A few weeks ago I wrote a post ahead of the FOMC meeting where I highlighted the value of technical analysis in determining the condition of the market in the absence of the news. This week that post becomes relevant again as the same conditions are persisting ahead of the budget and debt ceiling deadlines in Washington DC. However, I want to make an additional point that by using technical analysis you can avoid the pitfall of reacting to each and every news event. Instead, by simply following the underlying indicators of the market you can make portfolio changes when it appears that conditions are deteriorating rather than on a guess (or fear) that conditions might get worse.
Just as it was two weeks ago, our core market health indicators are still all positive, but perceptions of near term risk are rising. Almost every other indicator I follow is telling the same story. As a result, our core portfolios are 100% long in the face of a looming event. My emotions wanted to add a hedge ahead of the budget deadline, but my indicators tell me to wait. Experience has taught me that following the market gives a higher probability for success than trying to guess what the market will do. I suspect this is a result of my own failing that I can’t see the future. Any changes to our portfolio over the next week or so would come from a warning signal from our market risk indicator. As a result, I’ll follow my long term game plan which tells me to wait and see if Washington melts down and quickly hedge if it does.
As I mentioned above, almost all of the intermediate to long term indicators I follow are in the same condition as two weeks ago. If you’re interested in the details you can read this post. A few short term indicators have changed a bit with the most notable being our Twitter sentiment indicator.
Twitter sentiment for the S&P 500 Index (SPX) printed some fairly negative readings (-17) on the daily indicator when the market failed near 1730 and made a quick drop below the 1700 level. Since the initial break lower daily sentiment is now recovering as traders on Twitter are getting more comfortable with falling prices. Many tweets mention the current budget battle, but have a bias toward a positive outcome. This is reflected in positive daily readings even though price is declining.
Smoothed sentiment has been dragged down by the large negative daily prints. It has now fallen below zero and broken the uptrend line created out of the August lows. As I mentioned when the consolidation warning was cleared on 9/10/13, I prefer divergences (or peaks and valleys) in sentiment to be at least 3 weeks apart to create a trend. This is largely a result of the fact that people tend to change their bias slowly over time. Since the last two valleys aren’t quite three weeks apart I’m willing to give smoothed sentiment a little more room and redraw the trend line if a valley is created above the 9/3/13 low. It will only take a few low positive daily readings (+5) to turn smoothed sentiment up over the next several days. This is another indication that market participants aren’t too concerned yet.
Support and resistance levels generated from the Twitter stream coiled even tighter this past week. The vast majority of tweets below the market target 1680 on SPX as support. Above the market the most tweeted level is 1700 with a tiny cluster near 1710. No other level generated a significant amount of interest. This makes the range extremely important. All the white space above 1700 and below 1680 show market participants waiting so a break of the range should see prices move quickly the same direction.
Sector sentiment is showing a convincing rotation to safety this past week. As we mentioned the previous week, when all of the sectors are showing a positive bias it indicates the beginning of rotation and has marked the last few short term tops. The sectors continue to follow the same pattern as the last two tops where they were all positive, then moved to a defensive posture. This suggests that we’ve still got a bit more downside ahead of us.
From a sentiment perspective, the market is tightly coiled at a make or break point. Traders are targeting a very narrow range, smoothed sentiment is at an inflection point, and the sectors show defensiveness by investors. Watch the range as it will most likely be your first indication of the next direction.
Intermediate and long term indicators suggest the market should go higher, while short term indicators are showing that a bit more weakness may be ahead. The perception of risk is rising, but not to warning levels. This environment requires patience to wait until market internals warrant a change. As a result, we’ll stick to our game plan and keep our core portfolios 100% long unless our market risk indicator signals.