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Volatility Begets Volatility

150828vix

Many people have the mistaken idea that high volatility (VIX) means falling markets. They’ve been trained by financial news outlets to associate volatility with fear. This notion is only half right. Volatility is also connected to greed. In reality, volatility is a reflection of the size of a price movement regardless of the direction. Take a look at the chart below and you’ll see that during the late 1990s price was rising, but in wide daily ranges. This caused VIX to rise substantially while the market was going up. VIX went up from about 10 to 27 (170%) while the S&P 500 index (SPX) almost doubled from late 1995 to just before the Russian financial crisis of 1998. So without much “fear” in the market VIX nearly tripled. After the Russian financial crisis VIX stayed elevated in a range between roughly 19 and 30 as SPX climbed 38%. Large range days while the market was rising created an elevated VIX. SIDE NOTE: I’m using VIX to show the price move

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Market Risk Warning

150821MarketHealth

My market risk indicator is warning today. That changes the portfolio allocations of the Long / Short portfolio and the Volatility Hedged portfolio to 50% long high beta stocks and 50% aggressively hedged. An aggressive hedge is a vehicle that benefits from higher volatility such as put options, or volatility ETF/ETNs like VXZ or XVZ. Please note that XVZ is thinly traded so limit orders (and likely several small purchases) would be prudent. Use your own discretion in which product you use…and as always never buy a product you don’t understand. If you’re using put options our portfolio allocations indicate that you should fully cover your portfolio at or near the money. Use your own discretion in term structure, but be aware that I look to mid term (4 to 7 months) puts first. If you’re uncomfortable with volatility or put options an actively managed bear fund like HDGE is a short option to use as a hedge. It will likely offer more protection than a simple short of the

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Likely Going Lower

150821spx

As a technical analyst I love it when independent chart patterns suggest the same resolution in the market. I’ve been highlighting two important chart patterns over the past month that will tell us if the market will eventually resolve in a rally or a decline. Yesterday both charts broke below their trigger lines suggesting a fairly large decline is ahead of us. The first chart is of the S&P 500 Index (SPX). It has been painting a tight line for most of the year. It finally fell below the bottom of the range. This break projects a minimum downside target of 1940 which would be about a 9% decline in total. I’m guessing that we’ll finally get the long awaited 10% projection. The second chart is of the Dow Jones Industrial Average (DJIA). It has been painting a rounded top pattern. Yesterday it broke below 17075. This break projects a minimum downside target of 15825 which would be a roughly 13.5% decline. From a Dow Theory perspective a decline to

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Market Quality Falls

150814markethealth

Over the past week my measures of market health bounced around with some gaining and others falling. Most notably, measures of market quality fell below zero. This changes the core portfolio allocations to the following. Long/Cash portfolio: 100% cash. Long/Short portfolio 50% long stocks that I believe will outperform in and uptrend — 50% short the S&P 500 Index (using SH or a short of SPY). My market risk indicator is still reluctant to warn. The two least sensitive components have flat lined over the past several weeks. They have been moving slightly just above or below zero. The most sensitive components are are compressing in a range well above zero. This leaves the volatility hedged portfolio 100% long. Basically, the market is on dangerous underpinnings, but price hasn’t broken down. My market risk indicator is telling us that market participants are waiting for a price break before getting concerned. The indexes are painting patterns that can be either accumulation or distribution. They are best characterized as trendless. A great

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Risk Rising

150807markethealth

Over the past week all of my core market health indicators fell. My measures of market quality are still hanging on, but fell sharply this week. Although they didn’t go negative this week it is likely they will by next Friday unless the market rallies sharply. The core portfolio allocations remain the same. One thing of note is that the two least sensitive components of my market risk indicator are currently warning. The other two have some breathing room, but they are more sensitive to price moves so a break below 2040 or 2000 on the S&P 500 Index (SPX) would likely generate a market risk warning. In the absence of a market risk warning the volatility hedged portfolio is still 100% long. The current range between 2040 and 2140 on SPX is now six months long. Tight ranges like this one that are only 5% wide represent either accumulation or distribution. By looking only at price we can’t tell which it is until the range breaks. But, looking at

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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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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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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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Market Changing Character

150629DowTheory

Here are a couple of things that haven’t happened since late 2012. First is a downtrend in the Dow Jones Industrial Average (DJIA) that is more than a month long. Since the last secondary low for DJIA the down trends have lasted roughly a month. If DJIA closes at the current level today it will be in a down trend that is now six weeks old. The transports (DJTA) are now in a down trend that is six months long. One of the tenets of Dow Theory is that bull markets will have long up trends and short down trends. In context of the two and a half year rally out of the 2012 lows neither of these declines are significant, but they do point to a changing character in the market. As a reminder, Dow Theory is still in a long term bullish trend. The current declines haven’t changed that trend. I’ll keep you updated to any significant or interesting things that happen with Dow Theory. Another thing that

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Core Indicators Healthy But Risk Rising

150626MarketHealth

Over the past week the market has dipped a bit, but for the most part my core market health indicators have held steady. The one exception is my measures of risk. They have risen a bit and once again two of the four components of my market risk indicator are warning. The other two are a long way away so at the moment this appears to be just another short term dip in a long term uptrend. All of our portfolios are still 100% long. There’s been a lot of talk about the transports (DJTA) this week and the implications of their downtrend. If you look at the decline in a longer term context you can see that DJTA’s downtrend has only retraced about 20% of the rally out of its last secondary low. A “normal” decline in a bull market can decline more than 50% or even 67% of a move from a secondary low and still be healthy. With the industrials (DJIA) only a few percent away from

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