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Canaries in the Coal Mine

The market broke above the important 1525 level today, but did so with a few warning signs.  We’re still seeing negative divergences as the market moves higher.  This doesn’t mean that the market is going to fall in the immediate future. However, it does warn that we’re seeing a slow move away from bullishness towards caution by portfolio managers.  Below I’ll highlight a few things we’re seeing and explain what we think it means.

The first chart is new 52 week highs on NYSE.  The S&P 500 Index (SPX) has moved higher since the beginning of the year.  At the resolution of the Fiscal Cliff issue the market ran sharply higher for two days.  At that time new highs on NYSE spiked to nearly the same level they had achieved last September (when price was trading at about the same level…so far, so good).  Today price is almost 5% higher, but new highs are lower, causing a negative divergence that has lasted for over six weeks.  This is one of the first things we often see before a pause in the market.  It can be for several reasons. 1) profit taking on stocks that have met targets 2) rotation from one group of stocks to another 3) new money does not want to buy the high fliers at elevated levels. Regardless of the reason, it means that sellers are starting to make gains on buyers.  The same condition exists on Nasdaq.

Our next chart is NYSE stocks above their 50 day moving average.  It has been painting a negative divergence with SPX for about a month. This tells us that not only are there fewer stocks being pushed to new highs, but there are also fewer stocks that investors are willing to buy at their 50 day moving average.  In addition, it signals that people may be selling positions that fall below the 50 dma.  Stocks above their 200 dma are just slightly lower than the first of the year, but still a negative divergence since price is higher.  More evidence that more sellers are emerging at the 200 day moving averages and fewer buyers.  This isn’t a good condition in light of the fact that SPX is quite elevated above its own 50 and 200 dma.

Another chart we want to highlight is the Put/Call ratio for the indexes. Notice that from the first of the year (on a weekly basis) it has been rising.  Investors have slowly been adding index put protection to their portfolios and/or buying fewer calls.  This signals an expectation of lower prices ahead.

The last chart is of an actively managed short ETF (HDGE).  It is starting to tick up even as SPX is making new highs.  That means that traders are putting on short positions.  Investors who trade both long and short are starting to move away from longs and towards shorts, which is another way to protect their portfolio.

When you add it all up you can see that there are subtle changes occurring under the covers of this market.  The evidence tells us that portfolio managers are doing some house cleaning.  They’re selling their losers and under performers, trimming or refusing to buy high fliers, and adding protection to their portfolios. In short, they’re preparing for a choppy or volatile market.  Keep an eye on the indicators we’ve mentioned in this post.  If they clear their current conditions then the market can move higher.  If not, it will signal a time that we’ll do some house cleaning of our own.


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