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
Our core measures of risk have been bouncing back and forth across the zero line this week. The category closed today barely above. A weekly close below zero will cause us to change our allocations in the long / cash portfolios to 100% cash. The long / short hedge portfolio will go 50% long and 50% short the S&P 500 Index (using SH or an outright short of SPY). Our market risk indicator has two of four components warning at the moment. Two are deep in negative territory. One has been moving back and forth across zero over the past several weeks. The fourth component is still a good bit away from turning negative so it appears that the market risk indicator won’t signal this week. As a result, the Volatility Hedge will most likely stay 100% long. A sharp move lower between now and Friday would be required to trigger a hedge signal in that portfolio. One chart I’m watching at the moment for clues to which way we
Just a quick note. No portfolio changes this week. If I get time over the weekend I’ll do a full update with our core indicators and things I’m watching.
Over the past week most of our core market health indicators improved a bit. Our core measures of risk made it into positive territory. As a result, long/cash allocations will now be 20% long and 80% cash. The hedged portfolio will be 60% long stocks we believe will out perform in an uptrend and 40% short the S&P 500 Index (SH). The volatility hedge is 100% long (since 10/24/14). Below is a chart that shows changes to our portfolio allocations. Green lines represent adding exposure and reducing the hedge. Yellow lines represent reducing exposure and adding a hedge. Red lines represent an aggressive hedge using a security that benefits from increasing volatility. This week marks the first week since July that all four components of our market risk indicator are positive. Our market risk indicator is completely independent of our core measures of risk mentioned above so we now have two sets of indicators confirming that market participants are comfortable. It feels more like complacency (and top ticking) to me, but my
Just a quick note this week. The damage done to our core indicators hasn’t been repaired by the rally back near the old highs in the S&P 500 Index. Part of the reason our indicators are having trouble clearing is a result of the steep V pattern being painted so fast that price is outrunning everything else (causing our indicators to lag). Unfortunately, that isn’t the only problem. A larger problem is that our measures of the economy and market quality are still falling. This poses a longer term problem for the market as a whole. So here we are, back at all time highs and hedged. Long time readers know this isn’t a cause for concern…because hedging isn’t about being right or wrong. It’s about acknowledging I can’t see the future so I simply hedge out risk if our indicators are warning or unclear. Our current allocations for the long/cash portfolios are 100% cash. Our hedged portfolio is 50% long stocks we believe will out perform the market in
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
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
Over the past week all of our market health indicators fell. Our measures of trend fell into negative territory which causes us to change our portfolio allocations. The Long / Cash portfolios will now be 60% long and 40% cash. The hedged portfolio will be 80% long stocks we believe will out perform the market in an uptrend (high beta stocks) and 20% short the S&P 500 Index (SH). Our market risk indicator hasn’t signaled so our volatility hedge is still 100% long. Below is a chart with the core portfolio allocation changes over the past year. The green lines represent adding exposure to the market and the yellow lines represent raising cash or adding a hedge. Here is a chart of the current readings (normalized) of our market health categories. The thing I’m watching most carefully at the moment is breadth. The NYSE cumulative Advance / Decline line (NYAD) is getting close to painting a lower low. This would be a warning sign of the most significant top we’ve
On Tuesday we mentioned that our measures of trend were negative. That condition has resolved itself so it looks like we won’t be making any portfolio changes tomorrow. This is a good example of avoiding a whip saw by waiting for Friday’s data to make decisions. Our portfolios are designed to be long term in nature and have infrequent allocation changes. Since we use weekly data for all of the signals they tend to track the intermediate term trends. The sensitivity in our measures of trend show how long in the tooth the current long term trend is. Even with new highs our trend measures are barely positive so it won’t take much weakness to raise more cash. I’ll do an update of all of our core market health measures tomorrow.
It’s still early in the week, but I wanted to give you a heads up that our measures of trend are currently negative. We require a weekly close below zero before changing any portfolio allocations so this is simply early warning that we might be raising some cash and adding a larger hedge come Friday…but I’ll wait till Friday to make any changes in order to avoid whip saws. Our market risk indicator has two of its four components signalling, but the two positive components are a long way from a warning. What is interesting about their current condition is that the least sensitive components are warning while the most sensitive are a long way from a signal. This means there is some instability in the underlying market and that we’d quickly get a market risk signal if prices drop substantially. Our core measure of risk fell out of over bought readings in early July, moved back up to kiss overbought in August, and is now falling again. This is