War Appears Imminent: Is It Time To Sell?

Includes: IWB, SPY, VOO
by: MCR MarketReport

Last week, after reading a few articles on Seeking Alpha that referenced seasonality in trading, and the perceived ominous approach of the fall months, I decided to pen the article "Approaching the Worst Historical Month for the S&P 500." I noticed with the recent correction that many authors who were bulls at the all-time highs were now turning bears. I have noticed this phenomena ever since the crash of 2008 and the recovery. The second the S&P 500 (NYSEARCA:SPY) drops about 5%, the herd rushes for the exits. I looked around at the various economic, fundamental, and proprietary technical indicators that I have developed and could not find any reason to panic. I ended the article with the question "So is it time to get out of the market?" And the answer of "Maybe not just yet."

Last week was relatively quiet for economic reports. Durable goods orders came in weak, however, ex-aircraft orders, they were not as weak as the headline numbers suggest. Manufacturers' New Orders: Non-defense Capital Goods shows a decline, but it remains in an overall uptrend, and way too early to consider calling a top.

On Thursday, good news came from the employment front that reported a drop in initial jobless claims to 331,000. The overall trend here is also improving.

Economic indicators do not seem to be flashing any imminent warning signs.

Turning to the fixed-income market, I use the 3-month 10-year Treasury Note Spread as one of my early warning indicators. With the 3-month yield held near zero, and a spike in 10-year yields, we are seeing a steepening of the yield curve, and, as we all know, the rise in interest rates of the 10-year can have a negative effect on future growth. However, I use the spread as an indicator of short-term stress in the financial markets. The chart below is a plot of both the 3-month treasury rate and the 10-year. As investors sense danger in the market, they rush to the safety of short-term treasuries. Looking at the chart below, the 3 month spiked prior to the fall of '87, prior to the dot.com bust in 2000, and rallied again all the way until the summer of 2007 prior to the financial crisis. While Fed intervention and policy has diminished its value, I still find it useful in the battery of indicators I use to assess overall market health.

Turning to market breadth indicators, the S&P 500 New Quarterly Lows indicator appears to have peaked at around 60:

The consensus of the economic, fundamental, market breadth, and fund flow indicators that I follow leads me to believe that there is still not a compelling reason to leave the markets in a panic at this moment. Obviously no one can predict the future, but looking underneath the surface of the news and actually looking at the data, I and my clients are staying invested in the market in appropriate investments for client age and risk tolerance (i.e. market index ETFs such as VOO). As an aside, in my articles, I will do my best to provide market research and 'actionable' intelligence. I will also try to present a different economic, fundamental, or trading indicator that I use in every article. On my instablog I will be providing weekly market updates.

With regards to my article last week, I found no compelling reason to head for the exits at that point either, even though a missile strike appeared imminent. This weekend, the President has postponed a unilateral strike on Syria in retaliation for the reported use of chemical weapons in order to get congressional input. Current news suggests that Republicans will support President Obama in action against Syria.

As Mark Twain said, "History doesn't repeat itself, but it does rhyme." There are striking similarities between our current situation, and the period leading up to Desert Shield/Storm. Iraq invaded Kuwait August 2nd, 1990. Let's take a look at market action prior to that date in the form of the Russell 1000 index (the ETF is IWB; however, it was not traded back then so we will use market data for the index itself). Following is a price chart of the index with the number of stocks making New Quarterly Highs minus the number of stocks making New Quarterly Lows. I find it a timely and useful measure of market health as it takes into account all one thousand stocks of the index rather than a handful of stocks that might dominate the market weighting. The quarterly data is much more timely than the 52 week new highs/new lows. The market had begun to roll over in late July, however, the real story was told by the deterioration in the number of stocks making new highs vs. lows. Traders were quietly heading towards the exits as the overlying index staggered along.

The current readings are indeed negative at a -64, however, they have not (yet) deteriorated to an extreme level. I will watch these levels closely and report them here.

Current Reading September 3, 2013

For now, as stated before, I would remain in your appropriate asset allocation for your age and risk-tolerance. A Vanguard risk-tolerance self-assessment quiz can be downloaded here.

Disclosure: I am long SPY, MDY, IWM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.