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Time For A Direction

Over the next couple of weeks the market will be forced to choose a direction. The S&P 500 Index (SPX) is being squeezed between its 50 day moving average near 1860 and its last peak near 1900.  Each day that goes by the 50 dma will move higher and put more pressure on the index. The pressure will force SPX to either move higher or fail at its 50 dma so we should get a direction over the next few weeks.

Coincidentally, support and resistance levels gleaned from the Twitter stream are compressing in  the same range. There are a few scattered tweets down near 1850, but the majority are near 1860.  Above the market the most tweeted level is near 1900. This tight range suggests that traders are watching closely for a break before committing themselves.

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Quantified messages from the StockTwits community issued a consolidation warning for SPX Friday at the close. Please note, this isn’t a prediction that the market will move lower, merely warning that sentiment and momentum from active market participants is falling which often results in choppiness.  The warning is triggered by a negative divergence between quantified messages and price that has been followed by a break below the confirming uptrend in the indicator. Basically, market participants are getting more cautious or shorting the market as it moves higher. Our indicator that quantifies the Twitter stream looks much the same but doesn’t have a confirming uptrend to give an official warning.  Here’s a bit more information about how we use the indicator for those of you who are interested.

Our core market health indicators are cautious enough to put our portfolio allocations at 70% long stocks we believe will out perform in an uptrend and 30% short the S&P 500 Index as a hedge.  However, the history of these indicators gives a 60% chance that this is normal rotation and profit taking that will result in higher prices when it’s done.  The bad news is that there is a 40% chance that the market is putting in an intermediate term top that will take prices below the 200 day moving average…and most likely down more than 10%.  So a break lower over the next few weeks should be significant.

Although many of our indicators are fairly negative, there are still some hold outs that I suspect will need to break down if the market is going to correct.  Here are a few charts I’ll be watching over the next couple of weeks that should provide warning of a more significant drop in price if they break down.

First is the spread between Investment Grade Bonds (LQD) and High Yield or Junk Bonds (JNK).  The two have been diverging in a way that suggests market participants are reducing risk.  If the triangle in JNK breaks on the downside and LQD continues higher it will signal caution is warranted.

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The bullish percent index is telling us that there are still a lot charts that were broken early in the year that haven’t recovered.  It will warn if the 60% level is broken on a weekly basis.

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The percent of stocks above their 200 day moving average has a good headline number at 80%, but the underlying stocks aren’t in a great position to hold up the market if it starts to fall. Take a look at how much damage was done in January when SPX only dipped a bit more than 6% and again in April on a 5% dip. This tells us there are a lot of stocks very close to their 200 dma so it won’t take much downside to hurt this indicator badly.  I use the 60% level to get me concerned.

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Finally, the NYSE Advance Decline Line (NYAD) is evidence that so far this has simply been normal rotation and profit taking.  Of course, if your portfolio was weighted towards momentum names it hasn’t felt that way the past few months.  Nevertheless, NYAD will need to break its recent trend for the market to turn down in a serious way.

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Conclusion

It’s time for a direction and we’ve got plenty of things to watch that will help us safely navigate the move. A break of the recent range, sentiment from active market participants, and breadth will provide the best information over the next few weeks.

 
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