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Make or Break Time

We’re seeing more of the same this week…other than the obvious 2% fall in price.  Perception of risk continues to rise, but market internals and our core market health indicators remain fairly positive.  Our largest concern is once again our market risk indicator.  It signaled during the week, however, the positive price action late in the day on Friday cleared the warning condition.  Because our core portfolios are designed for intermediate to long term allocations we require a weekly signal before changing any positions.  As a result, our portfolio allocations remain the same.  We suspect that we’ll be hedging and raising cash if the market continues to fall into late next week.

Our second major concern is the action of bonds and interest rates over the past month. Bonds have been falling with stocks recently which doesn’t bode well for financial markets as a whole.  When stocks and bonds move somewhat opposite it reflects rotation between the two asset classes.  The past year is a good example where enough money was flowing out of longer term US Government bonds (TLT) and into stocks to cause bonds to fall while stocks rose.  But over the past month bonds have fallen sharply as stocks have given up over 5%.  This suggests that market participants are becoming less willing to hold either stocks or bonds.  Instead, they prefer cash.  Holding cash is a sign of uncertainty or doubt in all asset classes which often leads to large declines.

Sentiment on Twitter for Bonds (TLT)

Our Twitter sentiment indicator for a long term bond ETF (TLT) is currently confirming the down trend. It does have a positive divergence with price, however, until price turns that divergence holds very little information of value (and consequently little to inspire hope).  As of today, it appears as if bonds will continue to fall.  We’d like to see money raised from bonds put to work in stocks rather than parked in cash.

Our Twitter sentiment indicator for the S&P 500 Index (SPX) had its two highest intensity days ever on Thursday and Friday as the market fell.  The intensity scores were nearly double their 50 day moving average. This indicates that traders were both excited and fearful of the fall in price.  Thursday had a daily print of -26 which is fairly extreme. Friday however, came in with a barely positive reading even though SPX had a sharp sell off that morning.

Smoothed sentiment continues to be squeezed between a longer term uptrend and a short term down trend.  This suggests a continued willingness by traders on Twitter to buy the dips. This is confirmed by many tweets mentioning a healthy correction rather than a change in the long term trend.  In addition, there are a number of tweets calling for a bounce due to oversold conditions. Smoothed sentiment is also still above zero and has a very short term positive divergence with price which is another sign that stocks could move higher.

Support and resistance levels generated from the Twitter stream fell a bit with the market.  The calls for lower prices increased significantly indicating that traders are fearful or are waiting for lower prices before committing money.  The break below 1600 on SPX on a weekly basis moves that level from support to resistance, with 1618 and 1650 above that.  The 1600 level was sold fairly aggressively going into the close on Friday. It is a level the bulls need to reclaim and the bears don’t want to see again. Below the market support is now 1580, 1550, and 1540.

Sector sentiment reflected across the board selling with only Energy and Financials holding up.  This suggests investors are moving to cash rather than rotating between sectors.

From a sentiment perspective fear is rising, but there is still hope that the market can rally at least in the short term. If a rally materializes we want to see a clean break above 1600 on SPX that brings with it strong daily sentiment readings. This would indicate traders buying and cheering the rally. Any divergence or lackluster prints on the daily indicator would indicate that traders are selling into the rally or expressing disbelief.

It’s make or break time for the market.  SPX is sitting just below a critical support/resistance level.  Perception of risk is rising, but market internals haven’t deteriorated to a point that generally bring longer term down trends. Sentiment on Twitter shows a willingness to buy the dips, but fear of lower prices.  The conditions are in place for at least a bounce, however, the uncertainty evidenced by the hoarding of cash may keep buyers sitting on their hands.  Conclusion: any rally needs to prove itself and any selling will most likely accelerate.

We’ll be watching bonds, our market risk indicator, and how sentiment reacts to any rally.  Those three things should give us the most important information about probable market direction.

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