Equity Market Snapshot 01-23-2015

The recent increase in volatility has raised serious concerns among many traders and investors. The following article applies several different technical indicators to the S&P 500 Index (SPX) in the daily and monthly time frames. This article will replace the regularly scheduled Thursday post.

SPX Daily Analysis through 01-23-2015

The top panel in Figure 1 below is a daily candlestick chart of the S&P 500 index (SPX).  The blue and violet lines are 21-day and 40-day moving averages respectively. The red line represents the CBOE Skew Index (axis not shown).  The blue line in the second panel is my proprietary cumulative relative-strength market timing indicator (RSMTI).  The violet line represents an intermediate-term moving average of the RSMTI and the dashed green line depicts a short-term moving average of the RSMTI.  The red and green histogram bars depict the weekly changes in the cumulative RSMTI. The blue line in the third panel represents the accumulation distribution indicator and the violet line illustrates a moving average of the accumulation distribution indicator.

The blue line in the fourth panel represents the cumulative advance-decline line for the combined NYSE, NASDAQ, and AMEX exchanges.  The other lines in the fourth panel represent moving averages of the advance-decline line.  Finally, the blue line in the bottom panel represents the normalized short-term deviation of the advance-decline line and the violet line depicts its moving average.  The red and green horizontal lines identify overbought and oversold thresholds that frequently identify probable reversals or consolidations.

Now, let's draw some conclusions from the chart. Rather than discuss all of the indicators, which I typically do in the Equity Market Snapshot, I want to focus on the RSMTI indicator. The RSMTI is one of my favorite and most reliable leading equity market indicators. It evaluates the relative performance of pairs of securities that reveal the strength of the equity market.

The cumulative RSMTI crossed below its 21-day and 40-day moving averages in late November of 2014 and has remained below the moving averages for two consecutive months. This region is surrounded with the dark-red rectangle.  During that time, the SPX has made repeated attempts to break out with no success. Until the RSMTI begins to improve, the equity market will not be able to mount a sustained rally.

During the two month period, the normalized short-term deviation of the advance-decline line (fourth panel) identified two high probability reversals, one bullish (green vertical line) and one bearish (red vertical line). Given the negative trend in the RSMTI, the bearish reversal in late December of 2014 would have been particularly attractive.

Figure 1: SPX 20150123 Daily

Figure 1: SPX 20150123 Daily

 

RUT Monthly Analysis through 01-23-2015

The Monthly candlestick chart for RUT is depicted in Figure 2 below.  The five panels contain the same indicators as Figure 1. As was the case in the daily analysis above, I want to focus on the RSMTI. The relative log-return of the RSMTI for January 2015 (month-to-date) was -9.28%.

 

Figure 2: SPX 20150123 Monthly

Figure 2: SPX 20150123 Monthly

Since 2006, only six calendar months have generated RSMTI levels approaching or exceeding the current RSMTI value of -9.28%, three of which are shown on the monthly chart above. Below are the months, the RSMTI levels, and the SPX monthly returns.

Figure 3: Extreme RSMTI 2000-2015

Figure 3: Extreme RSMTI 2000-2015

In the five previous months that the RSMTI approached or exceeded the bearish extreme value of -9.28%, the average SPX return was -9.10% and the monthly SPX returns ranged from -5.70% to -16.9%. What I find particularly troubling is that the month-to-date SPX return in January 2015 is only -0.30%. Each of the previous months experienced a significant decline in the SPX.

Conclusion

While it is never wise to assign too much weight to any one indicator, the magnitude of this divergence in January 2015 is startling, especially for such a reliable indicator. To eliminate the divergence, the equity market would need to pullback, the RSMTI would need to reverse direction, or both.

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About Brian Johnson

I have been an investment professional for over 30 years. I worked as a fixed income portfolio manager, personally managing over $13 billion in assets for institutional clients. I was also the President of a financial consulting and software development firm, developing artificial intelligence based forecasting and risk management systems for institutional investment managers. I am now a full-time proprietary trader in options, futures, stocks, and ETFs using both algorithmic and discretionary trading strategies. In addition to my professional investment experience, I designed and taught courses in financial derivatives for both MBA and undergraduate business programs on a part-time basis for a number of years.
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