Baseline Analytics Blog

Market risk assessment tools and tactical investment opportunities driven by curated financial insight

TrendFlex Market Trend Risk Assessment - 12/27/2016

As equities reach new highs, several market trend risk indicators as measured by our proprietary TrendFlex system are underscoring the risk to long positions at this stage of the rally.

Our flagship TrendFlex Classis CR (credit risk premium indicator) is about as bullish (for equities) as it can be, which can be interpreted as a contrarian signal.  We are firm believers in "reversion to the mean," and as the chart below suggests, the wide gap between the ratio of corporate vs. treasury debt versus its moving average (dotted line) calls for a possible pause in the equity uptrend.

TFCCR12232016

The weekly version of the TrendFlex CR similarly demonstrates today's extreme readings:

TFACR12232016

No doubt that the charts above are wildly bullish.  Although we are trend followers, we take very seriously the indicators that measure the risk of a trend change.  

Baseline Analytics Extremes highlights three key TrendFlex Indicators and their level of extremes.  The key indicators include the following:

  1. CBOE VIX and Put/Call Ratio
  2. TED Spread
  3. LQD vs. S&P 500 GAP reading

Here is what these indicators are telling us, following the market close of 12/23/16.

The Vix/Put Call Gap versus their respective moving averages measures complacency among traders and investors. Note the VIX (top portion of chart below) falling well below its moving average.  As can be seen on the chart, such gaps below (and above) its moving average tend to precede shifts in the S&P 500. VIX is hinting at a potential setback in equities.  Interestingly, the Put/Call ratio is neutral.

VIX12232016

The TED Spread is a measure of perceived credit risk in the US Economy.  Peaks in the spread (see blue areas in bottom of chart below).  This indicator has preceded shifts in the market trend rather consistently over the timeframe displayed below.  It may be hinting at a firming of Treasuries following their rather sharp selloff since peaking in July.

TED12232016 

Finally, the gap between our LQD/S&P 500 ratio (a derivative of the Trendflex CR indicator) is sitting at an extreme low (see bottom portion of chart below).  This large gap suggests that equities have moved too far too fast and are in needs of a consolidation of recent returns.  

LQD Gap 12232016

We have also previously noted the progress in the Dow Theory technical indicator.  The two indices  (Dow Jones Industrial Average and Dow Transportation Index) recently hit new highs, a traditional technical measure of a confirmed bull market.  Again, however, we harken to a cautious stance given the swiftness of this move upward and the extreme readings in our various indicators.

Dow122316

What to do? Think about wading into long positions in instruments that have swooned during this uptrend (perhaps small positions in bonds, gold, agricultural commodities) to diversify and dollar-cost average.  Europe and emerging markets are also beginning to look interesting (perhaps VGK and EEM will play catch-up to the US). Hedging long positions with e-Mini S&P 500 futures may be in order, as well as selling call options.  

Equities have tended to do well in the week before the holidays and afterward, but have consistently slipped as the new year dawns.  We would rather hedge our bets and look for prices to settle down before adding to long positions, as the major indices, although overbought, are clearly bullish.  

Best to your investing, and Happy New Year!

Mr. Palmerton is the Founder of Baseline Analytics, and has 30 years of experience spanning corporate finance, asset management and financial markets research. He has held positions as CFO, Director of Finance, and Financial Management and Analysis roles for Fortune 500 and multi-national firms (ADP, Honeywell, Linde Group) as well as for early-stage and emerging growth ventures).

Bob founded Baseline Analytics in 2005. With the objective to utilize technical analysis of the financial markets, coupled with macro-economic trends, Baseline Analytics strives to keep investors on the right side of the market at all times. Bob developed the TrendFlex indicator, comprised of a blend of financial indicators that assess the risk of a change in market trend. Baseline Analytics’ TrendFlex models are utilized as the basis for asset allocation strategies of The Absolute Return Market Trend Portfolio. Mr. Palmerton’s articles and blogs can be found on Seeking Alpha, Finding Technicals and Baseline Analytics.

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