posted on 23 May 2016
by Lance Roberts, Clarity Financial
I want to update what I wrote last week:
While on Monday of last week the market did rocket above the 50-dma, it was unable to hold that level this week with Friday's rally failing at that resistance. The 2040 level is now an extremely critical level of support in what appears to be a fairly significant topping process.
As I discussed in Tuesday's "Technically Speaking" post:
It will be critical for the market holds 2040 next week and rally back above the 50-dma in order to continue the bullish bias.
One interesting aspect of the rally over the last couple of months is that it has not substantially changed the outlook of individual investors about the market. While individuals remain skeptical of the recent rally, the sentiment of professionals has rocketed higher. The chart below is the ratio of individual to professional bullish sentiment.
This is interesting because while individuals remain skeptical of the recent rally, they have not changed their asset allocations to a more defensive posture.
In other words, while they are concerned about a potential "bear" market, they are unwilling to do anything about it due to "fear of missing out." The Federal Reserve has apparently completed its mission of convincing the vast majority of the population that "stocks can no longer go down."
This is potentially a dangerous concept. The chart below is a composite index of both individual and profession net bullish sentiment.
The recent downward spike in net bullish sentiment was quickly reversed. While many have pointed to high levels of "bearish sentiment" as a sign of a "major market bottom," the quick recovery back to high levels of net bullish sentiment suggest differently.
As noted above, the quick recovery of bullish sentiment is more again to what was seen during the topping process of the market in 2007. During a more protracted "bear market," net bullish sentiment tends to remain extremely negative as the decline proceeds.
It is worth noting that the composite bull/bear ratio hit the highest levels in the composite's history as QE3 ran its final course. The reversal in sentiment, as stated above, seems to be more akin to the previous topping process than just a correction within an ongoing bull market.
But like I said above.
USD Breaks Above Resistance
Two weeks ago, I suggested that the decline in the US dollar had neared completion and that a sharp reversal was likely.
Well, with the revelation of the recent FOMC minutes the worries about a June rate hike, as suspected, have indeed surfaced sending the US dollar spiking above resistance.
If this rally in the dollar continues higher, it should coincide with a further decline in the major market averages and specifically the basic materials, industrials and energy based sectors.
Let me repeat again from last week:
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.
I have not been, or am I currently, convicted about the potential of the market for a further advance from here. Again, this is why allocation models remain extremely underweight equity risk exposure currently.
Short-term portfolio management instructions currently remain:
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 several weeks, RISK based sectors outpaced performance relative to SAFETY. However, starting last week and continuing this week, that level of outperformance has begun to fade.
The rotation from defensive to "risk on" sectors is now complete and potentially signals a further short-term correction in the market is possible. However, for now:
The sector comparison chart below shows the 9-major sectors of the S&P 500.
In other markets warnings are also developing:
As stated above, complacency in this market could be dangerous to your financial health.
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.
Last week's market action was a direct reflection of the Fed's FOMC minutes. Financial stocks picked up in performance while Staples, REIT's and Utilities sharply declined. The movement in the interest rate sensitive sectors of the market was not unexpected as interest rates ticked up in anticipation of a June rate hike.
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 17 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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