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
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.
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
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.
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
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
Our market risk indicator warned on 10/10/14 and since that time the market has dropped and recovered in an extremely sharp V formation. The quick move is causing the indicator to whipsaw on a daily basis. It has been moving back and forth between warning and clearing the warning. If the market doesn’t fall sharply between now and Friday I expect the warning to be cleared which will cause a whipsaw hedge signal as discussed in this post. With that said, the picture is still cloudy so we’ll have to wait until week’s end for clarification. As always, I’ll post before the last hour of trading with an official call (and any portfolio allocation changes). One point on the issue of whipsaws. Please be aware that this indicator is specifically designed to warn of the heightened possibility of quick drops in the market. It has a good record of warning before big declines, but also has a lot of whipsaws. As a result, we use it mainly for a signal to
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