I analyze macroeconomic issues from a fundamental perspective, and I analyze market behavior from a technical perspective. Original macroeconomic analysis can be found here and both macro analysis and commentary can be found on my Caps blog. If you like or appreciate my analysis, please add yourself to my Following List

Thursday, June 24, 2010

You say goodbye and I say hello, Another look at an old friend: Risk

Over a month ago I wrote this post: A look at an old friend: Risk and had this to say:

There are many ways that we measure "risk" in the market. Most of it is actually not risk, but measures of volatility that people ascribe to risk. But things like the Beta and trends in the VIX are used to describe the risk environment (the volatility environment). I have talked about the VIX many times (such as Impressive VIX and VIX-Sentiment). And I am interested in another topic today.

Equity Risk

Looking at the movement of Small Caps relative to Large Caps can be very informative. Small Caps are much more volatile and during the good times can juice your returns (and during the bad times can crash like, well ... small caps during 2008).

But these moves are based on herd behavior. The herd is always very bullish at market peaks and very bearish at bottoms. So looking at when Small Caps are richly valued relative to Large Caps describes when bullishness becomes uber-bullishness and can be the precursor to a trend change. This is another indirect sentiment measure that I like.

In particular, when I look back over the last few years, the ratio of the Dow Industrials to the Russell 2000 reaches a certain level when trend changes occur. The ratio is at that same level currently. And the market is saying "I AM SUPER BULLISH!!!". Lots of talk about going to new highs is funneling money into more speculative issues, like junk bonds, homebuilders and yes small caps.

Which says to me: The risk environment is extreme.

Good luck out there.

Here was the chart from that time:

The market continues to break down and we have several bearish developments

1) Volume on the down moves are *much higher* than the volume corrective rallies back up
2) Many, if not the majority, of major indices (international and domestic) have been making lower highs and lower lows for the past few months
3) Many of the US indices have closed below their 200 day MAs for weeks
4) Last week on a break back above the 200 day MA, it tested the 50 day MA from underneath *and failed* (this is quite bearish). This is true for the SPX, INDU, NYA, RUT, COMPQ, and NDX
5) Many ETFs are showing death crosses (50 day MA below the 200 day MA) but we now have a major US index showing the same behavior: The NYSE Composite (NYA)
6) Many international indices are showing the same behavior: CAC 40, IBEX, NIKKEI, SSEC (Shanghai), HSI, etc. The are not small indices, this is a big deal

I could point to a whole host of fundamental factors as well, but those are well-documented in my Caps blog. The real point is to show that we are in the midst of a trend change. Does that mean we go into crash mode? Maybe, maybe not. But I think this is a possibility you should be cognizant of and at least prepare for in the way of reducing exposure to risky issues.

At any rate, here is my updated risk chart. It is saying that risk is most definitely increasing

Oil Chart

Short term looks like it could be bearish

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