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Tops Are a Process

Over the past several weeks the StockTwits community, the Twitter stream, and market internals have been sending signs of weakness that suggest the market may be in the process of topping.  As you know, I don’t like to make predictions about the future. Instead I make portfolio adjustments based on the current condition of market internals and other technical indicators expecting favorable odds over the long term.  Here are some things I’ve noticed over the past three weeks that have indicated caution is warranted.

On February 26th I posted a chart showing a lack of trade signals coming from the Twitter stream as the market was moving strongly out of a short term bottom.  That was unusual behavior and suggested that traders weren’t supporting the most active stocks on Twitter.

On the next day I posted a chart to Twitter and StockTwits that indicated volatility (VIX) should move higher based on quantified messages from StockTwits.  After several weeks of confirming lower volatility the StockTwits community broke the trend with new messages suggesting VIX would move higher.

On March 3rd I highlighted some market breadth charts that indicated that breadth was worse than the headline numbers indicated.  As of today, the Bullish Percent Index is still having a hard time recovering.  The Percent of Stocks Above their 200 Day Moving Average is still diverging from the market and many individual charts are very close to breaking below their 200 dma.  If these two indicators move sharply lower on further weakness in the market it will be a strong indication that a top is in progress. I consider readings below the 60% level a red flag.

On Friday the performance of the Twitter Top 10 portfolio fell below the S&P 500 Index (SPX).  This is another caution sign because it indicates that the most loved stocks on Twitter are losing momentum.

Friday also brought with it weakness from a broad range of indicators that I use for portfolio allocations.  These indicators are categorized into the economy, market risk, quality, trend, and strength.  Currently our measures of the economy, market quality, and market strength are negative.  Our measures of market trend are deteriorating rapidly and perceptions of risk are rising.

Our Twitter Sentiment indicator for the S&P 500 Index (SPX) dropped rapidly last week.  Smoothed sentiment has now painted two lower highs since the end of last year and the weakness in price last week has caused it to dip below zero.  Any further weakness in the daily indicator will most likely create a lower low in smoothed sentiment.  We didn’t get  two higher lows that were three weeks apart in smoothed sentiment so I can’t call an official consolidation warning, but all of the above confirm lower prices. One thing of note is that the volume and intensity of tweets hasn’t quite reach levels normally associated with a short term low.  The lows of last October and June showed a lot more excitement and fear on the Twitter stream.

Although the Twitter stream didn’t give us a consolidation warning, the StockTwits community did.  Smoothed sentiment from StockTwits has been diverging from price for nearly a month and has now broken below its confirming up trend line.  It is also below zero and its last low.  This signals a warning because it shows a lack of support at current prices from active traders and indicates that the crowd is moving from bullish to bearish.

Support and resistance levels generated from Twitter aren’t showing a lot of fear.  There is a support level building in the 1830 area on SPX and the 1800 level continues to get tweeted on a regular basis.  Below that there are only a few scattered tweets so it appears that traders aren’t too concerned yet.  Above the market 1850 has a huge number of tweets making it a line in the sand for both bulls and bears.  1890 is the next resistance level.

Sector sentiment is showing weakness in the market as Industrials and Basic Materials have a strong negative bias. The defensive sectors of Utilities and Health Care continue to have a positive bias.

Conclusion

Tops are a process so it takes the accumulation of evidence over time to draw conclusions.  We’ve been getting subtle warnings for over three weeks and Friday brought with it hard evidence from market internals and a consolidation warning from the StockTwits community.  Risk is rising, breadth is weakening, and momentum stocks are losing support. What makes this most concerning is that we’re getting so many warning signs just 2% away from all time highs.

Over the next week I’ll be watch three things most carefully. First is our measures of risk, second is market breadth, and third is support levels from Twitter.  If breadth deteriorates, perceptions of risk rise, and traders start tweeting substantially lower prices it will signal that the market could accelerate lower.  For now we’re cautious and moderately hedged.  Since tops are a process I’ll wait for more evidence before making further portfolio adjustments.

 
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