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Shaky Foundation

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The S&P 500 Index (SPX) is starting to paint a pattern that often leads to instability and a quick drop lower. Look at the chart below and you’ll see wide quick swings going in both directions. This indicates uncertainty by market participants. It is a pattern we haven’t seen for a very long time which makes it more important. Another thing I’m seeing is perceptions of risk rising. Three of four components of our market risk indicator are warning at the moment. We still have one hold out, but it is dropping rapidly. As I’ve mentioned over and over again I don’t think the market can have a substantial correction until breadth breaks down. One measure that is getting close to warning is the percent of stocks above their 200 day moving average. I get concerned when it falls below 60%. Add it all together and we’ve got a market with a shaky foundation. Caution is warranted.

 
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Dow Theory Best Indicator Since 2009

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Out of the lows in 2009 there has only been one of the indicators that I follow that hasn’t had whipsaws or bad signals somewhere along the way. That “indicator” is Dow Theory. It has continued to confirm  a long term bull market for the entire period from its bullish trend change in July 2009. This is due to time being an important factor in Dow Theory. The system outlined by Charles Dow and William Peter Hamilton waited for roughly three weeks of trend before declaring a secondary reaction point. The lack of secondary lows that subsequently failed has kept Dow Theory bullish. On the chart below I’ve annotated the secondary low and high points from the last several years. In addition there is a Dow Theory line during the first several months in 2012. We’re now approaching a month long decline in the Transportation average (DJTA). The industrial average (DJIA) will need to break below the December lows to pass the three week mark. At this point we’ll need

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Gold Stocks and the Market

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I did a write up on Trade Followers about a buy signal for gold stocks generated from Twitter momentum / sentiment. It’s time to watch the trade closely for signs that it might turn into a long term trend change for gold and gold stocks (GDX). Here’s the associated chart…as a teaser. In addition, there are some interesting things happening with small cap stocks (RUT) and the NASDAQ 100 (NDX) that will likely tell us which way the market will break. Those two indexes will likely tell the tale. The short story is if sentiment for RUT breaks lower the market will likely follow. If sentiment for NDX breaks higher then odds favor new all time highs. Here’s a link to the post.

 
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Possible Allocation Change on Friday

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Our core measures of risk have been bouncing back and forth across the zero line this week. The category closed today barely above. A weekly close below zero will cause us to change our allocations in the long / cash portfolios to 100% cash. The long / short hedge portfolio will go 50% long and 50% short the S&P 500 Index (using SH or an outright short of SPY). Our market risk indicator has two of four components warning at the moment. Two are deep in negative territory. One has been moving back and forth across zero over the past several weeks. The fourth component is still a good bit away from turning negative so it appears that the market risk indicator won’t signal this week. As a result, the Volatility Hedge will most likely stay 100% long. A sharp move lower between now and Friday would be required to trigger a hedge signal in that portfolio. One chart I’m watching at the moment for clues to which way we

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Risk Rising

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Over the past week all of our core market health indicators fell. Most notable is our measures of risk. Our core measures of risk fell from moderate levels to almost warning. It will take a large sell off in the last hour to take this category below zero and have us increase our hedges and/or raise cash. Our market risk indicator has three of its four components warning. This is very unusual given the fact that the market is only down about 3% from all time highs. This tells me that market participants are skittish…which increases the risk of a sharp sell off. If this indicator signals we’ll be changing the hedge to an instrument that benefits from higher volatility. I don’t expect it to signal today, but if it does I’ll update this post before the market closes. Another sign of rising risk is the performance of Junk Bonds (JNK) compared to High Quality Bonds (LQD). LQD is rising while JNK is falling. This tells us that bond holders

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Consolidation Warning from Trade Followers

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The Trade Followers momentum indicators for many of the major indexes (DJIA, SPX, and Nasdaq 100) are warning of a short term correction in the market. This increases the odds that we’ve finally got the short term top I’ve been expecting for the last month. I still think that the most important index at the moment is the Russell 2000 so I’d like to see it confirm before getting too bearish. If we’re getting the expected dip then it will be important to watch how internal indicators react.

 
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Market Health Improves

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Over the past week most of our market health indicators improved. None of them moved enough to change our portfolio allocation, however our measures of market quality and strength are getting very close to going positive. I expect at least one of them to go positive by the end of next week if the market continues upward. If we get a dip then we may have to wait as long as the first of the year before making any allocation changes. We’re experiencing a market that is trying to sort itself out after a huge decline and retracement. The retracement still hasn’t repaired the damage done to market internals during the decline. Below are some examples. As I mentioned recently, the NYSE Advance / Decline line (NYAD) finally broke above its previous peak. This is an encouraging sign, but the breakout is weak and NYAD turned down last week even though the S&P 500 Index (SPX) posted a small gain. In an strong bullish market I would expect to see

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Maybe A Dip

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I’ve been waiting for a short term top for almost three weeks now. Maybe we’ve finally got one. If this is the case it’s time to watch market internals to see if they hold up or fail in the face of lower prices. One of the things I’m watching most carefully is the percent of stocks above their 200 day moving average. Long time readers know I like to see them stay above the 60% level. My reason for concern is that many previously loved stocks are flirting with their 200 dma. The market is at a point where these stocks need to see higher prices that keep them (or get them) above their 200 dma or they’ll likely drag the market lower.

 
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Watch the Next Dip

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I often talk about watching market internals during a rally out of a dip for signs that confirm the run. Indicators that are derived from price are mostly showing confirmation, but many other market internals are lagging price. This lag is causing negative divergences that often accompany intermediate to long term market tops. With those divergences in place it’s now time to watch internals during the next dip. Here are a few things I’m watching. First is the percent of stocks in the S&P 500 Index (SPX) that are above their 200 day moving average. Currently about 77% are above their 200 dma. This is a healthy number, but below the readings of the last two years due to the damage done on the last dip. About 10% of the stocks in SPX did not recover their 200 dma after being pushed below in October. If this trend continues on subsequent dips it will provide warning of a longer term top being put in place. If it can hold above

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No Portfolio Changes This Week

Just a quick note this week. The damage done to our core indicators hasn’t been repaired by the rally back near the old highs in the S&P 500 Index. Part of the reason our indicators are having trouble clearing is a result of the steep V pattern being painted so fast that price is outrunning everything else (causing our indicators to lag). Unfortunately, that isn’t the only problem. A larger problem is that our measures of the economy and market quality are still falling. This poses a longer term problem for the market as a whole. So here we are, back at all time highs and hedged. Long time readers know this isn’t a cause for concern…because hedging isn’t about being right or wrong. It’s about acknowledging I can’t see the future so I simply hedge out risk if our indicators are warning or unclear. Our current allocations for the long/cash portfolios are 100% cash. Our hedged portfolio is 50% long stocks we believe will out perform the market in

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