Friday, March 15, 2013

It Remains Risk-On -- Until Not

I realize in many respects the market is looking toppy, especially considering that the DJ Industrials have recorded 10 consecutive up days, a very rare occurrence. And we're within a few points away from Tom DeMark's call for a top in the S&P 500.

However, as I wrote previously, market tops can take some time to fully develop. And that's particularly true if the current rally has been characterized by extreme, compressed momentum -- as is the case with this YTD rally.

Until the market begins to demonstrate more technical red flags, the bias remains risk-on.

I keep an eye on several indicators and metrics that attempt to track where we are on the risk-on/risk-off spectrum. Many involve calculating relative movement between a known risk-on vehicle versus a safe-haven, risk-off vehicle.

For example, the following chart shows the Morgan Stanley Cyclical Index (CYC) versus the Consumer Staples SPDR (XLP) in the lower inset. When CYC is outperforming XLP and the relative line is ascending, the S&P 500 (upper inset) tends to do well, and vice versa.

How I use this chart is I track the CYC:XLP versus its 100-day moving average and when the CYC:XLP line crosses up through its 100-day MA, it's risk-on and vice-versa, when the CYC:XLP pierces down through the 100-day MA it's risk-off. The blue arrows on the S&P 500 indicate the MA crosses. Since October 2006, there have been 11 signals or MA crossovers and as you can see, they've been more right than wrong in terms of gauging the risk-on/risk-off environment and getting on the right side of ensuing market direction. I would never make a decision using just one indicator or input, but other metrics I follow in this regard look similar.

As I wrote in the headline, until proven otherwise, it remains risk-on.

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