This week wasn’t a good week for my core market health indicators. My measures of market quality, trend, and strength all fell even as the market rallied on Thursday and Friday. This isn’t what the bulls want to see for a sustained rally. So far, this is looking like a bear market rally rather than the start of a new intermediate or long term uptrend. If we have entered a bear market (Dow Theory hasn’t confirmed a bear market yet) then bear market rules will apply to how I read various indicators. Elder Impulse for the S&P 500 Index on a weekly chart is a good example. Notice that during a bull market a blue bar that follows a red bar is usually a good time to buy the dip. However, since the top in May a blue bar that follows a red bar gives us little useful information. Even though Dow Theory hasn’t confirmed a bear market yet, I believe that the odds are very high that we’ll likely
This week didn’t do much to help my core market health indicators or my market risk indicator. Everything is mired in red. We’ve finally got a decent bounce underway, now we watch to see if the core indicators get better or risk abates. Until then, we’ll stay aggressively hedged.
During the day yesterday, the Dow Jones Industrial Average (DJIA) traded as low as 15,450. This was well below the last secondary low for DJIA at 15,666. Fortunately for the bulls, the market rebounded and closed a hundred points above the last secondary low. Remember, Dow Theory uses closing prices (not intra-day) so yesterday’s action didn’t break the long term bull trend. The bull market is still intact, but it’s on life support. The market is bouncing today so now we wait until the market turns down again… to see if 15,666 can hold again or is broken.
I’m seeing several signs that we’re at an inflection point for the long term trend of the market (meaning years). It has been uptrending since 2009 and it looks like it’s make or break time for the bull. Here are some of the things I’m seeing that indicate the market must rally very soon or the long term trend will be down and a new bear market has begun. First is my market risk indicator, which is an intermediate term indicator, has just signaled. Take a look at the chart below and you’ll see that it signals at inflection points. It generally warns very near the low or just as the market is generating downside momentum. This indicator suggests that more excitement (either up or down) is close. Next we have Dow Theory. It is only a few percentage points away from signaling a long term bear market. This indicator marks very long term trends in the market. When both indexes break their secondary lows it tells us that the
Wow. What a week. Like the market all of my core health indicators got hammered. They are now all deep in negative territory. I’ll let the chart speak for itself. One thing of note is that my market risk indicator is now signalling. This changes the volatility hedged portfolio to 50% long and 50% hedged with mid term volatility (an ETF/ETN like VXZ) or dynamic volatility (XVZ). For official tracking purposes I use XVZ, but the instrument is thinly traded so it introduces problems in actual portfolio management. First is that thin trading means it is difficult to fill large trades at a good “market” price. Second is that in a swiftly declining market the bid may as much as 20% below the market so you’ll have difficulty getting out of the position (or rebalancing) when pure panic has set in. As a result, I personally use mid term volatility like VXZ instead of dynamic volatility. But, since the back test has been done with XVZ I’ll continue to use
It’s crunch time for Dow Theory. We’re still in a long term bull market, but only about 4% away from a bear market signal. If the August closing low of 15666 on the Dow Jones Industrial Average (DJIA) is broken to the downside we’ll have a confirmed long term down trend underway. Currently, DJIA has retraced about 65% of the rally out of the August low. This is about as far as a “normal” secondary low carries. Any further lows in the market will increase the odds that 15666 will be broken. So what we really want to see (if you’re bullish long term) is a resumption of the long term up trend soon (and without much more price damage). So if Dow Theory signals a bear market what does that mean for portfolio management? For me, it means that I’ll be more willing wait for a 15% dip in the longs before rebalancing the longs and shorts. Conversely, I’ll be quicker to sell profit from the longs and firm
As I mentioned on Monday, the damage done to the core indicators would be hard to overcome and that the intermediate term trend is now likely down. Since Monday things have only gotten worse. All of my core indicators dipped even deeper into the red. As a result, the core portfolio allocations are now fully hedged or 100% in cash. My market risk indicator has three of four components warning at the moment, but the forth is still positive. That leaves the volatility hedged portfolio 100% long. Here’s a complete list of the allocations: Long / Cash portfolio: 100% cash Long / Short Hedged portfolio: 50% long high beta stocks and 50% short the S&P 500 index (or use SH) Volatility Hedged portfolio: 100% long As an example of the broken intermediate term trend here’s a point and figure chart of the S&P 500 index. The damage done this week was pretty significant, but looking longer term there is still the possibility that once the current correction has ended we’ll
I don’t have my primary internet access at the moment so just a quick note about allocations. All of the core indicators are negative so the new allocations are as follows: Long / Cash: 100% cash Long / Short: 50% long high beta stocks and 50% short the S&P 500 index Volitality Hedge: 100% long I’ll do a full post when I get internet access.
When a big decline occurs on a single day it’s a good time to step back and look at how much damage was done to the intermediate and long term time frames. Yesterday’s market action was pretty horrific for a single day. It was enough to cause all of my core indicator categories to go negative. As you know, I wait until Friday before making any portfolio allocation changes, but the damage done yesterday will be hard to overcome. That means it is likely that the intermediate term trend is down (or that we could see another month or so of decline). The long term trend, however, is still in question. Here are a few charts that show both good an bad signs for the longer term trend. First is a chart of the Dow Jones Industrial and Transportation averages (DJIA and DJTA). While the transports have clearly broken down and signaled a Dow Theory non-confirmation, the industrials are still well within the bounds of a “normal” consolidation of the
2015 was a year of whipsaws for the core portfolios. Take a look at the chart below and you’ll see the allocation changes throughout the year. Green lines represent adding exposure, yellow reducing exposure (or adding a hedge), and red represents a market risk warning. The core portfolios added exposure early in the year only to reduce it just before the August drop. It was nice to sleep at night during the turbulence, but it didn’t help the portfolios much because we then added exposure just before the market started to dip again. If you were holding small caps the changes were more painful than if your portfolio was closer to Nasdaq or the S&P 500 Index (SPX). Overall, the portfolios did as expected in a flat year for the market. Without a direction, whipsaws are expected. The important thing to notice on the chart is that the core portfolios were 100% in cash or 50% long and 50% short just before the decline in August. In contrast, my market