Weekend Update: Mixed Market Turns Negative

It was another nasty week for the markets. The SP500 confirmed the breakdown signals we have had from the Nasdaq and Russell 2000 over the past month; the large-cap stocks finally followed through with the broader market weakness.

This violation of the intermediate term trend doesn't mean sell everything and hide, but does signal a "no new stock entry" environment. Everyone has a different strategy on how they deal with corrections in the market. Some sell everything based on the health of the market averages, some proceed as if nothing has changed as long as their individual stocks keep holding up, and others do a little bit of both. My plan for dealing with corrections is to continue to hold onto my winners provided they are above their stops, but no longer take new stock* entry signals while the averages are below their trend levels. Roughly 4 out of 5 stocks trade with the market. Meaning if the market trades lower, 4 of 5 stocks will follow the averages lower. Its not that we can't pick winners in that kind of environment, but the risk vs reward is skewed against us and I simply choose to wait for better probability scenarios. It is important to understand that you don't always need to be trading, often it is better to sit on your hands and wait for the dust to settle...Cash is a position too.

Risk is significantly elevated, this doesn't mean stocks are going to crash from here (though they certainly could) but our probabilities of success are much lower.  Momentum indicators RSI and MACD are both divergent and bearish on the weekly timeframe:

These indicators show overall strength of trend direction and momentum. You can see for the SP500 that both of these indicators failed to reach higher highs when prices did on the last advance. A divergence by itself is only a warning signal, but when price confirms the weakness and breaks down, you can have yourself an ugly situation. These charts are weekly timeframe as well which suggests this is not a short term development. The markets have been undergoing some significant technical damage recently and we will need to be extra cautious at these levels.

We have not yet seen the monthly timeframe confirm these signals which would be my ultimate sell signal. That is why I feel this is likely the near term correction I have been sensing before one final major move higher in this bull market. To restate that: I feel this is likely the Wave 4 beginning that will lead to a strong Wave 5 rally. I do not think this is THE top for this current 5-year rally. That being said, we observe ALL signals regardless of our "feelings" because we simply do not know when the next major correction will play out. Sometimes there will be false signals and we will just buy right back in on our next setup. Thats the beauty of having a strong methodology for trading the markets; if we are right and the breakdown turns into a major bear market, we will have gotten out of the way very early. If the market stabilizes and the signal is false, we get right back in once conditions improve. We take a very small risk to protect against ALL significant downside threats.

As expected with the recent weakness, we received a couple exit signals within our Portfolio heading into next week:

Exiting HAIN

We saw a full trend breakdown this week with price slicing right through the intermediate term support going back to early 2013. RS trend also failed the corresponding uptrend support for the rally. This tells me HAIN is either going to correct back down to the prior breakout level near $70 or we will see prices digest the strong gains from the last two years by moving sideways. It will take a strong stabilization and rebound to negate this intermediate term signal. We will take our substantial gains and step aside.

Reducing PBW to 1/3 holding

Clean Energy failed to hold onto its breakout and sliced through its 20 WMA. The one hope going forward is that the RS trend vs SP500 is still holding its support. We are selling 2/3 of our position and will continue to hold 1/3 until the Relative Strength fails to hold trend. While these support levels were breached this week we still have a series of higher highs and higher lows. The breakdown did not create a lower low in the dominant uptrend, so we still have some mild positives for now. We will continue to watch this space closely for any future hints.

PPG (no position change) Close Watch

While PPG technically slipped through our initial stop level this week, I am not selling just yet as the signal was very marginal. We have been watching the $188 level as support and there was a break of that this week by $.18. However RS trend is right at support and there has been a large price cluster around this area. With an uptrend like this in place I am willing to use a small amount of discretion with our position and give this one more week's grace to see what the real intentions are. PPG is on close watch.

 With this week's signals the Portfolio's current allocations are as follows:
Stocks: 41%  (AEP 3/3, CMI 3/3, WFC 2/3, UNH 2/3, PPG 2/3, PBW 1/3)
Bonds: 10%  (TLT 3/3)
Cash:   48%  (F, DDD, HAIN---no positions)

We continue to see increased allocations toward Cash and away from stocks. This is the natural rotation flow that a trend strategy enables; we let the market lead us to the proper investment allocations. This is the most defensive positioning we have had since the blog began in late 2012. Seeing that the market has been so strong for this entire time should give you some pause at these elevated levels.

With no positions in F, DDD, and HAIN the market it telling us that momentum and growth are being sold while dividend and large caps are holding up better due to their more defensive nature. In terms of trend and Relative Performance I would say our Portfolio is accurately positioned to reduce risk and capitalize on what is working in the market.

Chart of the Week

TLT (20+ Year Treasury Bond)

We've been talking about this one for a while now and it was important for Bonds to break above the $109.50 level. That level has been a major inflection point for multiple years and this week's action broke through with conviction. Of course it is notable due to bonds' negative correlation with stocks. I've said stocks could be in trouble over the near to intermediate term if bonds were able to breakout here. Well, they have. This occurs just at the time the SP500 has joined the Russell 2000 and Nasdaq with intermediate trend breakdown. I am positioned bullishly toward bonds in my accounts and will continue to do so above $106 and below $115.40.

---The bottom line is that its time to be cautious. We are not certain of any outcome in the future but as of Friday's trading, stocks are a much more risky bet. I use the charts for one primary task: To know where am I willing to transfer the risk to someone else. When an uptrend fails it logically follows that the trend is changing. If a stock is not going up I don't really care to own it. I will look for something better with a higher probability of success. Thats all this game really is; we are always looking for the highest probability of success with the least amount of risk. When the probability does not favor my position, I adjust it. All that adjustment is is a transfer of risk from my account to someone else's. I might get this one wrong, but over time the odds favor the adjustment.

*Bonds and Commodities are negative and low correlation asset classes. They can be owned at times when stocks struggle.