Our Market Risk Indicator signaled last Friday in the last hour of trading which caused us to add an aggressive hedge to the hedged portfolio. I have to say that I was surprised to see an acceleration of the selling without some consolidation near the 200 day moving average for the S&P 500 Index (SPX) first. The reason for my surprise is that the market had already fallen sharply before the signal came and that condition often causes whip saws in the indicator. The market has since recovered much of the decline from earlier in the week. So what do we do next? If the market continues to rally I suspect that our risk indicator will clear its warning within a week or so (similar to the whip saws in March and June of 2011 on the chart below – Note: red lines are risk signals, blue lines are cleared warnings). If this happens then we’ll change our hedge back to a simple short of the S&P 500 index (using
The volatility in the market over the past week was accompanied by a deterioration in all of our core market health indicators. Every category is now negative. As a result, our long/cash portfolio allocations are now 100% cash. Our hedged portfolio allocation is 50% long stocks we believe will out perform the market in an uptrend and 50% short the S&P 500 Index (ticker symbol SH). Please note that this isn’t a prediction of a market decline. Instead it is simply acknowledgement that enough things are wrong with our underlying indicators that I feel it prudent to step aside until the indicators give clear positive signs. UPDATE 3:32 PM Eastern – OUR MARKET RISK INDICATOR SIGNALED AFTER THIS INITIAL POST. AS A RESULT, OUR HEDGED PORTFOLIO WILL USE AN AGGRESSIVE HEDGE. Our Market Risk Indicator is very close to a warning, but it hasn’t yet (2 PM Eastern). It will take a steep sell off in today’s remaining trading session to create a signal. If it signals before the close
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
Our measures of trend have been bouncing back and forth across the zero line this week and are currently negative. If they are still negative on Friday we’ll be raising more cash and/or adding a larger hedge before the week ends. Here are some of the things I’m watching at the moment. The actively managed short ETF HDGE is currently rising even though a simple short of the S&P 500 Index (SH) is trending lower. This indicates that shorting selected stocks is starting to work. This often happens before the general market falls. In addition, mid term volatility (VXZ) is rising as well. This indicates that investors are getting nervous going into the end of the year. Small cap stocks (IWM) broke below the triangle I’ve been watching with an associated break in momentum from traders on Twitter. The negative gap in breadth between small and large cap stocks continues to grow. While everyone is watching small cap stocks I’m seeing deterioration in large caps under the cover of new
Social media indicators are showing mostly positive signs with some indecision and chasing by traders on Twitter. You can see the full commentary here. In addition, here are some charts of individual stocks with social media indicators for those of you who are interested.
Over the past week we saw a bit of divergence between our core market health indicators. Our measures of quality and risk got better, while our measures of trend and the economy weakened. None of them moved enough to change our core portfolio allocations. Our core measure of risk is still diverging with the last several peaks in the market. Since the extremely overbought condition on this indicator in late 2013 it has mostly painted lower highs as the market moves higher. This indicates that investors are getting less confident with each rally. As I’ve noted before, it takes time to build a top so this indicator provides information and something to watch carefully, but nothing to act on…yet. The most important thing to watch for a sign of a long term top continues to be breadth. So far we’re seeing small chinks in the armor, but nothing serious. The NYSE Advance / Decline Line (NYAD) is an example. It isn’t confirming the new highs in the S&P 500 Index
On Tuesday we mentioned that our measures of trend were negative. That condition has resolved itself so it looks like we won’t be making any portfolio changes tomorrow. This is a good example of avoiding a whip saw by waiting for Friday’s data to make decisions. Our portfolios are designed to be long term in nature and have infrequent allocation changes. Since we use weekly data for all of the signals they tend to track the intermediate term trends. The sensitivity in our measures of trend show how long in the tooth the current long term trend is. Even with new highs our trend measures are barely positive so it won’t take much weakness to raise more cash. I’ll do an update of all of our core market health measures tomorrow.
It’s still early in the week, but I wanted to give you a heads up that our measures of trend are currently negative. We require a weekly close below zero before changing any portfolio allocations so this is simply early warning that we might be raising some cash and adding a larger hedge come Friday…but I’ll wait till Friday to make any changes in order to avoid whip saws. Our market risk indicator has two of its four components signalling, but the two positive components are a long way from a warning. What is interesting about their current condition is that the least sensitive components are warning while the most sensitive are a long way from a signal. This means there is some instability in the underlying market and that we’d quickly get a market risk signal if prices drop substantially. Our core measure of risk fell out of over bought readings in early July, moved back up to kiss overbought in August, and is now falling again. This is
Although almost every indicator I follow is still positive I’m starting to see some chinks in the armor that suggest that a longer term top is in the making. Tops are a process and take a long time to form so there’s nothing to worry about yet, but here are some things to watch over the next several weeks. First is the ratio between the S&P 500 Index (SPX) and S&P 500 Equal Weight Index (SPXEW). We use the 20 week moving average as a bullish/bearish line. When the ratio is below the 20 week ma the market is often choppy as a result of reallocation rotation or the ratio falls as investors are rotating to safety. Recently it fell below the 20wma then retraced back to it and has turned down again. Investors are continuing to rotate to larger cap stocks which often precedes longer term tops. Next, the NYSE Advance Decline Line (NYAD) is reacting much more quickly to small price declines. This tells us that fewer stocks are
As we suspected last week the market was poised to rally to new highs in the absence of bad news. The early August dip had our risk indicator showing concern, but or core indicators held steady. The recent events provide a good example of maintaining discipline when fear enters the market. Even though we saw a lot of ancillary indicators and our risk indicator getting close to warning we held our portfolio allocations steady. The reason for this is that our core indicators weren’t substantially affected by the dip in the market. This past week all of our core indicators with the exception of the economy rose. This keeps us 100% long in all portfolios. I only see a few concerning things at the moment. Small cap stocks (Russell 2000 – RUT) continue to under perform and indicates that investors are reducing risk. This in conjunction with the sharp declines in momentum stocks during the first four months of the year warns that a longer term top may be in the