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Market Overview 2/16/12 – More Divergences

New week, same story.  The market spent time grinding higher last week while the majority of our core market health indicators ground lower.  None of them deteriorated enough to change our portfolio allocations, but raising cash or adding hedges sometime in the next few weeks looks inevitable.  A very sharp move higher that brings with it wide spread participation is about the only thing that could change the indicators.  We’re not predicting a down turn, rather we believe it is best to protect gains when the market is uncertain. We’ll wait for our indicators to turn before taking any action. We’ll note any warnings throughout the week on Twitter @DownsideHedge.  If we make any changes to the portfolio we’ll post an update before the close on Friday.

Market Positives

Our core market health indicators that measure risk, quality, trend, and strength continue to be positive (although as mentioned above, showing negative divergences). We have to leave them as a market positive even if we’re not optimistic.  Our market stability index is positive and rising suggesting that very few people expect any large shocks.

Probably the most positive thing we see is that the market continues to shake off bad news. Wal-Mart (WMT) warned on Friday that February sales were a “total disaster” and the S&P 500 Index only closed down one tenth of one percent.  It appears that market participants need evidence of slowing sales in other companies before turning bearish. They are treating the Wal-Mart news as specific to the company rather than a warning on the economy.

Mixed Signals

Breadth indicators are starting to show the first signs of diverging from price.  Stocks above their 200 day moving average ticked down this week, new highs on both NYSE and Nasdaq are falling, and new lows are ticking up (although from very low levels).  Actively managed short funds like HDGE are showing the slightest move upwards as well.  These are often the first technical breakdowns we observe ahead of a market top.  New moneys stops pushing the high fliers higher, stocks near their 200 day moving average are sold as money managers prune their losers, and traders start accumulating shorts. These conditions can occur well ahead of a market top, but show the balance shifting from bullish to bearish.

Our measures of the economy are still negative, but slowly rising. Our investor contentment index fell further below zero this week and is warning that investors are starting to get concerned.

Market Negatives

Our Twitter sentiment indicator for the S&P 500 Index (SPX) is still warning of a pause or correction in the market.  The daily indicator continues to paint lower highs even as SPX grinds higher. There is a theme building in the Twitterverse about the correction that just won’t materialize. Many people are tweeting about technical reasons the market should fall, but also warning that price hasn’t confirmed the weak internals.  The tone is mixed with frustration and boredom as traders wait for a direction. The daily indicator has kept its prints in the neutral zone (-10 to +10) for almost two weeks which is another sign of indecision by traders.

Smoothed sentiment strengthened from low levels last week, but continues to diverge from price and is still below zero. This shows that the bears continue to outweigh the bulls, however, they are very close to being evenly matched at the moment.

SPX was turned back at Twitter resistance of 1525 last week. This highlights the negative risk/reward scenario we mentioned in our previous update. When there is strong resistance just above the market but support has multiple levels well below current prices, traders are likely to close longs or enter short positions at the resistance level.  Twitter support and resistance levels are now tightening in a range between 1500 and 1525 on SPX.  There are very few tweets above or below those levels.  This suggests that traders are waiting for a break from the current range before taking action. There are so many tweets mentioning 1525 that a break above it will most likely cause a short covering rally that moves quickly higher. Any weakness will most likely cause a drop to 1500.

Conclusion

We’re in the same place we were last week where warnings of a counter move abound, but the market is making marginal new highs. The best guide for the coming week is Twitter support and resistance which is telling us that 1525 on SPX is where the action will be.  If the market can break above that level we’ll see higher prices.  If it drifts lower then 1500 will most likely be revisited.

 
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