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Friday, March 18, 2016

Last chance to reduce equity exposure before the bear market really gets going?

As you all know I believe the VIX is telling us we are in a bear market.  I am also convinced that some of you probably do not believe that.  I have talked about evidence of a recession and a bear market at times, but I am going to put all the information I have together here.  I will also be showing an indicator I developed last year that I have not shown yet.  I wanted to make sure I could interpret it in real time before doing so.

Lets start out with a look at the last two major tops with SPX and DJ15 (utilities).  As odd as that sounds I think you might find this chart interesting.

The vertical lines mark the month SPX made its final high.  The green arrows mark the month the utilities made their final high.  Notice it came after SPX in both bear markets.  Here we are again with the utilities at a new high and SPX is not.  It was after that final new high in the utilities that SPX really started to tank.  If we turn down again I think the bear will really get going this time.

Here is another chart I showed quite a while back.

This is the number of NYSE stocks which have their 13 month EMA above their 34 EMA.  In the 30 years of data I have dropping below 60 has been followed by a recession,.  That recession was not necessarily right away though.  It fell below 60 last Sept. so it has already been there for a while.  It had little to no lead time in 1990 and 2008, but a long lead time in 2000.  We have a long lead time now.  How many times have I commented on how this market reminds me of 2000?  The data has us on recession watch because of weakness.  This chart says a recession in the near future is probably unavoidable.

I have always believed there was a lot more information contained in the NYSE advancing and declining data that I was not getting.  I decided to see if I could figure out a better way to look at it.  I think I found some truly meaningful information.  I have been using the short and intermediate versions of this indicator for a while now for index swing trades quite effectively.  I decided to play around with long term versions to see if it could give me some information about bull and bear markets.  I think it works pretty well.  I call it Traderbob's bull/bear pressure. This works on the daily data and the data goes back to 2000 so it covers both major tops this century.  Here is the chart with just the long version.  Now that the cat is out of the bag I will show it in the daily update with the short and intermediate versions as appropriate.

This indicator has two lines.  The green one is buying pressure and the red one is selling pressure.  Notice the sell off last Aug. and again this year sent the red line will above the green line at the peak of the rally last fall. This is key.  Lets look at the prior too bull market tops and we will see the same pattern.

It would have been nice if the data had gone back to 1999 so I could see the full top formation.  What we can see though is the same pattern.  The sell offs in the fall of 2000 and spring of 2001 saw the red line higher then the green line in the Jan. 01 rally.  If I had data further back it is possible the indicator would have given an earlier warning, but I don't know.  Lets look at the 2007 top.

The same pattern showed up with the sell off in Jan. 08.  That bear market really got its claws after the peak in May 2008 not shown on this chart.

There is a constant theme in the nearly 16 years of data I have on this indicator.  During bull markets, rallies show the green line climbing above the peak of the red line in the pullbacks.  During bear markets the green line always falls short of the red line peak.  Once that red line peak from the last bottom is eclipsed the next bull market is on.  This indicator gives fairly early confirmation of a new bull market.

This next table is very interesting.  I can't remember if I have shown it on the blog before or not.  I think I did.  Anyway here it is.

This chart clearly shows that high valuation and recessions lead to very big sell offs.  We can also see we are at the second highest valuation in history. 

Lets review the situation.  The VIX and my bull pressure indicator both say we are in a bear market.  The bull pressure indicator says this rally is probably the last chance to reduce equity exposure.  We know historically that recessions and high valuation are a seriously negative combination.  The monthly 13/34 chart indicates a recession in the near future is highly likely.  The more money you have and/or the older you are the more important it is to review your current equity exposure.  The older you are the less time you have to make up for big drawdowns.  Current valuations indicate it could be a decade or more before we get back here again if we do indeed have another big sell off.  Do you have that kind of time?  The market is giving us a gift exit here.  I believe down the road people that don't take advantage of that will be sorry.  The odds of an upside break out and further bull market seem extremely small to me.  The risk/reward seems heavily skewed to the downside.


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The information in this blog is provided for educational purposes only and is not to be construed as investment advice.