Month: March 2013

Yesterday I was talking with my firm’s Chief Investment Strategist about the market internals that have been weakening and the likelihood of the S&P hitting a new high. I realized that the market is simply playing a game of Jenga. We all remember playing Jenga, taking your turn to pull out a piece and setting it on top with the hopes that the tower wouldn’t come crashing down. The equity market’s tower has been getting taller, but just like in Jenga – the base has been weakening.

I discussed last week the charts that were concerning me regarding the integrity of the advance taken by stocks. In the short-term this is okay, the tower can still get taller with each brick that’s removed and put on top and we live to fight another day. But at some point the tower’s base becomes compromised and it topples, to what degree of damage is done is unknown and not something we can predict or focus on.

I would be very surprised if we don’t break above the 2007 peak in the S&P. It’s often said that stocks are attracted like a magnet to round numbers, and the same could be said with new highs. We could very well see a few points over the ’07 peak as the last few reluctant buyers step in. However, we still must contend with the dilapidated base and the risk associated with those last few S&P points (Jenga bricks) we need to get to a new high.

One of the great things about technical analysis is the ability to allow price to shine the light and lead the way down the path of investing. Technical Analysts don’t have to worry about ‘fair value’ ‘cash flow’ or ‘historical earnings’. We have the ability to recognize the yellow flags the market shows us and wait and see if price confirms. I’ve been discussing these yellow flags of concern for the last two months or so, I would have thought we’d see some form of price reaction, but by not being trigger happy we can sit patiently and let the price action do it’s thing. Will we break the high? Like I said, I would be surprised if we don’t. But that doesn’t erase the risk of the market’s game of Jenga toppling over at some point.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+.

Each night as I go through my chart deck there are a set of charts that keep drawing my attention. These are setups involving divergences in breadth and risky assets that pose risks to dismantling the rally we’ve enjoyed since the end of last year. I’ve been fairly vocal for my distrust of this rally but have allowed price to dictate my opinion. However, these price charts are what are beginning to change my stance on U.S. equities.

So let’s get into it….

First up we have the Summation Index. This is a simple indicator that adds up the McClellan Oscillator readings, which looks at the net advancing issues. A divergence of this indicator warns us that a rally is being led by fewer and fewer advancing stocks, meaning breadth is narrowing.

On the bottom panel of the chart below we have the ratio between the high beta ETF ($SPHB) and the low beta ETF ($SPLB). This relationship can give us an idea of the health of the ‘risk on’ trade. When high beta stocks are outperforming their low beta counterparts we can have stronger trust in the continuation of an equity advance. But when the line begins to drop (as it has been for the last month) then we can see traders shifting into lower beta names as they potentially seek protection while still maintaining an equity allocation. As the chart shows, when both of these instruments have diverged from price, a correction has followed.

Next up we have the Relative Strength Index (RSI) of the relationship between stocks ($SPY) and bonds ($TLT). While equities in general (based on the S&P 500) have been hitting new highs, the momentum of $SPY:$TLT has been waning – putting in lower highs. Which leads us to believe there is some deterioration taking place in the outperformance of equities against fixed income. Like the previous chart showed, this type of divergence has not fared well for a continuation of equity appreciation.

The last chart I want to show comes from the Short Side of Long, one of my favorite blogs. Tiho posted some great sentiment charts he put together from the latest Merrill Lynch Fund Manager Survey. The chart below shows the equity weighting of fund managers hitting a high that has only been seen twice in the last seven years (2010 and 2007). It appears global fund managers have nearly all positioned themselves on one side of the stock market’s teeter-totter, leaving practically no one to push their side higher.

So these are some of the charts that are concerning me in regards to equity risk. I also tweeted out a chart of the falling percentage of stocks above their 50-day moving average, another bad sign for stocks. I’m not here to top tick the equity market or persuade you from having an equity allocation, but these setups don’t bode well for stocks, and we’ll see if Mr. Market decides to give them any credence.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+.