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Resistance Returns

sp-resistance
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After today’s big drop in the market we are back below the resistance line that you’ve seen here several times in the past.

What caused the drop? Could be the report from the BBC that Russian Troops are amassing on the Ukrainian border. Could be the report that China is cutting back on bank credit to its industrial companies. Could be that given the predominance of bulls in the market, some traders decided to take the other side of the trade, go short, and sell the stuff that has gone up the most this year.

Take a look at this Industry Heat Map from an excel spreadsheet I maintain:

industry-heatmap
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If you look at the industry groups in green (those groups closed higher today – the ones in red closed lower), you will see that they are predominantly the groups that have underperformed last year and this year-to-date or they are high dividend payers or both. Those are groups people buy when they are scared.

So if investors are scared, then we should see the Volatility Index (VIX) starting to tick up:

vix

We are starting to see a bit of volatility enter the trading world – note the three peaks on the right side of the graph, and each one is marginally higher than the last. They are no where nearly as high as we got in February’s (comparatively) big sell-off in the S&P 500 Index, but maybe the third higher high in the VIX is pointing to more selling to come?

Should we be concerned that there is something happening that is a threat to the financial system (like a major war in Europe)? When that sort of issue is out there – and those typically lead to either a 20%+ market pullback – I go to my old friend the TED Spread (it is a gauge of risk in the financial system that demonstrates the flow of funds out of EuroDollar denominated deposits into Treasuries – the Treasury Security represents a flight to quality at times of international crisis):

ted

Right now, there is no spike higher telling us that whatever is happening could lead to a 20%+ correction. When that sort of reading is present, we automatically raise cash in client portfolios. I have been using the TED spread since the 1987 stock market crash. In every instance that it had a spike higher, a major crash or pullback in the market 20%+ occurred – so I take it very seriously. However, it does not work the other way – you can have significant market pullbacks without the TED Spread moving higher.

What do I watch to give me a perspective on a coming major pullback? You’ve seen them here before but we should look at them now since its been a couple of months:

The Kansas City Federal Reserve Financial Stress Index:

kcfsi

You can see what it did prior to the 2008 stock market crash – we have no reading like that now.

The Recession Probabilities Index:

recprousm156n_max_630_378

You see the reading it had prior to the 2008 Recession – we have no reading like that now.

There are others that I follow, but all show the same indication – there is nothing right now to indicate a major correction is nearing – however, with valuations as high as they are and so many people leaning on one side of the boat, the bullish side, you can reach a tipping point quickly.

Geopolitical events, like the standoff over Ukraine turning into a Russian invasion and NATO responding, can turn dangerous fast and send the TED spread higher to worrisome levels in a very short period of time. A beautiful Spring day can turn into something ugly based upon political ambitions that cannot be factored into valuation formulas and require moves to build a cash cushion as a risk management action (except for those folks that want to be 100% invested at all times – they are exempt from this activity). Because of this, the TED Spread is something that I watch nearly daily and take action on as necessary when it gets jumpy.

At this time, all indicators are that this is just a pullback to Resistance because investors were not confident enough to move the index higher in a sustainable manner. We could see some more selling or we could have a recovery back above the Resistance line – we didn’t close on the low of the day, as you can see on the graph of today’s action below, but we were not much above it.

today

So, based on this, I think it will all be a news-related market for a day or two and depending upon what happens overnight with the reported headlines, we will either see a recovery of today’s sell-off or further selling as more folks move into capital preservation mode and sell the news. First quarter earnings reports are still a few weeks away, so the headlines are likely to rule in the meantime.

For now, it doesn’t appear to be anything critical but we will monitor things and report back to you here on the blog if something changes.

Mark