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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 times over the past couple of years.  In fact, this ratio has been slowly rising since 2012 due to both VIX and VXV declining (with VXV falling at a faster pace).  The move from 2012 shows overall fear coming out of the market slowly with each scare having less impact on investors, but adding tension as the rally progressed. The current move shows fear rising slowly accompanied by some indecision as VIX and VXV compress in triangles.  As you can see from the chart below moves that bounced above and below 1 have coincided with short term lows since 2011.  Bulls want to see this indicator get back below 1 next week. I’m watching it as a warning.

Our market risk indicator is getting near a signal, but hasn’t been falling rapidly. Our market stability indicator has been holding steady just below the zero line for the past month. Our investor contentment index however, has fallen to its lowest level since June/July of last year. These three indicators taken together show investors getting uncomfortable, but not panicking…yet.  I suspect weakness somewhere below 1800 to 1760 on SPX will trigger our market risk indicator.

Market breadth was substantially damaged last week with both the percent of stocks above their 200 day moving average and the bullish percent index declining sharply.  Although the headline numbers for these indicators haven’t been bad, breadth has been at a tipping point since the first of the year.  The steep decline in these two indicators on a small drop in price is an example of how fragile market internals are.  Long time readers know I use a weekly close below 60% as a red flag.

New highs on both NYSE and Nasdaq continue to decline.  The level of new lows on Nasdaq is the highest since November of 2012 when the current intermediate term rally started. This is just another sign of how close we are to a tipping point.

Our Twitter Sentiment indicator for the S&P 500 index (SPX) is on the verge of a consolidation warning. Previous warnings in the last year have resulted in one successful signal and three whip saws. This speaks to the strong nature of the 2013 rally.  The first consolidation warning in 2014 came late as traders on Twitter were slow to abandon a market where people have bought every dip. If we get a signal early next week it will be another late warning.

The daily indicator is being whipped rapidly by the moves in price. When SPX broke above 1875 the daily indicator made two prints above +25. The move below 1840 brought with it a -17 reading.  This indicates chasing and indecision as traders are simply reacting to price rather than weighing fundamental and technical indicators against current values.  Another sign of indecision is smoothed sentiment compressing in a triangle even though the market has broken both sides of the recent range.

Support and resistance levels for SPX are showing a bit of fear entering the market with calls for 1780 coming before the market broke below 1840.  The break of 1840 brought with it a waterfall of tweets that extend down to 1760.  The most tweeted levels below the market are 1800, 1780, and 1760.  1800 represents major support that appears to be a must hold for the bulls.  Above the market the 1840 and 1850 range is a major resistance level with the 1875 to 1900 range above that.  The tweets above span ranges rather than specific numbers which adds to the argument that traders are uncertain.  They’ve been trained over the past year that selling weakness brings pain, but the last few months the pain has come from holding weakness expecting a quick rebound. It appears that upside targets are being based on hope.

Sector sentiment shows a clear rotation to safety with Consumer Staples and Utilities garnering the highest readings and Consumer Discretionary the lowest.

Overall sentiment is showing indecision, but with a negative bias. The daily indicator is being whipped around by price. Smoothed sentiment is compressing in a triangle, but falling. Support and resistance levels are covering ranges, but the majority of tweets are below the market. And sector sentiment shows a rotation to safety.  The Twitter stream is urging caution, but has a strong support level at 1800 on SPX.  I’ll be watching how smooth sentiment reacts to any bounce between here and that level.

Conclusion

It’s make or break time for the market. Nearly all the indicators are urging caution, but have fallen to levels where the market has resumed its uptrend over the past few years.  This coming week will almost certainly bring with it evidence of extreme danger or a reprieve.  We have a moderately large hedge in place that I suspect it will quickly turn into an aggressive hedge if the market can’t bounce next week.

 

 
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