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Waiting

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Just a heads up about our core indicators and portfolio allocations. At the moment our core measures of risk are positive. It appears that they’ll stay that way into the close tomorrow. It would take an extremely sharp down day tomorrow to push them back to negative. As a result, the core portfolio allocations will most likely change tomorrow. The long / cash portfolios will both be 20% long and 80% cash. The hedged portfolio will be 60% long stocks we believe will outperform in an up trend and 40% short the S&P 500 Index (SPX). The volatility hedge will remain 100% long. The market is drifting higher as the Trade Followers momentum indicators suggested last week. Meanwhile, the things I’ve been watching lately have drifted sideways. That leaves us in a position where we are waiting for a dip to see how market internals react. One thing of note is the percent of stocks above their 200 day moving average. It is sitting at 76% which is a healthy

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Market Health Still Negative

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Almost all of our core market health indicators improved over the past week, however none of them could get back above the zero line. If the market can continue to climb it looks like our measures of risk and quality could clear by next Friday. The problem I see is that we’re due for a bit of consolidation so the nature of the next dip will be extremely important. A very healthy sign would be for our indicators to continue to rise in the face of falling prices. Here is a chart of our health indicator categories. Since they’re all below zero our core portfolios are either fully hedged or in cash. The volatility hedge portfolio is 100% long due to the fact that our market risk indicator isn’t warning. One thing I’ve been watching closely for the last several weeks is the performance of small caps (IWM). They should either break upward to new highs or consolidate fairly soon. I want to see any dip muted as a sign

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Watch the Next Dip

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I often talk about watching market internals during a rally out of a dip for signs that confirm the run. Indicators that are derived from price are mostly showing confirmation, but many other market internals are lagging price. This lag is causing negative divergences that often accompany intermediate to long term market tops. With those divergences in place it’s now time to watch internals during the next dip. Here are a few things I’m watching. First is the percent of stocks in the S&P 500 Index (SPX) that are above their 200 day moving average. Currently about 77% are above their 200 dma. This is a healthy number, but below the readings of the last two years due to the damage done on the last dip. About 10% of the stocks in SPX did not recover their 200 dma after being pushed below in October. If this trend continues on subsequent dips it will provide warning of a longer term top being put in place. If it can hold above

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Still Hedged

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Another week and our core market health indicator categories are still mired in negative territory. That leaves the long/cash portfolios 100% cash and the hedged portfolio 50% long and 50% short the S&P 500 index (SPX). As I mentioned last week, I don’t see this as a problem…because hedging isn’t about being right or wrong. It’s about reducing risk when market internals are unclear. Just for fun I went back to see how many times all of our indicators were negative and the market was rallying past previous highs. There were five instances since 2000. Three of them resulted in the market continuing to rally and clearing our all of the warnings. They were April 2005, June 2006, and May 2012. There were two times the market continued rallying, but our indicators didn’t completely clear. The first was in April of 2000. By the end of August 2000 (just before the market turned over hard) the hedged portfolio was 80% long and 20% hedged. By 9/22/2000 it was fully hedged again (50% long

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Risk Off

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The last dip in the market caused some damage to the psyche of market participants. So much so that they are exhibiting signs of reducing risk in a variety of ways. Here are three examples. First is high quality bonds (LQD) against junk bonds (JNK). The damage done to junk bonds in July and October isn’t being repaired. People are shying away from junk. Which means they’re starting to get worried about cash flow and the ability to repay debt by middling companies. I’d like to see JNK start to mirror LQD again to give an all clear signal. Next is high beta stocks (SPHB) against low volatility stocks (SPLV). The October sell off did a lot of damage to high beta stocks that was largely recovered, but low volatility stocks held up and have sped to higher highs. This indicates some rotation to safety during the last rally. A move to higher highs by SPHB will be the first step in repairing this relationship. Another indication of reduction of

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Dow Theory Bullish Confirmation

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A few weeks ago I mentioned that Dow Theory was still confirming the long term bull market even though many others were calling a bearish long term trend change. On Friday, both the Dow Jones Industrial Average (DJIA) and Dow Jones Transportation Average (DJTA) closed above their last secondary high points. This confirms again that we’re still in a long term bull market. Those that called for a sell signal made the most common mistake in interpreting Dow Theory. These technicians misidentified the last secondary low point as a result of not paying attention to the size of the price decline. Secondary reactions should retrace between 33% and 66% of the rally from the previous secondary low. As a result, the last secondary reaction was in 2012. This means that price will have to fall below those points (about 12542 for DJIA and 4847 for DJTA) without any rallies to change the trend from bullish to bearish. As I’ve mentioned before, that’s not a likely scenario. You can read this post

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No Portfolio Changes This Week

Just a quick note this week. The damage done to our core indicators hasn’t been repaired by the rally back near the old highs in the S&P 500 Index. Part of the reason our indicators are having trouble clearing is a result of the steep V pattern being painted so fast that price is outrunning everything else (causing our indicators to lag). Unfortunately, that isn’t the only problem. A larger problem is that our measures of the economy and market quality are still falling. This poses a longer term problem for the market as a whole. So here we are, back at all time highs and hedged. Long time readers know this isn’t a cause for concern…because hedging isn’t about being right or wrong. It’s about acknowledging I can’t see the future so I simply hedge out risk if our indicators are warning or unclear. Our current allocations for the long/cash portfolios are 100% cash. Our hedged portfolio is 50% long stocks we believe will out perform the market in

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Some Indicators Work at Tops – Others at Bottoms

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I had the honor of being on a panel with JC Parets, Chris Kimble, Ryan Detrick, and Charlie Bilello at Stocktoberfest this year. They are a great group of guys with a wealth of information that should be in everyone’s daily must read list (and of course follow them on Twitter and StockTwits too). For those of you who couldn’t attend, below are a few charts I shared to illustrate that some indicators work better at tops and others at bottoms. In addition, I did a presentation in behalf of Trade Followers. You can see the images from that presentation here.

 
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Softening Hedge

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Our Market Risk Indicator cleared its warning this week. However, our core measures of market health are still mired in negative territory. As a result, we’ll be softening the hedge in the hedged portfolio and staying 100% in cash in the long/cash portfolios. To soften the hedge we’re removing put options and/or volatility products. For the model portfolio we’re selling ETFs or ETNs like VXZ, VIXM, or XVZ and replacing it with at short of the S&P 500 Index (you can use the symbol SH). The end result is a portfolio that is roughly 50% long stocks we believe will outperform in an uptrend (high beta stocks are likely candidates for the hedged portfolio) and 50% short the S&P 500 Index. Below is a chart with the changes in our portfolio allocations over the past year. Green lines represent adding exposure, yellow lines are reducing exposure (and adding SH as a hedge), red lines are market risk signals where the hedged portfolio uses instruments that benefit from increasing volatility as

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Market Risk Update

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Our market risk indicator warned on 10/10/14 and since that time the market has dropped and recovered in an extremely sharp V formation. The quick move is causing the indicator to whipsaw on a daily basis. It has been moving back and forth between warning and clearing the warning. If the market doesn’t fall sharply between now and Friday I expect the warning to be cleared which will cause a whipsaw hedge signal as discussed in this post. With that said, the picture is still cloudy so we’ll have to wait until week’s end for clarification. As always, I’ll post before the last hour of trading with an official call (and any portfolio allocation changes). One point on the issue of whipsaws. Please be aware that this indicator is specifically designed to warn of the heightened possibility of quick drops in the market. It has a good record of warning before big declines, but also has a lot of whipsaws. As a result, we use it mainly for a signal to

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