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Group Think

150731DowTheory

During May of this year a meme spread through the financial world about the under performance of the Dow Jones Transportation Index (DJTA) in relation to the Dow Jones Industrial Index (DJIA). Everyone was talking about the Dow Theory non-confirmation and what it meant for the markets. Today DJTA is still under performing, but the crowd isn’t talking about it. They’ve moved on. It doesn’t matter anymore. Why? Group think. Group think is common in the financial markets (and society in general). An idea that seems reasonable often finds wide support regardless of its merit due to market participants repeating the meme without taking the time to do some independent research or even think about it. When dealing with stock market memes it doesn’t matter if it’s correct it only matters how many other people think it’s correct. Group think moves markets. An example of group think came in early 2013 when a study stating low volatility stocks out perform high beta stocks was widely circulated. This study was repeated

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Core Indicators Not Impressed

150731markethealth

My core market health indicators weren’t impressed by this week’s rally. All of them fell in the face of a rising S&P 500 Index (SPX). This isn’t an encouraging trend. During the month of July as the market traded sideways in a 5% range my core indicator categories have broken down one after another. This week my measures of market strength fell below zero which is changing the allocations in the core portfolios. The new allocations are as follows. Long / Cash portfolio: 20% L0ng and 80% Cash Long / Short portfolio: 60% Long and 40% Short the S&P 500 Index Below is a chart with the portfolio changes over the past year. Green is adding exposure / reducing a hedge. Yellow represents adding a hedge or raising cash. Red represents a market risk warning where I use an aggressive hedge (with put options or a product that benefits from rising volatility). Fortunately price hasn’t broken yet and as a result market participants are comfortable keeping core measures of risk

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Dow Industrials Catching Down to Transports

Published on July 28, 2015 by in Dow Theory
Dow Theory Rounded Top

Yesterday the Dow Jones Industrial Average (DJIA) broke below its early July low. At the same time the Dow Jones Transportation Average (DJTA) held above its early July low. Since the top in the transports last December they have led the industrials lower. Yesterday broke that trend. It now appears that DJIA is catching down to DJTA. Another thing to watch with the industrials is that they’re starting to paint a rounded top with the downtrend from the last peak now two and a half months long. There hasn’t been a lot of price damage in DJIA, but the time damage is starting to be significant. The longer the market drips lower the more it drains confidence from bullish investors. Rounded tops are made by one set of market participants buying small dips while another set sells into the rallies over a long period of time. So DJIA has time damage with the formation of a rounded top, but price hasn’t broke yet. Keep a careful watch on DJIA if

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Core Portfolios Getting Cautious

150724MarketHealth

Over the past week most of my core market health indicators fell. Most notable is my measures of the economy which have gone negative. As a result, the core portfolios are adding a larger hedge or raising cash. Below are the current core portfolio allocations. Long / Cash: Long 40% – Cash 60% Long / Short: Long 70% – Short the S&P 500 Index 30% My market risk indicator currently has two of four indicators warning, but the other two a long way away from a signal. It appears that people aren’t too concerned about the current dip. In the absence of any risk event (i.e. Greece, Ebola, etc.) my risk indicator generally won’t signal without serious price deterioration. As a result, the Volatility Hedge stays long during “normal” consolidation periods. It is currently 100% long and I expect it to stay that way unless we see a steeper decline ensue. Below is a chart with changes to the core portfolio allocations over the past year. Green lines represent adding

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Bottom Falling Out

Published on July 22, 2015 by in Market Comments
150722NyseHighsLows

I’m starting to see signs that market participants are abandoning their losers and pressing their shorts. When this occurs near all time highs it often means some pain is ahead for the major indexes. Here are some charts that serve as examples. First is NYSE New Highs / Lows. New lows have now risen above the point when the S&P 500 Index (SPX) was making lows in early July and last December. This indicates market participants aren’t bottom fishing. Instead, they’re abandoning positions that are causing too much pain. Another point of interest in this chart is that NYSE didn’t recover much from both June and July lows. This type of divergence from SPX is troubling. The Russell 2000 Index (RUT) and Dow Jones Industrial Index (DJIA) are also showing negative divergences from SPX. Next is a chart that compares a short of the S&P 500 Index (SH) and an actively managed bear fund (HDGE). SH has fallen to new lows while HDGE is holding up. This indicates that traders

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Thinning Market Trying to Recover

150717MarketHealth

Over the past week most of my core market health indicators improved. However, none of them moved enough to change the core portfolio allocations. This is a little discouraging given the fact that the S&P 500 Index (SPX) has rallied sharply. The overall picture I’m seeing is a thinning market that is trying to recover. Which is in line with a modest hedge or a moderate amount of cash for a cautious investor. Aggressive investors would be more comfortable riding out dips unless they are accompanied by high risk (Volatility Hedge). Below are the current allocations. Long / Cash portfolio: Long 60% – Cash 40% Long / Short portfolio: Long 80% – Short 20% Volatility Hedge: 100% Long The percent of stocks in SPX that are above their 200 day moving average has recovered from 50% back to 60%. This is a small positive sign that indicates some value buying is occurring (rather than dumping stocks as they break below their 200 dma). Unfortunately, the market has 15% fewer bullish

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Long Term Trend Battle

Published on July 15, 2015 by in Market Comments
150715spxMonthly

I’m seeing several indications of weakness in the long term trend, but at the same time I’m seeing a lot of indicators that continue to show strength. It appears as if the battle for the long term trend has started. The first sign of weakness comes from monthly MACD for the S&P 500 Index (SPX). It has been rolling over since late last year and finally had a bearish cross in April. Momentum for SPX has been falling, but it is still at healthy levels. So here we’ve got two measures of momentum where one is bearish and the other is bullish. The next conflict comes from a point and figure chart for SPX. It recently broke its uptrend line that was put in place in late 2012. This created a new down trend and is considered bearish. Price has since recovered and is now only a few points away from breaking the down trend. If SPX can get above 2020 a new uptrend line will start and turn SPX

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Decision Time

150710MarketHealth

We end this week in a critical situation. My core indicators were all damaged during the high volatility moves both up and down this week. Core measures of risk and trend have now gone negative. The measures of the economy are close to going negative and market quality and strength aren’t far behind. As a result the core portfolios are raising cash and or adding a hedge. The new core allocations are as follows. Long / Cash: 60% Long and 40% Cash Long / Short: 80% Long stocks I believe will out perform in an uptrend — 20% short the S&P 500 Index (SPX) My market risk indicator hasn’t signaled yet so the volatility hedge will remain 100% Long. So, what’s an investor to do? Follow the core portfolios or the volatility hedged portfolio? The answer lies in your risk tolerance. The volatility hedged portfolio is designed to ride out most dips in the market and only hedge when the odds for a steep decline rise. The core portfolios are

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Portfolio Allocation Changes Likely

Just a quick note today about my core indicators. Measures of risk and trend have gone negative. Core measures of the economy, market quality, and strength are very close to going negative. If the situation isn’t repaired by Friday our core portfolios will have allocation changes that will result in raising cash and/or adding a short of the S&P 500 Index (SPX). The most likely scenario is that the core portfolios will be roughly 60% exposed to the market. Either with 40% cash or 80% long positions and 20% short positions. A continued decline into Friday would most likely result in more cash and/or hedges. The volatility hedge relies on my market risk indicator. It hasn’t warned yet, but is getting closer. It still has two components that are still positive. At the moment it appears that this portfolio will remain 100% long. A swift decline Thursday and Friday would likely have it changing to an aggressive hedge (using puts or a volatility ETF/ETN). It’s time to take a look

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Core Indicators Falling

150702markethealth

All of my core market health indicators fell this week, but none of them fell enough to change our core portfolio allocations. All of the portfolios are still 100% long. One thing of note is that my measures risk, economy, and trend are all very close to going negative. I suspect the market will need to rally next week or the core portfolio allocations will change by raising cash and/or adding some shorts. Have a good holiday weekend everyone.

 
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