Over the past week our core market health indicators were mixed, with most of them weakening even as the market moved higher. None of them fell enough to change our portfolio allocations. We remain 80% long and 20% cash in both of our Long / Cash portfolios. Our Long / Short portfolio is still 90% long the stocks we believe will outperform the general market and 10% short the S&P 500 Index (SPX).
Market Positives
Our core market health indicators that measure quality, trend, and strength of the market remained above zero, but weakened this past week. Our measures of risk were mixed and our measures of the economy strengthened. Market breadth continues to confirm, but is starting to stall. This is a normal condition for a rally that is a bit over extended.
Our investor contentment index is also above zero, but fell sharply last week. Our market stability indicator rose sharply this week and closed well above zero. The combination of these two indicators tell us that investors aren’t concerned about the longer term prospects for the market, but believe it needs a correction. We read this as a small warning for the near term.
All of the major indexes moved higher this past week. All but Nasdaq made new 52 week highs, but Nasdaq isn’t too far away so any movement higher will most likely provide confirmation to the other indexes.
Mixed Signals
Our Twitter Sentiment indicator for the S&P 500 Index (SPX) had an extreme negative reading of -19 on Thursday of last week. This didn’t quite meet our criteria for a negative initiation thrust, but should serve as a warning that there are a lot of market participants on Twitter cheering weakness and shorting the current levels. Friday brought a moderately strong reading of +14 on a day that SPX rallied more than 1%. The daily indicator continues to print lower highs as more bearish tweets show up even as the market moves higher. The tone from the bulls is mixed between “I told you so” and mere observation that the market is making new highs. The bears vacillate between being incredulous and angry. The battle between bulls and bears continues to rage, but not quite at the levels of the previous week.
Smoothed sentiment broke below zero over the last week giving us another warning that this rally is getting extended. Sentiment has been diverging from price for over a month, has broken below its confirming trend line, and is now below zero. These conditions suggest that the bears are building to a point where they will soon turn the market downwards. However, many traders calling for the market to top are also looking for an entry point below current prices. This indicates that any correction should be shallow.
Twitter support levels rose again this week with calls below 1470 on SPX drying up and calls above the market rising to the 1570 level. 1520 and 1550 were the most tweeted areas above current prices so we consider them major resistance. With the market breaking above 1500 and successfully retesting it last week that level changed from resistance to support. 1500 was by far the most tweeted number and is becoming a strong line in the sand for both bulls and bears. We consider 1500 and 1470 as major support.
We have a condition where support and resistance are looking upwards while sentiment is turning bearish. This tells us that the market might move higher into the 1520 or even 1550 level before correcting, but each higher print will be met with more sellers. As we mentioned above, many market participants are looking for a correction that they can buy so any dip will be met with buyers. A correction that starts near 1520 or below could carry as low as 1470 on its first stop. While a blow off run to 1550 would most likely come back to 1500 before determining the next direction.
Market Negatives
Sentiment continues to be the only headwind for the market so we’ll keep an eye on it to see if it turns up or brings the market down.
Conclusion
The market is setting up for a minor correction. It is getting overextended to the point that a small pullback would be healthy. The most likely levels for the correction to start are between current levels and 1550 on SPX.
Market Risk Moderate
Long / Short Hedge Portfolio
Long / Cash Portfolio
How do you define a correction? Because officially, a correction is a 10% drop, not any less. If by ‘minor correction’ you mean less than 10%, that’s not a correction. It’s like a ‘minor pregnancy.’
Sorry about being vague. We don’t define corrections, bear markets, etc. in terms of percentages. For us a ‘minor correction’ is a counter move in the market that doesn’t do much damage to market internals. It is a dip where people show up in force to buy the dip. That’s all we’re expecting at this point, however, our views will change is we see a lot of internal damage.
A ‘correction’ does enough damage to market internals that many market participants get scared that it will continue for an extended period of time and turn into a bear market. It causes enough confusion and uncertainty that the bottom is usually defined by a large capitulation move. Both the April to June and September to November counter moves in 2012 met our criteria for a ‘correction’ even though the Sept/Nov move was less than 10%.
There is no such thing as a ‘minor correction.’ A drop down to 1470 on the S & P 500 is far from a correction (not even close to a 10% drop).
Kind of like being ‘just a little bit pregnant.’