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Market Indicator Explanations

Weekly Relative Strength Performance Monitor

The Weekly Relative Strength Performance Monitor presents the companies seeing the biggest and the worst changes in the WMA RS Composite Scores. Using the Relative Strength score calculations from our Trading Model, we calculate the one-day and 5-day change in the composite (short + mid-term) RS scores.  The principle here is that in bull markets some companies will see greater inflow into their stock, while in a bear markets some companies will see less less outflow from their stock. Investors can position their portfolios to stick with these relative leadership names.  The RS Monitor is best suited for investors comfortable with a momentum trading strategy.

Market Risk Indicators

The Market Risk Indicators attempt to detect changes in market participants attitude towards risk. A selection of market-based data is run in panel regressions with the variables returning the highest betas retained for inclusion in the indicator.  Two dependent variables — the NYSE Index and the DJ Stoxx 600 – are used to create a risk indicator for the U.S. market and a risk indicator for the European market. The selected variables are then re-run in an OLS regression to determine the weightings in the indicators. The variables are grouped into four clusters. First, we use binomial index pairs, with one member serving as a high beta or risk-on proxy and the other member a low-beta, risk-off proxy.  When the former strengthens relative to the latter, the pair contributes positively (greater appetite for risk) to the composite risk indicator. Conversely, when the low-beta sector strengthens relative to the high beta sector, the pair contributes negatively (lower appetite for risk) to the composite risk indicator.  The second cluster includes volatility indexes.  The third cluster is comprised of credit spreads. The final cluster groups exchange data.  The variable included are ( signifies variable in European risk model):

  • Nasdaq Composite vs. S&P 100
  • S&P Consumer Discretionary Index vs. S&P Consumer Staples Index
  • S&P Industrials vs. S&P Utilities
  • Russell 2000 vs. S&P 100
  • Nasdaq Biotech Index vs. S&P Healthcare Index
  • Philadelphia Semiconductor Index + DJ Internet Index vs. DJ U.S. Telecom Index
  • S&P 600 Small Cap Energy Index vs. AMEX Energy Index
  • IBOX High Yield Bond Index vs. U.S. 5-Year Government Bond contract
  • Stoxx Cyclical Index vs. Stoxx Defensives Index
  • Stoxx Industrials + Stoxx Chemicals vs. Stoxx Food & Beverage
  • Stoxx Banks + Stoxx Automobiles vs. Stoxx Healthcare
  • DJ UBS Industrial Metals Index vs. S&P Goldman Sachs Precious Metals Index
  • Australian Dollar vs. Japanese Yen

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  • VIX volatility index (S&P options volatility)
  • VXN volatility index (Nasdaq options volatility)
  • RVX volatility index (Russell 2000 options volatility)
  • VXV volatility index (VIX 3-month volatility)
  • V2X volatility index (Euro Stoxx 50 options volatility)
  • V1X volatility index (Dax options volatility)
  • VCAC volatility index (CAC40 options volatility)
  • VFTSE volatility index (FTSE 100 options volatility)

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  • CBOT Equity Put/Call Ratio
  • CBOT Total Put/Call Ratio
  • NYSE New 52-weeks highs
  • S&P 500 Advance/Decline line
  • NYSE Advance/Decline line
  • EuroStoxx 50 Advance/Decline line
  • S&P Europe 350 Advance/Decline line
  • Stoxx 600 Advance/Decline line
  • Percent of NYSE stocks about 200-day moving average

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  • Corporate yields on BBA bonds less U.S. Government 10-year yields
  • Corporate yields on BBA bonds less Investment Grade AAA yields
  • TED spread
  • PIGS government bond yields less German Bund yields
  • European Corporate bonds yields less German Bund yields

The above indicators are dynamically-weighted to produce a score ranging between 0 (most risk averse) to 100 (highest risk appetite).  The direction of change of the indicator is of equal importance to the absolute level.  A rising index suggests a greater appetite for risk while a falling index implies greater risk aversion.  The chart may also be used to detect any divergences between the risk indicator and the broad stock index. We recommend accumulating / adding new positions only when the indicator is rising, while holding onto positions as long as the indicator remains solidly in “Risk-On” mode. A reading above 65 confirms a fully-invested portfolio. Based on portfolio risk tolerance, readings between 35 and 65 may justify lightening up on risky assets. Readings under 35 signal investor capitulation and a excellent time to deploy cash.

Sentiment Indicator

Our sentiment indictor uses a mix of market-based readings and investor sentiments surveys. The components and weightings are determined through a panel regression. Among the sentiment indicator components, we have included:

  • VIX volatility index
  • VNX volatility index
  • CBOE  Equity Put/Call Ratio
  • CBOE Composite Put/Call Ratio
  • McClellan indicator levels on S&P 500, Nasdaq-100, and Russell 2000
  • American Association of Individual Investors Sentiment Readings
  • Market Vane Survey Data
  • Investors Intelligence Investor Sentiment Data

We have delimited an “Extreme Optimism” zone and “Extreme Pessimism” zone. We consider a rising sentiment indicator reading as bullish. However, when the indicator enters into the “Extreme Optimism” zone, we seek to lighten up on long positions during rallies.  Conversely, we consider a falling sentiment indicator reading as bearish. However, when the indicator enters into the “Extreme Pessimism” zone, we begin to look for buying opportunities.