Here on August 11, the NYSE A/D Line’s 50-day trendline has not yet crossed over and below its 200-day moving average. It appears poised to make that transition. Yet equally concerning is the reality that the A/D Line itself had fallen below its 200-day for the first time since July of 2011. Meanwhile, there have been a series of lower lows for the A/D Line since I first began highlighting market internals in May.
Risk preferences – risk-taking versus risk-aversion – can be witnessed across a variety of measures and a variety of asset types. Indubitably, risk-aversion has the momentum, whether one is looking at recent relative performance of large-cap over small-cap, domestic over foreign, or investment grade credit over higher-yielding credit. Over the last two months, the iShares 7-10 Year Treasury Bond (IEF) has gained 3.1% whereas the iShares High Yield Corporate Bond (HYG) has lost 1.7%. The demand for safety is trumping the risk of “junk.”
One final sign that serves as a huge “yellow” caution: the S&P 500’s Advancing-Declining Volume Line (AD Volume Line). In essence, if the AD Volume Line is rising, there is significant strength behind advancing stocks. If it is falling, however, you have significant selling pressure behind the decliners.
Right now, the S&P 500’s AD Volume Line isn’t just falling. Its 50-day moving average has fallen below its 200-day moving average for the first time since… yes, you guessed it… July 2011.
By way of review, extreme valuations for equities have existed for the better part of a year. (Note: This can viewed a dozen ways at my “Don’t Party Like It’s 1999″ commentary.) Macro-economic weakness has been getting weaker, whether it is the lack of consumer spending, the breakdown in business spending, manufacturing woes, wholesale inventory buildups, export deceleration, slumping commodities, wage flatness and/or labor force participation. Micro-economic concerns may be summed up with earnings stagnation and the “revenue recession.” (Note: I discussed the “macro” and “micro” at great length at the end of July in “5 Reasons To Lower Your Allocation To Riskier Assets.”) And market internals? Nearly every conceivable way that I’ve looked at them – from lack of breadth in equities, to missteps by leaders like Apple (AAPL) and Disney (DIS) to widening credit spreads to treasury demand – “risk-off” is garnering the limelight.
As I have written previously, a tactical approach to asset allocation does not require that you abandon participation altogether. I have moved the bulk of my client base (over the last three months) from a 65% equity stake (e.g., domestic, foreign, large, small, etc.) and 35% income position (e.g, short, long, investment grade, higher yielding, etc.) to something that might resemble 55% stock (mostly large-cap domestic), 25% income (mostly investment grade) and 20% cash/cash equivalents.
Cash today will reduce the adverse impact of significant price depreciation. The same can be said for larger domestic companies faring better in the storm than foreign companies or smaller corporations; similarly, investment grade should provide relief where higher-yield debt is likely to struggle alongside other riskier assets. In other words, these tactical shifts will weather a hurricane, as well as permit me to raise risks at more attractive prices.
Additional evidence of market internals “rolling over” completely might encourage the use of other “risk-off” measures. For instance, 55% stock might be lowered to 40%, bolstering the overall cash stash to 35% (or one-third). Another possibility? Multi-asset stock hedging. My colleague and I created the FTSE Multi-Asset Stock Hedge Index (MASH) for those who wish to neutralize stock crises and stock bears without using leverage, options or shorting. Components of the index include ETFs like PIMCO 20+ Year Zero Coupon (ZROZ), PowerShares Dollar Bullish (UUP), Currency Shares Swiss Franc (FXF) and iShares National AMT Free Muni (MUB).
Gary Gordon is president of Pacific Park Financial, Inc.