Over the past week most of my core measures of market health improved. Most notably is that my measures of risk went positive. This changes the portfolio allocations as follows: Long / Cash portfolio: 20% long and 80% cash Long / Short Hedged portfolio: 60% long high beta stocks and 40% short the S&P 500 Index (or the ETF SH) Volatility Hedged portfolio: 100% long (from 10/9/15) Another thing of note this week is that the Bullish Percent Index (BPSPX) is back above 60%. This reduces the risk of a steep or waterfall type decline. Here’s a post that explains the risk associated with poor breadth in the market.
I’m seeing several indications of weakness in the long term trend, but at the same time I’m seeing a lot of indicators that continue to show strength. It appears as if the battle for the long term trend has started. The first sign of weakness comes from monthly MACD for the S&P 500 Index (SPX). It has been rolling over since late last year and finally had a bearish cross in April. Momentum for SPX has been falling, but it is still at healthy levels. So here we’ve got two measures of momentum where one is bearish and the other is bullish. The next conflict comes from a point and figure chart for SPX. It recently broke its uptrend line that was put in place in late 2012. This created a new down trend and is considered bearish. Price has since recovered and is now only a few points away from breaking the down trend. If SPX can get above 2020 a new uptrend line will start and turn SPX
We end this week in a critical situation. My core indicators were all damaged during the high volatility moves both up and down this week. Core measures of risk and trend have now gone negative. The measures of the economy are close to going negative and market quality and strength aren’t far behind. As a result the core portfolios are raising cash and or adding a hedge. The new core allocations are as follows. Long / Cash: 60% Long and 40% Cash Long / Short: 80% Long stocks I believe will out perform in an uptrend — 20% short the S&P 500 Index (SPX) My market risk indicator hasn’t signaled yet so the volatility hedge will remain 100% Long. So, what’s an investor to do? Follow the core portfolios or the volatility hedged portfolio? The answer lies in your risk tolerance. The volatility hedged portfolio is designed to ride out most dips in the market and only hedge when the odds for a steep decline rise. The core portfolios are
Over the past few days various measures of breadth have show quite a bit of weakness. As I noted in this post, large market declines come when breadth is already weak. With such weak readings the odds have increased that this decline will be 10% or more. Below are some breadth examples. First is NYSE Advance/Declines. They led the current decline in the S&P 500 Index (SPX). Small caps are especially sensitive to this condition. Next is the Bullish Percent Index (BPSPX). It currently has less than 60% of the stocks in SPX with bullish point and figure charts. This indicates a significant number of stocks in down trends. Last is the percent of stocks in SPX that are below their 200 day moving average. Nearly 50% of SPX stocks are below their 200 dma. With all three measures of breadth showing significant weakness, a signal from my market risk indicator should be taken seriously.
A few weeks ago Urban Carmel at The Fat Pitch wrote a post that concluded that the NYSE Advance / Decline line (NYAD) was a poor timing indicator. I generally agree with his assessment. I think that most measures of breadth by themselves are poor timing indicators. Markets can fall when breadth is healthy and breadth often diverges at market tops for a very long time before the market actually falls. For example, the Bullish Percent Index (BPSPX) and the percent of stocks below their 200 day moving average have been diverging with the S&P 500 index (SPX) for over a year (or two depending on how you count). The fact that breadth isn’t timely is why I don’t use it as a part of my “core” indicators. Instead, you’ll hear me refer to various forms of breadth as ancillary or secondary indicators that give good background information. So what information does it give? Answer: When breadth is poor the odds increase that a decline will be large. If breadth
There really isn’t anything significant happening in market internals lately. From all appearances the market wants to go higher, but probably needs to consolidate a bit before another rally. If the market dips keep an eye on breadth to see if anything changes from bullish to bearish for early warning of a significant decline. Here’s an update of some of the breadth measures I follow. They all have healthy readings, but with a few nuances. The NYSE Advance / Decline line (NYAD) is confirming the recent move to new highs. This is the most healthy sign of breadth I’m watching. Breadth between the most bullish stocks on Twitter and StockTwits and the most bearish stocks is also showing readings that are consistent with a bullish trend. However, it is now at levels that have often preceded a short term decline. The bullish percent index (BPSPX) has historically strong readings above 60%, but is down from the giddy readings during the rally in 2013. The highs over the past six months
I’ve stated several times over the past year that breadth must deteriorate for the market to fall substantially. In mid July I pointed out the weakness in the ratio between the S&P 500 index (SPX) and SPX equal weighted (SPXEW). When it falls below its 20 week moving average it is often a sign of choppy markets to come. The market rallied after SPXEW’s initial failure, but during that rally SPXEW only made it back to the underside of its 20 week moving average then turned back over again taking the market with it. This is a great example of how tops are a process, not a single event. I’m not suggesting that we’ve seen the top, but wanted to point out how much time it takes for one indicator after another to weaken, then fail, before a top is actually in place. Tops usually take several months and are often fraught with whipsaws in our indicators (and portfolio allocations) before the weight of selling causes a severe down turn.
Our core measures of risk are very close to going negative. If they make it below zero by Friday we’ll be raising more cash and/or adding a larger hedge. Our measures of market quality and strength are also falling, but they’ve got a bit more room before going negative. With that said, the market is due for a bounce so conditions could change quickly. I’ll do a post on Friday well before the close with any changes to our portfolio allocations. This decline is different in nature than the previous two this year in that it appears to be more about portfolio positioning for the longer term than fear (of any kind). The most sensitive components of our Market Risk Indicator aren’t being severely impacted while the slow moving components have rounded out tops and moved below zero. Our core measures of risk (that are completely independent of our Market Risk Indicator) have mostly been diverging with price since the end of last year and are now close to going
It’s looking like the market is ready for a bounce. The nature of any bounce will tell us whether we should expect new highs or if the rally will fail. Here are some of the critical charts I’ll be watching over the next week or two. A chart I show often when the market is starting a move lower is the ratio between near term volatility (VIX) and mid term volatility (VXV). Spikes in this ratio show immediate fear is greater than longer term fear. They are usually associated with an event or a sudden recognition of danger by many market participants. When the market bounces out of a short term low this ratio can help us determine if near term fear is subsiding or lingering. Over the next few weeks we want to see it fall below .9 to give the all clear signal. If it can’t move below that level the odds favor more downside ahead. This indicator couldn’t clear the warning two weeks ago and signaled that
Over the course of this year I’ve been consistent in repeating that I didn’t think the market could suffer a correction unless breadth broke down. Even though many other indicators have warned on and off this year, breadth has held strong. This week the picture changed a bit. First let’s look at the breadth indicator that warned first. The ratio between the S&P 500 Equal Weight Index (SPXEW) and the S&P 500 (SPX) warned in early July when it broke below its 20 week moving average. It turned back up this week but as a result of large caps selling faster than small caps. When a ratio turns up I like it to result from upturns in the numerator and denominator so this upturn isn’t exactly positive. The NYSE Advance/Decline line (NYAD) is currently experiencing its largest decline in a year. This indicator shows that since the first of July there has been broad based selling as more stocks are declining than advancing. Other declines in the market this year