually in place. Tops usually take several months and are often fraught with whipsaws in our indicators (and portfolio allocations) before the weight of selling causes a severe down turn.
During the dip over the past two or three weeks financial, technology, and health care stocks have kept the strongest support on Twitter. They are emerging as new leaders that could fuel a rally into the end of the year. If they begin to fail then a larger correction is likely ahead. You can read the full article at Trade Followers.
During the week several of our core health indicators dipped into negative territory, but the rebound on Thursday and Friday repaired enough internal damage to keep our portfolio allocations the same as last week. The most notable weakness came from our core measures of risk and strength. They are both approaching the zero line and it won’t take much weakness in the market to take them lower. Our measures of market quality are holding up relatively better than the other indicators, but are also on a downward trajectory. We’ve got a market that is on the edge of a serious warning that is currently bouncing. The nature of the bounce will tell us a lot about performance going into the end of the year. If the rally is accompanied with strengthening internals and improved market health we should see a rally back to or above the recent highs. Of course, a lack of confirmation from our indicators will cause concern of a draw down that carries to at least the
Our core measures of risk are very close to going negative. If they make it below zero by Friday we’ll be raising more cash and/or adding a larger hedge. Our measures of market quality and strength are also falling, but they’ve got a bit more room before going negative. With that said, the market is due for a bounce so conditions could change quickly. I’ll do a post on Friday well before the close with any changes to our portfolio allocations. This decline is different in nature than the previous two this year in that it appears to be more about portfolio positioning for the longer term than fear (of any kind). The most sensitive components of our Market Risk Indicator aren’t being severely impacted while the slow moving components have rounded out tops and moved below zero. Our core measures of risk (that are completely independent of our Market Risk Indicator) have mostly been diverging with price since the end of last year and are now close to going
Over the past week all of our market health indicators fell. Our measures of trend fell into negative territory which causes us to change our portfolio allocations. The Long / Cash portfolios will now be 60% long and 40% cash. The hedged portfolio will be 80% long stocks we believe will out perform the market in an uptrend (high beta stocks) and 20% short the S&P 500 Index (SH). Our market risk indicator hasn’t signaled so our volatility hedge is still 100% long. Below is a chart with the core portfolio allocation changes over the past year. The green lines represent adding exposure to the market and the yellow lines represent raising cash or adding a hedge. Here is a chart of the current readings (normalized) of our market health categories. The thing I’m watching most carefully at the moment is breadth. The NYSE cumulative Advance / Decline line (NYAD) is getting close to painting a lower low. This would be a warning sign of the most significant top we’ve
Our measures of trend have been bouncing back and forth across the zero line this week and are currently negative. If they are still negative on Friday we’ll be raising more cash and/or adding a larger hedge before the week ends. Here are some of the things I’m watching at the moment. The actively managed short ETF HDGE is currently rising even though a simple short of the S&P 500 Index (SH) is trending lower. This indicates that shorting selected stocks is starting to work. This often happens before the general market falls. In addition, mid term volatility (VXZ) is rising as well. This indicates that investors are getting nervous going into the end of the year. Small cap stocks (IWM) broke below the triangle I’ve been watching with an associated break in momentum from traders on Twitter. The negative gap in breadth between small and large cap stocks continues to grow. While everyone is watching small cap stocks I’m seeing deterioration in large caps under the cover of new
Social media indicators are showing mostly positive signs with some indecision and chasing by traders on Twitter. You can see the full commentary here. In addition, here are some charts of individual stocks with social media indicators for those of you who are interested.