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Home Archive for category "Market Risk"
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Make or Break Time

By almost all the measures I track it’s make or break time for the market.  I’m seeing a pattern in both core and ancillary indicators that has often marked lows in the market over the past few years.  Each time our indicators were close to signalling an extreme warning the market promptly turned back up and resumed the rally out of the 2009 lows. Over the longer term when our indicators have reached these levels the market rallied 35% of the time and had an extended decline or choppy period 65% of the time.  As you know, I can’t see the future so all we do is go with the odds.  As a result, our core portfolios raised cash and/or added a hedge yesterday.  Here are some highlights of things I’m seeing that makes me cautious. The ratio between near term volatility (VIX) and 3-Month volatility (VXV) is currently rising as a result of both VIX and VXV moving up.  This is a condition that has only occurred a few

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More Thoughts on the Volatility Hedge

I got a few questions about the volatility hedge strategy that I mentioned yesterday that provoked a few thoughts  I thought might interest you.  The first thought is that there is no need to go all the way to 50% hedged with XVZ (and 50% long) when our market risk indicator signals.  I personally use a large hedge when it signals because the indicator is designed to warn of an acceleration to the downside.  As a result, I’m willing to give up some upside gains on whip saws for the chance of making money if the market falls rapidly…and volatility rises.  However, I recognize that you may have different goals than mine so here’s a performance chart that shows varying sizes of the hedge.  Notice that a hedge below 20% (80% long and 20% XVZ) would have resulted in the portfolio continuing to fall with the market during the 2008 financial crisis.  However, during a large swift draw down a 20% hedge with volatility was enough to protect the portfolio

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Dancing on the Line

Just a quick note today to update you on some of our indicators that are dancing on the line between positive and negative.  First and most important is our market risk indicator has been bouncing back and forth between a warning signal during the day lately.  All but one of its components have been mostly negative for a few weeks now, but the one hold out has only started printing negative readings yesterday and today.  Since we’re intermediate to long term investors we don’t like to hedge our portfolio unless there is a high probability of a substantial decline (we ride out the smaller dips).  Currently, our risk indicator is telling us that the market could accelerate to the downside, but to avoid whipsaws we wait for a weekly warning signal (close the week with all components negative). As a result, we won’t be adding aggressive hedges or raising cash unless the current conditions persist into Friday. Our measures of market quality and strength have been flirting negative territory as

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Risk Rises as Market Health Holds Steady

Over the past week most of our core market health indicators held steady. As a result, there are no changes to our core portfolios.  The most significant changes came from our measures of risk and quality. Market quality fell and looks like it could go negative again over the next couple of weeks if the market doesn’t move to new highs. Our measures of risk are showing signs of concern with several components of our market risk indicator going negative.  This isn’t surprising considering all of the sabre rattling going on in Washington so I don’t have big concerns for the market yet. Our sentiment indicators that quantify tweets and StockTwits messages are pretty tame today even with the S&P 500 Index (SPX) down almost 10 points. Twitter is reading -3 and StockTwits +3 going into the last hour of trading. Bottom line, I’m seeing strength in our core indicators and overall sentiment which indicates market participants are still long, but some are hedging and reducing exposure over a weekend

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Perception of Risk Rising But No Panic

Over the past week all of our market health indicators improved except for the perception of risk.  None of them moved enough to change our core portfolio allocations. Our measures of the economy and market quality are very close to going positive which would result in removing our hedges and getting fully long if it occurs.  We’re looking at a market that is showing some strength under the covers while price is falling. One of the few things I see that is potentially troubling is various measures of breadth have been diverging from price and are now falling with the market.  But as I’ve mentioned in the past several weeks, breadth is coming down from extremely high levels.  As a result, I view the current consolidation a result of investors getting more selective in the stocks they want to own rather than fear or panic driving an increase in selling. Our investor contentment index and market stability index are both sitting right above the zero line which indicate a lack

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Market Health Rising as Stocks Fall

Our core market health indicators moved slightly higher this week even though the market fell.  This signals that the current correction is most likely healthy, rather than the start of a long term down trend.  The only fly in the ointment is our market risk indicator.  It signaled intra-day a couple of times this week, but it doesn’t appear that it will close the week on a warning signal. Bottom line we still have a battle brewing between rising perception of risk (bearish) against healthy underlying conditions in the market. This battle is occurring while the market is right next to an important support/resistance level. At the time of this writing (3:30 Eastern) the S&P 500 Index (SPX) is rallying into the close and is at about 1597.  We’d like to see it close the day above 1600 as that is one of our major support levels generated from the Twitter stream. Our portfolios will remain with the same allocations since we didn’t get a signal from market risk (or

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Market Risk Indicator is Signaling

Just a quick note today. Our market risk indicator is currently signaling. We require a weekly close for an official signal so a strong rally tomorrow could negate it.  If it is still signaling tomorrow before the close of the market we’ll be changing our portfolio allocations in the portfolios that use our risk indicator. Our core long cash portfolio will stay 80% long and 20% cash.  It follows market internals and our core market health indicators.  As a result, it doesn’t react to increasing odds of market risk. Our long cash portfolio that recognizes market risk will go 100% to cash.  Here’s a link with some information about both of our long / cash portfolios. Our hedged portfolio (long/short) will be aggressively hedged using put options or a volatility ETF (like XVZ). Please remember we won’t make any changes unless we’ve still got a signal at the close tomorrow.  We’ll post an update here and on Twitter @DownsideHedge before the market closes if we make any changes to the

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Risk vs. Internals

Stock market indicator from the Twitter stream

Over the past week our core market health indicators fell slightly, but we made no changes to our core portfolios. The details are in this post. We’re seeing a battle between event risk and market internals.  Overall our measures of market health and internal structure are constructive, while our measures of risk are signalling skittishness by investors. The S&P 500 Index (SPX) held up fairly well last week in the face of several market scares. It seemed like every day brought some new rumor that drove the market up and down. But when the dust settled SPX only gave up a little over one percentage point.  Meanwhile measures of intermediate term breadth like the percent of stocks above their 200 day moving average and the bullish percent index still have very healthy readings.  Looking at market internals this appears to be a garden variety consolidation.  We’re not seeing any real damage under the covers as price pulls back.  SPX has held a critical support level near 1600 and bounced twice

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Finally Some Excitement

As intermediate to long term investors we often ignore the daily gyrations of the market.  We don’t pay a lot of attention to what happens during the day because most of the time it just doesn’t matter.  In fact, a lot of times we’re flat out bored and have difficulty finding things to talk about.  Our days are usually filled with waiting for weeks on end for something that changes the underlying technical structure of the market enough to change our portfolio allocations.  Those changes are usually in small increments so they’re boring events too.  I’ll even make the confession that I don’t have CNBC or Fox Business on TV during the day.  I have Fast Money in my DVR, but only because it runs an hour after the market closes so it covers earnings announcements.  Long story even longer, most of the time what we see on a daily basis is irrelevant.  However, once in a while we get near an inflection point where things can get exciting very

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Near Term Risk Rising

Ratio of VIX vs VXV signals stock market corrections

One of the charts that we like to keep an eye on to determine the amount of perceived risk in the market is the ratio between one month volatility (VIX) and three month volatility (VXV).  When the ratio is low, market participants believe that near term risk is lower than risk further in the future.  When the ratio rises it shows a sentiment shift from money managers indicating that they are getting fearful about the near term. If the ratio moves above 1 it warns that more people are fearful about the next month than those worried about the next three months.  As a side note there is a new volatility ETF (XVZ) that attempts to take advantage of this theory. Right now we’re seeing the ratio approach 1 telling us that we’re almost to the point where investors believe there is more risk of the market being volatile over the next month than over the next three.  Over the past several years this has been a point that marks

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