My market risk indicator finally cleared its warning that was issued on 2/9/2018. We didn’t get the further downside that I expected (based on the odds), but our longs performed well enough that it blunted the loss from the volatility hedge (which held up relatively well due to a volatile month). My portfolio suffered a .6% loss. I feel it’s money well spent to sleep well at night when the market is in question. Most of my core market health indicators have strengthened since the last update. However, my core measures of risk still haven’t recovered. This measure is longer term in nature than my market risk indicator so it tends to take longer to clear. With everything added up the portfolio allocations are now as follows. Long / Cash portfolio: 80% long and 20% cash Long / Short portfolio: 90% long high beta stocks and 10% short the S&P 500 Index (or use an ETF like SH) Volatility Hedged portfolio: 100% long
FYI, my market risk indicator is still warning. The bullish percent index is still below 60, but close enough that it could clear soon. The S&P 500 Index (SPX) is consolidating along its 50 day moving average. A significant move above it would almost certainly clear the market risk warning. Another way the warning could clear is a retracement that doesn’t break below the lows posted earlier this month, then a slow steady climb upward. The market is at an inflection point and the market risk indicator is waiting to see which way it breaks so until the warning is cleared the portfolios are in cash or hedged with midterm volatility.
I mentioned on Monday that my market risk indicator was warning. It still hasn’t cleared and it doesn’t look like it has a chance to clear by the end of the day. As a result, I’m calling a warning signal. Market risk warnings come in two varieties. Ones that last for only a week or two (a false signal) and ones that last for several months (a significant correction or bear market). This signal has the odds tilted to more downside because the Bullish Percent Index (BPSPX) is below 60. When it is below 60 and my market risk indicator is warns the odds increase substantially (3 times more likely) that we’ve still got at least another 10% drop from here before we make an ultimate low. This isn’t a prediction, merely stating the odds based on history. This signal changes the portfolio allocations as follows: Long / Cash portfolio: 100% cash Long / Short portfolio: 50% long high beta stocks and 50% long midterm volatility (an ETF/ETN like VXZ or VIXM) Volatility
As of this moment, my market risk indicator is signalling. It requires a Friday close with all four components signalling to create a market risk warning. So we’ll have to wait till Friday before we panic with the rest of the market. Here are a couple of things I’m seeing. Two of the four components of my market risk indicator are very oversold. My core market health indicators are still all positive My core market health indicators are falling from overbought levels to more reasonable levels My conclusion is that the selling is due merely to fear and not concern over core market health. It looks to me like everyone knew that the market was overbought and now they’re all taking profit at the same time. As noted above, don’t panic until we see what the market looks like on Friday.
Over the last week, I saw broad based strength in my core market health indicator categories. My measures of market quality moved back into positive territory. This means that all of the portfolio allocations are now 100% long.
Over the past couple of weeks, my core market health indicator categories have started diverging. The market risk, economy, and strength categories are soaring higher, while the market quality and trend categories are lagging substantially. This is another sign that the market is due for some consolidation. Nevertheless, the market continues to move higher so we continue to watch and wait.
Last week, I mentioned that it might be time for some consolidation. This week, it appears more likely. My measures of market quality have dipped below zero and my measures of market trend are dropping pretty fast. This indicates that we should get some sideways to down movement over the next several weeks. I suspect that the market has at least one more good rally in it, but we’ll need a pause before it happens. The consolidation will most likely be due to rotation out of mega cap stocks into smaller stocks as a “sell the news” event when/if the tax plan passes. With market quality falling below zero the core portfolio allocations change as follows: Long / Cash portfolio: 80% long and 20% cash Long / Short portfolio: 90% long high beta stocks and 10% short the S&P 500 index Volatility Hedged portfolio: 100% long (since 11/11/2016)
Several of my core market health indicators are sitting on the edge of going negative. One notable exception are my core measures of risk. That category has moved into overbought territory. Normally, this means several weeks of continued rally, however, I’m in a bit of doubt due to the weakness in all the other categories. This time it might mean it’s time for some consolidation. I expect we’ll get more clarity over the next few weeks.