Discipline Amid Fear

As we suspected last week the market was poised to rally to new highs in the absence of bad news. The early August dip had our risk indicator showing concern, but or core indicators held steady. The recent events provide a good example of maintaining discipline when fear enters the market. Even though we saw a lot of ancillary indicators and our risk indicator getting close to warning we held our portfolio allocations steady. The reason for this is that our core indicators weren’t substantially affected by the dip in the market. This past week all of our core indicators with the exception of the economy rose. This keeps us 100% long in all portfolios.

I only see a few concerning things at the moment. Small cap stocks (Russell 2000 – RUT) continue to under perform and indicates that investors are reducing risk. This in conjunction with the sharp declines in momentum stocks during the first four months of the year warns that a longer term top may be in the making. We want to see the negative divergence in RUT repaired to confirm that the market can move substantially higher.

The Trade Followers social media indicators cleared their consolidation warning for the S&P 500 Index (SPX) on 8/14/14, but is now showing some frothy readings. High readings have often marked short term tops so we may have a bit of choppiness before moving higher.

Breadth indicators are confirming the move higher so the odds favor a continuation of the rally. Both the NYSE advance / decline line and the percent of stocks above their 200 day moving average are moving sharply higher. As I’ve mentioned all year, it’ll take a break down in breadth to take the market substantially lower.

Conclusion

Odds favor higher prices but we may experience a bit of sideways action near the 2000 level on SPX before moving higher. The under performance of small cap stocks and the profit taking in momentum stocks early in the year have us on alert for a longer term top being made. But tops are a process so we won’t take action in our portfolios unless we see weakness in or core indicators.