Recently I’ve seen a lot of people mention on Twitter and various blogs that the market doesn’t give you time to get out at tops. I have to politely disagree. If you’re an intermediate or long term investor the market will almost always give you warning that it is preparing to consolidate. As an example, here is one of our early warning posts from last October. Often the first warning signs are well ahead of the actual top, so the key to successful investing is in waiting for the weight of evidence to turn before making major changes to your portfolio. Here at Downside Hedge we move money slowly as market conditions change. From mid February we’ve been seeing signs of deteriorating market conditions. Our canaries in a coal mine post on 2/19 highlighted some of the deterioration that we’ve been seeing. The S&P 500 Index (SPX) was trading near 1520 at the time. SPX is now near 1565 and most of those conditions are still in place.
For a different perspective let’s look at some inter-market and sector relationships that are providing warning of consolidation (or possibly a larger correction). Since the first of the year, emerging market stocks (EEM) have been declining while SPX has been rising. It broke below its 50 day moving average in mid February, then failed a retest in mid March. It has now broken below its 200 day moving average and has a clearly defined down trend channel. This is a sign that investors are removing risk from their portfolios. This ETF has a large weighting to financials, information technology, materials, and energy…sectors that should be performing well in a strong world economy. The first warning signs from this ETF came when SPX was near 1550.
Our next chart is of the Russell 2000 Index (RUT). Notice that it has been diverging from SPX for several weeks. It is in a short term down trend and below its 50 day moving average. At the same time SPX has been making higher highs and the recent dip caught and rallied near its 50 day moving average. One more sign that money managers are removing risk from their portfolios. The warning signs from RUT started when SPX was between 1575 and 1600.
Our last chart compares defensive stocks (DEF) to SPX. Although SPX pushed to recent highs, the subsequent fall broke below recent lows. Meanwhile DEF continues to move higher. Defensive stocks have been out performing the general market all year. One more sign that risk is being avoided. The warnings from this ETF have been coming since the first of the year, but are now showing a major warning…when SPX is near 1565.
The market has given us plenty of warning in a price range between 1520 and 1600 on SPX. During that time period we have slowly tightened our stops, cut poorly performing positions, trimmed our high fliers, raised cash, and added shorts to our portfolios. We’re still modestly constructive in our hedged portfolio, but pretty defensive in our long / cash portfolios. We don’t know what will result from all the warnings we’re seeing, but we always take them seriously. By simply watching our indicators we’ve had plenty of time to protect our portfolios…regardless of whether the market is making a top or simply consolidating.