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Pivot Point

150313markethealth

Over the past week all of our core market health indicators fell slightly. The volatility and large range days in the market didn’t do a lot of damage. The one exception is our core measures of risk. They fell quite a bit and will likely go negative if the market continues to fall next week. On the other hand our measures of trend want to go positive, but just can’t get any upward momentum. If the market can rally next week then they will likely go positive. That puts us at a pivot point between increasing risk or a continued up trend. Another sign that the market is at a critical point comes from Trade Followers. Their algorithm that captures support and resistance levels for the S&P 500 Index (SPX) puts 2040 as a must hold level. If that level breaks then 2020 is the next level of support, but minor in nature. There is very little support below that level which sets up the potential for a cascade lower

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Shaky Foundation

150128spx

The S&P 500 Index (SPX) is starting to paint a pattern that often leads to instability and a quick drop lower. Look at the chart below and you’ll see wide quick swings going in both directions. This indicates uncertainty by market participants. It is a pattern we haven’t seen for a very long time which makes it more important. Another thing I’m seeing is perceptions of risk rising. Three of four components of our market risk indicator are warning at the moment. We still have one hold out, but it is dropping rapidly. As I’ve mentioned over and over again I don’t think the market can have a substantial correction until breadth breaks down. One measure that is getting close to warning is the percent of stocks above their 200 day moving average. I get concerned when it falls below 60%. Add it all together and we’ve got a market with a shaky foundation. Caution is warranted.

 
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Risk on the Rise and Core Indicators Oversold

150116MarketHealth

Over the past week our core measures of risk fell into negative territory. It was the last category to go negative. Our other measures of market health started going negative in early September and haven’t recovered. In fact, they have continued to deteriorate to the point where several of our indicators are now oversold. Our measures of market quality and strength are at points that have often marked lows similar to May 2012 and April 2013. The only recent occurrence of oversold conditions when the market was close to all time highs came in early 2008 and persisted into July/August of 2008. This puts the market in a position where it could go either way. Until conditions clear our Long / Cash portfolios will be 100% in cash. Our Long / Short hedged portfolio will be 50% long stock that we believe will outperform in an uptrend (high beta stocks) and 50% short the S&P 500 Index (using SH or a short of SPY). Our Market Risk Indicator has only

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Risk Rising

150114sh

Once again our core measures of risk are negative. They’ve been there all week long. I suspect that it will take a close above 2050 on the S&P 500 Index (SPX) by Friday to get the category positive. That’s about the point where SPX has been when the risk measures flip. If they are negative on Friday the Long / Cash portfolios will go 100% to cash. The hedged (Long / Short) portfolio will be 50% long high beta stocks and 50% short SPX. Our market risk indicator has three of four components warning at the moment. The fourth component continues to slowly fall, but hasn’t gone negative yet. The volatility hedge is still 100% long and will stay that way unless the fourth component falls by the end of the week. One thing I’m seeing is a lot of mixed signals…I’ll post more about them on Friday, but here are a few examples. NYAD advance / declines are acting well, but the percent of stocks above their 200 day

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Risk Rising

141212markethealth

Over the past week all of our core market health indicators fell. Most notable is our measures of risk. Our core measures of risk fell from moderate levels to almost warning. It will take a large sell off in the last hour to take this category below zero and have us increase our hedges and/or raise cash. Our market risk indicator has three of its four components warning. This is very unusual given the fact that the market is only down about 3% from all time highs. This tells me that market participants are skittish…which increases the risk of a sharp sell off. If this indicator signals we’ll be changing the hedge to an instrument that benefits from higher volatility. I don’t expect it to signal today, but if it does I’ll update this post before the market closes. Another sign of rising risk is the performance of Junk Bonds (JNK) compared to High Quality Bonds (LQD). LQD is rising while JNK is falling. This tells us that bond holders

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Softening Hedge

141024allocations

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

141022marketrisk

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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What Next?

141017MarketRisk

Our Market Risk Indicator signaled last Friday in the last hour of trading which caused us to add an aggressive hedge to the hedged portfolio. I have to say that I was surprised to see an acceleration of the selling without some consolidation near the 200 day moving average for the S&P 500 Index (SPX) first. The reason for my surprise is that the market had already fallen sharply before the signal came and that condition often causes whip saws in the indicator. The market has since recovered much of the decline from earlier in the week. So what do we do next? If the market continues to rally I suspect that our risk indicator will clear its warning within a week or so (similar to the whip saws in March and June of 2011 on the chart below – Note: red lines are risk signals, blue lines are cleared warnings). If this happens then we’ll change our hedge back to a simple short of the S&P 500 index (using

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Moving to Cash or Full Hedge

141010markethealth

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

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Due for a Bounce

141001nyad

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

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