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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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Why Breadth Matters

150610bpspx

A few weeks ago Urban Carmel at The Fat Pitch wrote a post that concluded that the NYSE Advance / Decline line (NYAD) was a poor timing indicator. I generally agree with his assessment. I think that most measures of breadth by themselves are poor timing indicators. Markets can fall when breadth is healthy and breadth often diverges at market tops for a very long time before the market actually falls. For example, the Bullish Percent Index (BPSPX) and the percent of stocks below their 200 day moving average have been diverging with the S&P 500 index (SPX) for over a year (or two depending on how you count). The fact that breadth isn’t timely is why I don’t use it as a part of my “core” indicators. Instead, you’ll hear me refer to various forms of breadth as ancillary or secondary indicators that give good background information. So what information does it give?  Answer: When breadth is poor the odds increase that a decline will be large. If breadth

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Crosscurrents

150605markethealth

Over the past week my core measures of risk held steady while all of the components of my market risk indicator moved closer to warning. This is a crosscurrent where we’ve got positive core strength, but increasing skittishness by market participants. When this condition occurs we usually see higher volatility until both indicators start moving the same direction again (either up or down). Currently one of the four components of market risk is warning and a second is on the edge. The other two are still a safe distance away so it will likely take a sharp decline in the market to generate a warning signal. Another sign of crosscurrents comes from my core market health indicators vs. ancillary indicators. All of the core categories rose or held steady (even though the market fell). While, measures of breadth and other ancillary indicators are deteriorating. I suspect this likely result in more volatility before the market can move higher. Here are some things I’m seeing that provide background information that increases

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No Fear Yet

150417markethealth

The sharp drop in the market today is creating a lot of buzz from the financial press, but isn’t really showing up as fear or panic in the measures I follow. None of the four components of my Market Risk Indicator have gone negative. This is unusual given the fact that the drop is a result of the fear of a global macro event (speculation that Greece may leave the Euro) which could cause a large disruption in currency valuations. The day isn’t done yet, so there is the possibility that my measures of risk escalates into the close, but at the moment my they are treating this as a “normal” profit taking event. Our core measures of risk fell a bit this week, but like our Market Risk Indicator they aren’t showing panic. Our other market health indicators dipped slightly but haven’t been damaged enough to change any of our core portfolio allocations. I suspect that we’ll have enough evidence by next Friday to determine if the current dip

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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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