Chasing And Whipshaws

Over the past week we got more of the same from the indicators I follow.  The market chopped around and our indicators had a slight decline.  Market participant appear to be chasing price and being whipsawed by choppiness.  This action is showing up in market internals.  An example  is the ratio between near term volatility (VIX) and mid term volatility (VXV).  On a daily chart it moved above 1.0 signalling caution right at the low of the last dip.  Then when it moved back below .9 (usually signalling “all clear”) the market lost momentum and looks to be rolling over again.

The weekly chart of VIX vs. VXV shows two caution signals (above 1.0) since the first of the year that occurred on small dips in price. In addition, both VIX and VXV are making lows above all of the 2013 lows.  This indicates not only increased caution by market participants, but a bit of skittishness.  It is reacting much the same as measures of breadth that I’ve mentioned since the first of the year where small moves in price cause large swings.

Many of our indicators that warn of a rotation to safety and away from risk are starting to urge caution as well.  These indicators started diverging in late December and are falling like dominoes with a new one warning almost every week. An example is the divergence between high quality bonds and junk bonds.

Our measures of risk continue to show rising caution by investors, but not outright fear.  They are reacting more in line with price than our other indicators, but diverging.  This was a pattern during most of 2013 which resulted in a rising market and no signals from our market risk indicator.   This is why we have a modestly large market hedge instead of an aggressive one (using puts or volatility). Currently,  I suspect our market risk indicator will be the last to signal if the market accelerates downward, but I don’t expect it to lag by much.

Our Twitter sentiment indicator for the S&P 500 Index (SPX) is painting the same pattern of chasing and whipsaws like many of our other indicators.  The consolidation warning of a few weeks ago came right at a market low and now it has been cleared right before the market appears to be turning over again.  Smoothed sentiment broke below its last low and its confirming uptrend line at the market low then rallied above its last peak and down trend line right at a short term high.

Support and resistance levels gleaned from Twitter are starting to show uncertainty instead of the fear from recent weeks.  Tweets for prices above the market are slow in coming with most of them targeting recent highs or 1900 on SPX.  Below the market the calls are mostly for the last lows with a few more at 1800 and the 200 day moving average near 1770.  When the majority of tweets come at the levels of the last highs and lows it indicates traders are uncertain or playing the range.

One indicator that has refused to be whipsawed is quantified messages about volatility (VIX) from the StockTwits stream.  Every time volatility falls this indicator bounces at it confirming uptrend line.  It is still indicating that volatility will rise.

Sector sentiment has a late stage / defensive look with Basic Materials, Industrials, Energy, and Consumer Staples showing the most strength. While Consumer Discretionary and Technology show weakness.

Overall sentiment mirrors the majority of the other indicators we follow at Downside Hedge.  Market participants are uncertain which is resulting in chasing and whipsaws.  These conditions urge caution.

Conclusion

The choppy market continues with a slow deterioration of our indicators. Market participants are showing a low tolerance for risk, without signs of fear.  The prevalence of chasing and whipsaws tell us the market could go either way quickly if people pile on to a move.  We’re either rounding out a top or continuing to digest gains from the 2013 rally.  I don’t know which (and frankly I don’t care…which is the beauty of hedging).  We’ve currently got a modestly large market hedge against a portfolio that we believe will out perform the market on a sustained rally.  In addition, we suspect our risk indicator will signal quickly if the market starts to accelerate lower.  As a result, we’re comfortable waiting for a resolution before getting more aggressively long or hedged.