Over the past week all of my core measures of market health rose with the exception of the economy, which held steady. As price for the S&P 500 Index (SPX) rises, the internal indicators continue to improve. There are some short term divergences that may cause some consolidation in the near term, but overall the direction of the majority of indicators support a break to new highs. Although there was good improvement in the majority of the health categories, none of the negative ones rose enough to get above zero. I expect that both strength and trend may go positive by next week even if we get some small consolidation. A rally may drag market quality above zero as well. With the current readings the core portfolio allocations remain the same. The volatility hedge is still 100% long (from 10/9/15).
Over the past week most of my core measures of market health improved. Most notably is that my measures of risk went positive. This changes the portfolio allocations as follows: Long / Cash portfolio: 20% long and 80% cash Long / Short Hedged portfolio: 60% long high beta stocks and 40% short the S&P 500 Index (or the ETF SH) Volatility Hedged portfolio: 100% long (from 10/9/15) Another thing of note this week is that the Bullish Percent Index (BPSPX) is back above 60%. This reduces the risk of a steep or waterfall type decline. Here’s a post that explains the risk associated with poor breadth in the market.
Just a quick note. My measures of core risk are falling. With an inverted scale this is making the core risk category go positive. None of the other measures of market health are positive yet. So if the measures of risk stay positive into the close tomorrow (Friday) the core portfolios will be adding some exposure as follows. Long / Cash portfolio: 20% long and 80% cash Long / Short Hedged portfolio: 60% long high beta stocks and 40% short the S&P 500 Index (or use the ETF SH) I’ll make a post with a final call an hour before the market closes tomorrow, but wanted to give you a heads up so you can plan on what longs you’d like to hold.
On August first I warned that the meme of poor breadth would likely cause a “substantial disruption in the markets“. This week a new meme is emerging that the all time highs in the CBOE SKEW Index indicates everyone is afraid of a black swan event and thus the market is due to crash. There has been a spike in searches on Google for “skew index” confirming the frenzy. So, is the market going to fall due to an all time high in SKEW? I’m sorry, but I just don’t buy it. Why? Because the SKEW data doesn’t correspond to market tops. Take a look at the chart below and you’ll notice that SKEW doesn’t have a good track record of predicting declines. It has a plethora of false signals and just a few correct signals. What do you think would have happened to your portfolio if you had gone to cash or added a hedge every time SKEW spiked above 135? Side note: I pulled 135 as a signal
As I mentioned on Tuesday, my market risk indicator cleared during the week and the positive readings have held throughout the week. However, my core market health indicators are all still below zero. This changes the portfolio allocations as follows. Long / Cash portfolio: 100% cash Long / Short Hedged portfolio: 50% long stocks I believe will outperform in and uptrend and 50% short the S&P 500 Index Volatility Hedged portfolio: 100% long As was the case in mid August the core indicators don’t like the current market internals, but the perception of risk is low. You’ll need to assess your own needs and risk tolerance to decide how much of a hedge (if any) you leave on your portfolio. If you’d rather use an ETF for the long portion of your portfolio here are some ideas on how to find one. Look at the comments too as a reader found several ETFs that met the high beta criteria. At the end of August I wrote a post explaining why
Yesterday my market risk indicator moved back to positive territory. It’s looking like price above 1975 on the S&P 500 Index (SPX) is roughly the level where the risk indicator clears so you can use that level for planning during the week. If the readings can hold into Friday it will clear the current market risk warning. If that happens it will result in the Volatility Hedged portfolio going 100% long (for official tracking purposes I use SPX for the longs). The Core Long/Short Hedged portfolio will remove the aggressive hedge (mid term volatility) and replace it with a short of SPX (or using SH). The longs for the core portfolio are stocks that should outperform the market during an uptrend (high beta stocks). As I mentioned above I use SPX for tracking the Volatility Hedged portfolio, but I personally use high beta stocks with that strategy. Recently I’ve been asked if an ETF can be used for the long portion of the core portfolio rather than stocks. The answer
The most significant thing I’m seeing this week is my measures of risk strengthening amid large range days and high volatility. Market participants are getting comfortable with wide swings in their portfolios. The improvement in my measures of risk still aren’t enough to clear my market risk indicator, but a continued rally next week just might do it. On the other hand, my measures of stock market quality, trend, and strength all fell this week even with four days of rally. This action is similar to what I was seeing a few weeks ago that indicate we’re probably seeing another dead cat bounce. Last week I said that I intended to take some profit from the hedge if the market retested the August low. I didn’t do it for a couple of reasons. The major reason is that at the lows on Monday the hedged portfolios were roughly allocated still at 50% long, 33% aggressively hedged (with mid term volatility), 17% short the S&P 500 Index. As a result, I