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Risk on the Rise and Core Indicators Oversold

Over the past week our core measures of risk fell into negative territory. It was the last category to go negative. Our other measures of market health started going negative in early September and haven’t recovered. In fact, they have continued to deteriorate to the point where several of our indicators are now oversold. Our measures of market quality and strength are at points that have often marked lows similar to May 2012 and April 2013. The only recent occurrence of oversold conditions when the market was close to all time highs came in early 2008 and persisted into July/August of 2008. This puts the market in a position where it could go either way.


Until conditions clear our Long / Cash portfolios will be 100% in cash. Our Long / Short hedged portfolio will be 50% long stock that we believe will outperform in an uptrend (high beta stocks) and 50% short the S&P 500 Index (using SH or a short of SPY).

Our Market Risk Indicator has only three of four components negative. Risk is rising but not enough to warn of an accelerated down trend. As a result, our Volatility Hedged portfolio will remain 100% long.

In addition to the conflicting symbols from our core indicators (oversold near all time highs) I’m seeing some conflicting signs from breadth. The NYSE Advance / Decline (NYAD) line is holding up relatively well. As the market tests the December lows NYAD isn’t confirming the down trend by dipping lower than its last low.


At the same time the percent of stocks above their 200 day moving average is well below its December low reading. I get concerned when this indicator falls below 60%. Taking NYAD and stocks below their 200 dma into account I get a picture of a market where a lot of bottom fishing is going on at the same time as stocks that are showing moderate weakness are being sold.


Putting it all together we’re getting very mixed signals about a market that could go either way. Until the picture clears we’ll ride it out in cash or with a full hedge.

Below is a chart with our allocation changes over the past year. Green line represent adding exposure, yellow reducing exposure, and red an aggressive hedge using volatility or put options.


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