posted on 09 May 2016
On a short-term basis, the ongoing correction last week took the market back to its rising 50-day moving average and has worked off the overbought condition that previously existed.
Importantly, on Friday, the market defended the 50-dma and turned back into positive territory for the day.
As I have noted in the chart above, the yellow highlights point out the short-term oversold conditions which have been previously consistent with a market bounce. With the market defending the 50-dma on Friday, combined with the short-term oversold condition, a bounce early next week is likely.
However, this does not mean the markets are ready to go soaring back to new highs. As shown these bounces can, and have been, very short-lived in many cases.
The bounce on Friday was also important as the market defended the 400-day moving average as well. Just as I showed above, the combined defense of support at the 400-dma with an oversold condition suggests that markets are set up for at least a short-term bullish advance.
Intermediate-Term Setup Still Cautionary
As stated above, while the very short-term indicators suggest a more bullish backdrop going into next week, I do want to continue to issue a word of a caution:
Furthermore, as shown below, the current advance and topping process, remains in the confines currently of a "lower high and lower low" scenario. While it may not "feel" that way, we are still within the broader confines of a downward trending market. As I stated last week:
As I have repeatedly stated over the last couple of weeks the current market setup feels like a "trap." I remain cautious and already have an "inverse market" position loaded in our trading system to move portfolios quickly back to market neutral if markets break support.
In the short-term, bullish dynamics are in place giving short-term investors and traders an opportunity to put capital to work.
However, for longer-term investors, and particularly those with a short time-frame to retirement, let me leave you with the recent conclusion from Stan Druckenmiller of Duquesne Capital:
S.A.R.M. Model Allocation
The Sector Allocation Rotation Model (SARM) is an example of a basic well-diversified portfolio. The purpose of the model is to look "under the hood" of a portfolio to see what parts of the engine are driving returns versus detracting from it. From this analysis, we can then determine where to overweight sectors which are leading performance, reduce in areas lagging, and eliminate those areas that are dragging.
Over the last five weeks, RISK based sectors have continued their streak of improvements as money has flowed out of perceived areas of SAFETY.
The rotation from defensive to "risk on" sectors is now complete:
The sector comparison chart below shows the 9-major sectors of the S&P 500.
The best sectors for short-term traders to over-weight next week remains:
This is also shown in the sector analysis tables below.
S.A.R.M. Sector Analysis & Weighting
As stated above, the SARM Model is an "equally weighted model" adjusted for risk. The current risk weighting remains at 50% this week. It will require a move to new all-time highs in order to safely increase model allocations further at this juncture.
Relative performance of each sector of the model as compared to the S&P 500 is shown below. The table compares each position in the model relative to the benchmark over a 1, 4, 12, 24 and 52-week basis.
Historically speaking, sectors that are leading the markets higher continue to do so in the short-term and vice-versa. The relative improvement or weakness of each sector relative to index over time can show where money is flowing into and out of. Normally, these performance changes signal a change that last several weeks.
The last column is a sector specific "buy/sell" signal which is simply when the short-term weekly moving average has crossed above or below the long-term weekly average. The number of sectors on "buy signals" has improved from just two a few weeks ago to 10 this past week. Sectors that are on buy signals tend to outperform in the near term.
The risk-adjusted equally weighted model remains from last week. No changes this week.
The portfolio model remains at 35% Cash, 35% Bonds, and 30% in Equities.
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