Last week the market fell and did a lot of damage to many internal indicators, however, our core measures of market health were mixed. Not enough of them deteriorated to change our exposure to the market. We’re still aggressively hedged in our Long / Short strategy. Our Long / Cash strategy has been 100% cash since October 19th and our Core Long / Cash strategy is still 80% long and 20% cash. This is a condition that is unusual and tells us that while risk is high many money managers are waiting before making large changes to their portfolios. In short, they’re hopeful, but looking over their shoulder. Market Positives One of the few things we see as positive is that emerging markets (EEM) are still holding up relatively better than the general market. However, it’s hard to see how EEM can have the strength to hold up other sectors. More likely EEM will be dragged down with any further weakness so it really isn’t all that encouraging. Mixed Signals
Just a quick note today. The percent of stocks in the S&P 500 Index (SPX) above their 200 day moving average broke below a critical point. Over the past several years once more than about 40% of stocks break below their 200 day moving average the market starts to accelerate downward. This is usually a result of traders finding many more shorting opportunities. So the next bounce in the market should be watched carefully to see if this indicator can recover. If it doesn’t it means that traders are shorting as stocks rally back to touch the underside of their 200 day moving average. In addition, the Bullish Percent Index for SPX is starting to break down too. So not only are stocks breaking their 200 day moving average, many stocks are also breaking bullish chart patterns. Once the scales get tipped the market generally moves fairly quickly downward.
After a day like today it’s important to take a breath then step back and look at the big picture. For traders or investors a day like today can generate a lot of emotion that overwhelms clear thinking. When the market generates this much fun (if you’re hedged like we are) or when the market generates pure terror because it’s moving quickly against your positions, its a good time to get away from the emotion of the day by looking at longer term charts. One day events like today need to be measured in the context of the greater trend to fairly judge their implications. Below are daily, weekly, and monthly charts of the S&P 500 Index (SPX). If you look at the daily chart (pretending it doesn’t have today’s bar) it gives the impression that the market consolidated near a high, then fell a little bit, but was holding support. It would be reasonable to decide that the market was getting stronger and ready for a move back to
Last week we called for a bounce, but we sure didn’t expect it to only last one day. The choppy nature of the market is cause for concern. Many of our indicators weakened last week with enough of our measures of quality falling that we consider them negative. Our measures of trend and strength deteriorated significantly and are just a whisper away from being negative. As of 10/19/2012 our market risk indicator has us aggressively hedged in our Long / Short strategy and 100% cash in our Long / Cash strategy. Our Core Long / Cash strategy ignores the Market Risk Indicator and only follows our market health indicators. The current condition of our market health indicators suggests being 80% Long and 20% in cash. Without using our Market Risk Indicator you’ll suffer larger draw downs when the market moves sharply lower, but have better overall performance by taking more risk early in rallies. Market Positives Nasdaq and the Russell 2000 index (RUT) continued to hold support above their 200
Enough of our core indicators have weakened that our “core” Long / Cash Hedge strategy is now 80% Long and 20% in cash. Our core strategy ignores our Market Risk Indicator. As a result, it takes larger draw downs, but has better overall performance because it enters the market earlier in new rallies. If you follow our Market Risk Indicator you would have gone 100% to cash on 10/19/2012. You can see a comparison of the hedge strategies here. Below is the current chart for the core strategy. The green lines represent adding long stocks. The yellow lines represent raising cash.
Just a quick note today about our core market health indicators. The action today helped some of them, however, we’re still seeing deterioration in others. We’ll need a good up day on Friday following the October jobs report or we’ll have further evidence that this rally is stalling. We’re still of the opinion that we’re getting a chance to firm up our portfolio insurance. Think about taking profits in winners, removing losers from your portfolio, and in general raising cash. Of course, we’re all about hedging so if you are comfortable with hedging instruments now is a good time put on a hedge.
We had fairly serious down movement in the market last week, with Friday showing signs of a near term bottom. Although we’re due for a bounce, we’re still aggressively hedged because of the weakness in our Market Risk Indicator. Our core market health indicators are also deteriorating with many of them barely holding above the trigger line. Market Positives Our Twitter Sentiment indicator is currently painting a positive divergence with price. The break of support in the S&P 500 Index (SPX) at the 1420 level printed a large down day in price, but Twitter sentiment didn’t confirm that break. On Tuesday, while price was falling there were still a large number of tweets suggesting that SPX 1400 would hold. Many people talked about their confidence of the market’s ability to recover. Surprisingly, there were enough positive tweets on Tuesday that daily sentiment did not reach oversold levels (which would have indicated an initiation thrust and project much lower prices). The next three days of sideways to down movement in price
From the middle of September to the middle of October the S&P 500 Index (SPX) traded largely in a range. During this time we hoped that market internals would hold up signalling a healthy consolidation. The first trip down from 1375 on SPX didn’t do much internal damage. However, the rally back up and the subsequent sell off brought with them diverging internal indicators. These divergences served as a warning that the support range of 1420 to 1430 might not hold. As an example, take a look at the percent of S&P 500 stocks above their 200 day moving average in the chart below. The first decline from 1475 to 1430 in SPX brought the percent of stocks above their 200 DMA lower, but not to an extent that caused concern. On the following rally it was evident that many stocks could not regain their 200 DMA. This served as our first warning that traders were now selling many of those stocks as they bounced back toward their moving average. However,
Last Friday our Market Risk Indicator went negative. Although this puts us officially in warning mode it doesn’t mean that prices will necessarily fall. For this reason, you should never use our Market Risk Indicator as a signal to go either long or short. If you do, you’ll lose money. Remember, hedging is not the same as going short. Over the last four months the market has rallied and is now consolidating. This consolidation comes above very important support levels. If we were to look at nothing but price we’d have to conclude that the market is simply pausing before moving higher. Unfortunately, what looks healthy on the outside isn’t always healthy on the inside. Our risk indicator is telling us that even though price is acting reasonably, risk is rising. The red lines on the chart below represent our market risk indicator signalling a warning. The blue line are when the warning condition was cleared. When market risk rises investors have several options available to reduce risk. In our
What a week. We’re in the same place as we were last week, but it doesn’t feel like it. After making a trip to the top of the range and back down again we saw deterioration in many of our indicators. Most importantly our Market Risk Indicator went negative. This indicator overrides all of our other indicators as it often signals an acceleration to the down side. We’re not predicting a break of support in the 1420 to 1430 range on the S&P 500 Index (SPX). Rather we’ve been warned of a the chance of substantial risk so we’re buying insurance by aggressively hedging our portfolio. We’re effectively 50% long stocks we want to own and 50% short, however, we’re using aggressive hedging instruments like puts that match our portfolio or mid term volatility (like VIXM or VXZ). Market Positives Our measures of the economy and trend strengthening slightly, however they are slowing in momentum. Financial stocks are showing better relative strength which would bode well for the market if