Just a quick holiday update this week. Over the last week our core market health indicators were mixed. Our measures of trend have turned up sharply, but are still negative according to our readings. Our measures of strength are still positive, but deteriorating. Our measures of quality continue to trade sideways below the zero line. They went negative in October, but they haven’t turned down sharply. This tells us that market participants still see opportunity in individual stocks. Our measures of the economy turned down again and continue to fall further below zero. Our measures of risk have turned down once again. This leaves us in the same situation as we tweeted @DownsideHedge last week, that our core health indicators want to participate in the market, but our risk indicators refuse.
Accordingly, we are aggressively hedged in our Long / Short portfolio. In fact, we tightened our hedges on Wednesday due to strength in our longs and weakness in our hedges over the past several weeks…which made Friday’s action a pleasant surprise. Our Long / Cash strategy has been 100% cash since October 19th. Our Core Long / Cash strategy is 40% Long and 60% cash.
Our Twitter Sentiment indicator for the S&P 500 Index (SPX) is showing that optimism remains high among market participants even in the face of the risk provided by the stalled budget negotiations in Washington. Monday and Tuesday brought a lot of tweets about a rising trend channel and market participants trading the range it provides. While Friday’s negative action didn’t bring a large volume of negative tweets as we would have expected. Instead, traders continue to believe the Fiscal Cliff issue is temporary and are anxious for the buying opportunity it will provide. So even though price reversed sharply, negative sentiment did not spike downward.
On Tuesday we recorded the highest reading to date on daily sentiment. The last time we saw extremely high prints near a price high was in August and September. These both occurred as smoothed sentiment was diverging from price which warned of an impending top. We’re seeing the same activity now, however, smoothed sentiment is still above its rising trend line and still above zero suggesting the market has room to consolidate without doing serious damage to sentiment. A fall below the rising trend line will be our second warning of a top and a fall below zero will add further evidence of a bearish outcome.
Our Twitter support and resistance levels continue to stay in a fairly tight range between 1390 and 1460 on SPX, with most of the tweets between 1410 and 1460. Below the market there are several clusters of support building at 1410, 1400, and 1390. These levels were mentioned in many tweets as likely places traders would be buyers.
Above the market 1460 is by far the most mentioned resistance level. We consider it major resistance and a likely target for any further rally. 1500 is still being mentioned, but in less frequency so the prospects for that level are diminishing.
To summarize, we believe the divergence in smoothed sentiment is our first sign that the market is ready to consolidate. There is strong support between 1390 and 1410 which should slow any downward pressure and provide a place where the market can bounce. However, a break of those levels would most likely bring sharp selling due to the lack of any support below. Should a rally materialize we’ll be watching how sentiment reacts to the 1460 on SPX as it is a very strong resistance level.