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Mid-Term Concern Still Present

Published on July 29, 2013 by in Market Comments

Although I don’t see very many near term concerns in the market, we are seeing some cautiousness by longer term investors.  One of the things I like to watch is a comparison between a S&P 500 short (SH), an actively managed bear fund (HDGE), and mid term volatility (VXZ). As the market started to decline at the first of May we saw a slight rise in HDGE which signaled that people were starting to short the market, but were being cautious in pressing them.  At the same time VXZ started to rise much more rapidly, which indicated that investors who hedge their portfolios with futures or options further out on the curve were adding protection.  VXZ rising shows investors placing bets that the market will become volatile sometime over the next four to seven months.  The taper talk by Bernanke caused another surge higher in VXZ as people started targeting September to December as the beginning of the end of QE.  Once other Fed officials started making dovish comments much

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Strong and Weak Stocks Diverging

Every weekend I review the charts of the 50 most active stocks on Twitter then place them into categories. This past weekend I noticed that the number of stocks in a confirmed downtrend is growing.  In addition, the number of stocks in a confirmed up trend is growing too.  The number of stocks that are unclear, showing a divergence, or indicating that a counter trend move is falling. This is somewhat disconcerting for the longer term because it suggests that market participants are piling on to the strong stocks and ignoring the weak stocks.  This type of divergence is often one of the first signs of a thinning market. The value players have stopped trying to pick up stocks in down trends while the momentum players are buying anything in an up trend.  Our concern is that we may be in the early stages of a blow off top.  We want to see this situation resolve with more interest in the weak stocks and also some divergences in sentiment for

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Short Selling vs. Bottom Fishing

Since mid April we’ve seen a bit of bottom fishing among the 50 most active stocks on Twitter.  We currently have four stocks with counter trend bounce signals in place.  Each of those stocks have rallied to moving averages (50 and 200 day) and also down sloping trend lines.  This is a point where people who are bearish on the stocks should be selling them short.  This creates a battle between the longer term investors who are picking up the stocks as they fall and bears who sell every bounce off the underside of moving averages. By watching these battles we can learn about the underlying strength of the general market.  If the current rally is near a turning point we would expect to see more short selling in the market.  In addition, the stocks that are being sold should fall and continue their long term down trends.  For a general view we like to compare a short of the S&P 500 Index (SH) against an actively managed bear fund

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Now We Need Some Follow Through

Today the S&P 500 Index (SPX) broke to new all time highs and added over 19 points.  It did so with a  positive initiation thrust from daily Twitter sentiment.  The intensity of tweets was very high as well.  This is evidence that traders and investors on Twitter were hailing the move. Unlike other sentiment indicators, extreme bullish readings at new highs on Twitter sentiment confirm the move higher and signal that the market is likely to continue upwards.  Basically, today showed that people were excited about the new highs, rather than accumulating a lot of shorts at this level.  In fact, yesterday and today we saw a lot of short covering instead.  The bears are throwing in the towel for the moment. Now we have to see what the bulls have in their tank. Do they still have enough gas to push the market higher?  The way we’ll know is if we get some follow through.  To remain positive about this market moving higher I’d like to see SPX stay

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Caution Signs

Twitter sentiment for the stock market

We’re seeing caution signs from several areas. The most important to us is that our core market health indicators continue to weaken. They track the economy and market internals that we categorize into quality, trend, strength, and risk.  They have fallen enough to limit our exposure to the market in our Long / Cash portfolios and to moderately hedge in our hedged portfolio. The silver lining that has kept us out of an aggressive hedge is that price hasn’t confirmed the market internals and our measures of risk haven’t shown us that market participants are expecting a large move down in price. Today our Twitter sentiment indicator for the S&P 500 Index (SPX) again warned that the market may need some time to consolidate gains.  After the last warning near the end of January the market rose for another few weeks gaining 30 points. It then had a small reversal giving back 45 points.  Add one more thing giving us concern. Next is that several leading stocks on Twitter are

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Volatility Suggests Caution Warranted

Published on March 5, 2013 by in Market Comments
HDGE vs. SH vs. VXZ

We’ve shown this chart a couple of times over the past several weeks, but it continues to give warning as the market rallies higher. A short ETF for the S&P 500 Index (SH) is making new lows today as the S&P 500 Index (SPX) is breaking above its recent range.  However, a managed short fund (HDGE) is not confirming the move lower in SH.  As we’ve stated before, this condition warns of a larger and more sustained correction than many traders currently expect. Now we’re seeing volatility diverging from SH as well. In the bottom panel of the chart below we show mid-term volatility (VXZ) as an example.  Since we’re intermediate term investors we prefer to watch mid-term volatility rather than daily volatility (VIX).  VIX moves around too rapidly for us to get much good information about future market potential.  By looking at volatility further out on the term structure we get a better feel for a longer term trend. What we look for is a spike in VXZ after

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Shorts are Working

HDGE vs. SH

Last week we highlighted some indicators that were giving early warning that money managers were preparing for a choppy or volatile market. One of the charts we showed was of an actively managed short ETF (HDGE).  We pointed out that it was rising with the S&P 500 Index (SPX).  It indicated that traders were putting on short positions in preparation for a market sell off.  Now a week later we’re seeing HDGE continue to rise as traders press their shorts.  Just what you’d expect when the market starts to sell off. For clues about the depth and duration of a sell off we like to compare a short of the general market (SH) to an actively managed short fund like HDGE.  When the general market is being sold, but shorts are not working it tells us that traders aren’t expecting an extended draw down.  It shows that traders are mildly concerned about the market so they want some shorts, but also want liquidity due to their greater fear of the

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Market Overview 2/16/12 – More Divergences

New week, same story.  The market spent time grinding higher last week while the majority of our core market health indicators ground lower.  None of them deteriorated enough to change our portfolio allocations, but raising cash or adding hedges sometime in the next few weeks looks inevitable.  A very sharp move higher that brings with it wide spread participation is about the only thing that could change the indicators.  We’re not predicting a down turn, rather we believe it is best to protect gains when the market is uncertain. We’ll wait for our indicators to turn before taking any action. We’ll note any warnings throughout the week on Twitter @DownsideHedge.  If we make any changes to the portfolio we’ll post an update before the close on Friday. Market Positives Our core market health indicators that measure risk, quality, trend, and strength continue to be positive (although as mentioned above, showing negative divergences). We have to leave them as a market positive even if we’re not optimistic.  Our market stability index

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Short of S&P 500 Index Outperforming Aggressive Shorts

SH compared to HDGE and VXZ

If you read our weekly market overview you know that we had a hard time finding any good news in the internal indicators last week.  When so many technical indicators are negative we think it’s good to look for anything positive to see if it has meaning for the market.  If you look at the chart below you’ll see that just before large market declines HDGE often trades higher while SH trades sideways.  This condition happened before both the 2011 and 2012 declines. Today we’re seeing a contrary divergence where SH is trading higher and HDGE is trading lower.  This tells us that the weakest stocks are not being sold en masse.  Instead, enough of them have been bought over the past month to cause HDGE to trade lower.  At the same time large cap stocks as represented by SH are being sold more aggressively.  This is not a condition that generally precedes a sell off. When an unusual condition occurs, we as investors need to take note and try

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Long / Short Hedge – 50% Long 50% Aggressively Hedged

Long Short Hedging Strategy

Our Market Risk Indicator closed the week in negative territory.  This signal caused us to aggressively hedge our portfolio.  We’re effectively 50% Long and 50% short, but our shorts consist of instruments that will benefit from increased volatility in the market.  Some examples are puts against our long positions or mid term volatility like VIXM or VXZ.  A lesser alternative would be an actively managed bear fund similar to HDGE. The long portion of our portfolio continues to be stocks that we believe will outperform the general market over the long run. This move in the portfolio is not a prediction of lower prices in the market.  Rather, it reflects enough increased risk that we want to insure our portfolio.  As we’ve noted before, our Market Risk Indicator has many false signals that are usually short in duration.  If this signal is false we expect to take a small loss which we consider paying for insurance.  If the signal proves to be correct we expect to make money as volatility

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