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Market Health Improves

Over the past week most of our market health indicators improved. None of them moved enough to change our portfolio allocation, however our measures of market quality and strength are getting very close to going positive. I expect at least one of them to go positive by the end of next week if the market continues upward. If we get a dip then we may have to wait as long as the first of the year before making any allocation changes.

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We’re experiencing a market that is trying to sort itself out after a huge decline and retracement. The retracement still hasn’t repaired the damage done to market internals during the decline. Below are some examples.

As I mentioned recently, the NYSE Advance / Decline line (NYAD) finally broke above its previous peak. This is an encouraging sign, but the breakout is weak and NYAD turned down last week even though the S&P 500 Index (SPX) posted a small gain. In an strong bullish market I would expect to see a stronger NYAD after a month of posting all time highs. Keep an eye on this for clues to the longer term direction of the market.

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Another sign of internal damage comes from the number of stocks above their 200 day moving average. This measure of market breadth is at a historically healthy level of 80%, but at the bottom of the range painted during an extremely bullish time period beginning in January 2013. This indicator is telling me that the market is transitioning from very bullish to “normal”…if there is such a thing. Market participants are starting to get selective…which is how is used to be in the old days.

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A sign of a thinning market comes from NYSE New Highs and Lows. When new lows are high at the same time as the market is at new highs (current condition) it signals that losers are being sold and that market participants aren’t risking capital on turn around plays. A high number of new lows also adds some instability to the market. This indicator simply tells me to watch daily action more carefully.

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Finally, another thing I’m watching that looks like it could resolve in a positive way is the Russell 2000 (RUT). It is currently trading sideways above both its 200 and 50 day moving averages (after a strong rally). The problem I see is that RUT has also been trading sideways for a year without the ability to break decisively higher. Trade Followers Twitter Momentum is generally constructive, but it’s painting a triangle. The direction of the break from the triangle will most likely point the market’s next direction. A break higher should precede new highs in RUT.

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Conclusion

We’re in a market that is getting back to normal…from a previously extremely bullish market. The question is whether it can do it without a serious correction first. I’ll be watching small caps and NYAD most closely for clues. Until we get a clear resolution our portfolios will remain slightly long.

 
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