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Forced to Believe Price

Over the past week our core market health indicators all improved, but not enough to change any of our portfolio allocations. Our indicators still don’t believe the market can sustain higher prices.

Market Positives

Once again price is the winner.  The market continues to move higher and we can’t argue with it.  All of the major averages moved to new highs this week.  Even our last hold out, the Nasdaq 100 Index (NDX) finally surpassed the September 2012 peak.

Our measures of risk remain positive which tells us market participants are not concerned about a significant draw down. Measures of breadth are starting to resolve the negative divergences which help to confirm the higher prices in the indexes. Our investor contentment index made it back into positive territory this week which is a sign that investors are adding exposure as the market moves to new highs.

Our Twitter Sentiment Indicator for the S&P 500 Index (SPX) cleared its consolidation warning and is confirming the move higher with strong readings in smoothed sentiment.  It is still showing signs of traders chasing with wide swings on the daily indicator and a broadening pattern in smoothed sentiment that somewhat mirrors the megaphone pattern in price. The latest peak in smoothed sentiment appears to be confirming the break above 1600 in SPX.  Our only doubt is a result of the recent chasing of price.  The breakout is so new that we can’t tell if it is a continuation of a broadening top or a clean break.  Another week should give us a clearer picture, but for now we’ll consider it a positive break to new highs.

Over the past week while SPX was below 1600 there were virtually no tweets above that level.  Traders were reluctant to make predictions of higher highs.  In addition, there were very few tweets for prices below 1570 making a very tight range.  Once the market moved above 1600 everyone suddenly got an opinion and started targeting prices mostly in the following ranges; 1625, 1640, and 1665.  At the same time support levels magically moved up to 1600.  This highlights the level of uncertainty of traders on Twitter. There is still a cluster of support near 1570 that we view as a must hold area on any consolidation.

Twitter sector sentiment continues to confirm higher prices with the defensive sectors of utilities, consumer staples, and health care lagging, while energy, technology, and consumer discretionary stocks show the highest sentiment readings.  Our only concern is financials which are showing just a slight positive reading.  The tepid sentiment for financial stocks comes at a time when many of the big banks like Goldman Sachs (GS), Morgan Stanley (MS), and JPMorgan Chase (JPM) are still well below their recent highs.  This isn’t a condition we’d like to see if the market is going to sustain a rally.

Putting it all together we have to give the market the benefit of the doubt. Daily sentiment has a small divergence with price so we could see some weakness early next week, but 1600 on SPX should hold.  The broadening top pattern may still be in effect so we’ll be watching sentiment and support levels on the next dip to give us more clarity. Any break below 1570 on SPX that brings with it very negative sentiment will put the megaphone pattern back in play.

Mixed Signals

Our measures of the economy, market trend, quality, and strength all improved this past week, however they are still mired below zero.  As we mentioned in our market health indicators post this is similar to April and May of 2011 where our indicators diverged for almost four months after which the market declined 20%.  We’re not predicting that now, rather pointing out that our indicators need to improve to give us more confidence.

Market Negatives

Our market stability indicator moved deeper into negative territory this past week signalling that money managers have rising concerns about a more imminent decline.

Conclusion

At the moment the market is trying to force us to believe in price while our indicators are telling us to remain cautious.  We still can’t tell if traders are chasing or if they really believe the market can go substantially higher. Fortunately, we’re patient so we’ll simply wait with a modest hedge or high levels of cash until price or our indicators prove correct.

 
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