Duck and Cover?

Momentum divergences are a good indicator of weakness and warrant serious attention. In the clips below I highlighted the situation today as well as similar divergences going all the way back to 1990.

This indicator isn't perfect, but even if you took short positions, you wouldn't have been hurt much after false signals. Obviously it makes sense to use tight stops because if you're wrong, you'll find out very soon after a position is taken.

When my timing model is signaling a heavy equity allocation, as it is right now, I'll use a double inverse fund as a hedge.

The hedge is on.

Week of 7-26-2009

Timing Model = 3.5

100% long, 0% cash

Global allocation of long positions

MSCI EAFE Index 20%

MCCI Emerging Markets Index 40%

Russell 3000 Index - U.S. 40%

Top U.S. Sectors

U.S. Technology 3.5

Composite Internet 3.0

U.S. Semiconductor 2.5

U.S. Pharmaceuticals 2.0

U.S. Micro Cap 2.0

Mid Cap Growth 2.0

U.S. Oil Equipment, Services & Distribution 2.0

U.S. Basic Materials 2.0

Top Intl. ETFs

MSCI All Country Asia ex Japan Index Fund 2

MSCI Singapore Index Fund 2

FTSE/Xinhua China 25 Index Fund 2

MSCI Hong Kong Index Fund 2

MSCI South Africa Index Fund 2

MSCI Brazil Index Fund 2

MSCI Emerging Markets Index Fund 2

FTSE China (HK Listed) Index Fund 2

MSCI Austria Index Fund 2

Strategy 3

Money Markets 10%

Emerging Markets 10%

Precious Metals 10%

Industrial Materials 10%

EAFE 10%

U.S. Small Caps 10%

U.S. Large Cap 10%

International Real Estate 10%

U.S. REITs 10%

Energy 10%

Strategy 4

Money Markets 20%

Emerging Markets 20%

Precious Metals 20%

Industrial Materials 20%

EAFE 20%

I thought we would see some profit-taking this past week, but momentum continued to push prices higher. Short-term indicators are signaling the market is overbought, but overbought conditions never signal an immediate turn in prices.

Intermediate term sentiment is neutral but beginning to gravitate towards overly optimistic levels. Trend direction is the main driver in my timing model right now. So long as the S&P 500 and Value Line Composite can stay above their 75/200 day moving average, and sentiment stays neutral, my model will signal heavy exposure to equities.

I still believe we may see lower prices over the short term, but I would not be taking any short positions in an environment like this. There is just too much cash on the sidelines waiting for a pull back opportunity.

Strategy 4 revised

I've decided to change Strategy 4 a bit, which will presumably make the equity curve a bit more stable than the current version. If you recall, the current model takes 25% positions in the top 4 asset classes based on their past 90 day, 180 day, and 252 day momentum.

The new version is very similar, but with a twist: each asset class earns model points based on indice/eft's relationship to it's 200 day moving average, 75 day moving average, and 15,9 TRIX. Obviously there is a momentum element to trend indicators, but there is also a directional element.

First, I want to identify the top 4 asset classes for each time period (90,180, & 252). Each asset class with the 4 highest returns will recieve one point. This strategy is based on the findings of numerous well-known research papers asset class and sector momentum, studies that show past winners tend to continue outperforming in subsequent months.

Second, each asset class that is deemed in an uptrend by each trend indicator recieves a point. The concept behind this approach is to insure top sectors are also trending as well or better than the rest of the group.

In the clip below you'll notice Emerging Markets as measured by ishares MSCI Emerging Markets ETF (EEM) is above both it's 75 and 200 day moving average, but still below it's TRIX trigger line. Emerging Markets (EEM) scores 5 for 6 possible points in my model, and is also the top ranked asset class.

You will also notice in the clip below that Agricultural commodities, as measured by the PowerShares DB Multi-Sector Commodity Trust Agriculture Fund (DBA) has zero total points, and ranks last in my model.

I have decided to add money markets as an equal position as part of this strategy, giving each position a 20% weight. There is are a couple reasons for this: 1) reduce the volatility of the overall portfolio AND 2) provide a means to quickly switch into a new asset class without dealing with brokerage settlement delays.

There are a few additional rules I wanted to throw into the mix:

• Asset class ties will be decide by highest momentum scores first, followed by trend score in this order (200dma, 75dma, TRIX). If there is still a tie, the asset class choice for the 4th positon will be subjective.
• Asset classes in the top 4 ranks that fail to signal an uptrend in any of the 3 trend indicators will take a cash position. Theoretically, although highly unlikely, the portfolio can hold 100% cash at any time. This rule will also reduce volatility without having an enormous impact on returns.

Below is a screenshot of my Excel worksheet.

Week of 7-19-2009

Timing Model = 3.0

100% long, 0% cash

Global allocation of long positions

MSCI EAFE Index 20%

MCCI Emerging Markets Index 30%

Russell 3000 Index - U.S. 50%

Top U.S. Sectors

U.S. Technology 3.5

U.S. Health Care 2.5

U.S. Semiconductor 2.5

U.S. Pharmaceuticals 2.0

U.S. Biotechnology 2.0

Composite Internet 2.0

U.S. Micro Cap 2.0

Mid Cap Growth 2.0

U.S. Oil Equipment, Services & Distribution 2.0

Top Intl. ETFs

MSCI All Country Asia ex Japan Index Fund 2

MSCI Singapore Index Fund 2

FTSE/Xinhua China 25 Index Fund 2

MSCI Hong Kong Index Fund 2

MSCI South Africa Index Fund 2

S&P Latin America 40 Index Fund 2

MSCI Brazil Index Fund 2

MSCI Emerging Markets Index Fund 2

MSCI Sweden Index Fund 2

FTSE China (HK Listed) Index Fund 2

Strategy 3

Money Markets 11%

Emerging Markets 11%

Industrial Materials 11%

International Real Estate 11%

Precious Metals 11%

U.S. Small Caps 11%

U.S. Large Cap 11%

EAFE 11%

Energy 11%

Strategy 4

Emerging Markets 25%

Industrial Materials 25%

International Real Estate 25%

Precious Metals 25%

My timing model tacked on more long exposure throughout the week at the S&P 500 moved decisively away from it's 200 day moving average. Sentiment is all but neutral - the advisor and investor sentiment polls are the only thing signaling any degree of caution.

We are extremely overbought on a short term basis and I would expect to see some profit taking this week. Overall, my best guess is equities will trade in a range somewhere between 850-1000 for the next couple months. The S&P 500 and its 75 day moving average should be monitored closely.

Up, up and away?

Yesterday the S&P 500 closed above both it's 200 and 75 day moving average, boosting my timing model to a +1.0, signaling 70% long. If the 5 day moving average can do the same, my model will go to +2.0, or 90% long.

Trend indicators are prone to whipsaws, but it's important to stay on your toes and in sync with the market. I have no idea where we will go from here, but if it's up I don't want to be chasing it from much higher levels.

880 looks to be a significant support level right now.

Week of 7-12-2009

Timing Model = -1.0
30% long, 70% cash

Global allocation of long positions
MSCI EAFE Index 20%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 50%

Top U.S. Sectors
U.S. Technology 3.5
U.S. Micro Cap 3.5
U.S. Health Care 3.0
U.S. Semiconductor 3.0
Composite Internet 2.5
U.S. Biotechnology 2.0
U.S. Consumer Services 2.0
Mid Cap Growth 2.0

Top Intl. ETFs
FTSE China (HK Listed) Index Fund 3
MSCI All Country Asia ex Japan Index Fund 2
MSCI Taiwan Index Fund 2
MSCI Singapore Index Fund 2
FTSE/Xinhua China 25 Index Fund 2
MSCI Hong Kong Index Fund 2

Strategy 3
Money Markets 12.5%
Emerging Markets 12.5%
EAFE 12.5%
Industrial Materials 12.5%
International Real Estate 12.5%
Energy 12.5%
U.S. Small Caps 12.5%
Precious Metals 12.5%

Strategy 4
Emerging Markets 25%
EAFE 25%
Industrial Materials 25%
International Real Estate 25%

The S&P 500 closed just below it's 200 day moving average on Friday, but sentiment has become more neutral, resulting in a 30% long equity exposure. Needless to say, if the market rallies this week, equity exposure will rise. If the market falls, equity exposure will follow suit.

I have no gut feeling at to where the market will head next. The short/intermediate term indicators suggest a rolling over is taking place, but this could also be a head fake similar to what we've seen in past early bull markets.

Asian equities are dominating the foriegn ETF momentum rankings and Emerging is far outpacing U.S. and EAFE. It will be interesting to see if this can hold.

Trend Ambiguities

Today the S&P 500 closed below both it's 75 and 200 day moving average. If it holds tomorrow, my timing model will fall to -.5 or a 40% long equity exposure. This is a good example of one of the headaches one sees with trend indicators - potential whipsaws. This is especially true when two triggers are so close to one another.

Note, if the SPX 5 day moving average also falls below both longer term moving averages, my model will signal going to 100% cash. Keep in mind negative sentiment is fading, so if the status quo holds to the weekend, there would surely be some long exposure.

Week of 7-5-2009

Timing Model = 1.5
80% long, 20% cash

Global allocation of long positions
MSCI EAFE Index 30%
MCCI Emerging Markets Index 30%
Russell 3000 Index - U.S. 40%

Top U.S. Sectors
U.S. Semiconductor 3.0
U.S. Technology 3.0
U.S. Oil Equipment, Services & Distribution 3.0
Mid Cap Growth 2.5
U.S. Biotechnology 2.5
U.S. Micro Cap 2.0
Composite Internet 2.0

Top Intl. ETFs
MSCI Hong Kong Index Fund 2
MSCI Brazil Index Fund 2
MSCI All Country Asia ex Japan Index Fund 2
S&P Latin America 40 Index Fund 2
FTSE China (HK Listed) Index Fund 2
MSCI Singapore Index Fund 2

Strategy 3
Money Markets 11%
Emerging Markets 11%
Precious Metals 11%
Industrial Materials 11%
EAFE 11%
Energy 11%
U.S. Small Caps 11%
Internatiional Real Estate 11%
U.S. Large Cap 11%

Strategy 4
Emerging Markets 25%
Precious Metals 25%
Industrial Materials 25%
EAFE 25%

Not much has changed since last week. I'm still focused on the S&P 500 and it's relationship to it's 75 and 200 day moving average. Sentiment is still slightly negative but will be less of a factor over the coming weeks. The tape is critical here.