We’re increasing exposure in our core portfolios today. Our Long / Cash portfolios will now be 60% long. Our hedged portfolio will be 80% long and 20% short. The short is a simple short of the S&P 500 Index (or SH). I’ll update the charts and our market health indicators after the holiday weekend. Enjoy the weekend everyone.
Over the past week all of our core market health indicators fell sharply. Many of them have readings usually seen after a severe correction in price. This condition highlights the large disparity between market internals and price. We have a stock market that believes external forces (like QE) are the driving factor. Until that belief is shaken we suspect we’ll continue to see internals diverge from the market as a whole. Our measures of risk have finally started to show some weakness. Market participants are beginning to get concerned that this small consolidation could turn into something larger. Our market risk indicator is still quite far away from a signal, but our other measures of risk are getting fairly close. At the moment it appears that weakness over the next week might get our Long/Cash portfolios 100% in cash and or Hedged portfolio 50% Long and 50% short (using SH or an equivalent). While a rally would leave us positioned the same. It would take a very swift move down
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
Our core market health indicators deteriorated enough this week that we’re raising cash in our Long/Cash portfolios. They are both now 80% cash and 20% long. Our hedged portfolio is now 60% long (stocks we believe will outperform the market in an uptrend) and 40% short the S&P 500 Index (either short SPY or buy SH). Our measures of the economy slipped from -7 to -8. The economy measures continue to disappoint us as they just can’t seem to get a footing. They went negative near the first of December, got all the way down to -10 (our worst reading), moved back up to -3 at the beginning of February then turned over again. This indicator usually has a pretty good lead time at both bottoms and tops so the fact that it has kept a portion of our portfolios under invested for almost three months gives us concern. Our measures of risk dropped a bit this week to +5. There still isn’t much concern from market participants about a
We’re adding exposure to our portfolios today. Our measures of market quality improved enough to cause this change. On February 22nd, our indicators reacted to the weakness in price and fear of market participants that a correction had started. This caused us to raise cash and add more shorts in our portfolios. This added some protection just in case the sell off accelerated, but also left us with some exposure to the market if it rallied. As you know, our portfolios are designed to participate in up trends, but also protect us from any unrecoverable declines. This was an example of getting cautious that in hindsight was unnecessary, however in our opinion prudent. We don’t mind paying for insurance when the market is uncertain. Our portfolios still participated in almost half the gain of the recent rally, which is enough for us during any period of market uncertainty. We’re now adding more long stock exposure on the expectation of higher prices. Both of our Long/Cash portfolios now have allocations of
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
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
Just a quick note about our current portfolio positions. Our core market health indicators have deteriorated further throughout the week. They’ve fallen enough that we’re raising cash in our Long / Cash portfolios and adding hedges to our Hedged portfolio. Our Long/Cash portfolios are both now 40% long and 60% cash. Our Hedged portfolio is now 70% long and 30% hedged with a simple short of the S&P 500 Index. The ETF SH is an easy way to short SPX if you don’t want to short SPY. The long portion of our portfolio still remains the stocks we believe will outperform the market over the long term. However, we’ve trimmed some positions based on their future prospects and used that cash to purchase the hedge. Note: charts added on 2/24/13
Our Market Risk Indicator finally made it back to a positive reading this week. As we’ve noted in our weekly market comments, our core market health indicators have been fighting against market risk. While the market health indicators were strengthening over the past month our Market Risk Indicator stayed stubbornly negative. With the clearing of our risk indicator we move from an aggressively hedged position to a 90% long position with a 10% short position. The longs are stocks that we believe will outperform the market and the short is a simple short of the S&P 500 Index. An ETF that can be used is SH. As always, we can’t see the future so we allocate our portfolios based on the probabilities created by the history of our indicators. The current condition of our indicators suggests that the market should move higher over the intermediate term. Once again, not a prediction, merely a situation where the odds favor higher prices. The current hedge ratio is .11. The green lines in
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
Market Risk Moderate
Long / Short Hedge Portfolio
Long / Cash Portfolio