Like Stocks? Get Ready...

by: Brad Zigler

Back in December, we pointed to the exchange-traded fund (ETF) market's optimistic signals about stocks. It looks like the spread between the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) and the iShares S&P 100 ETF (NYSEARCA:OEF) has cleared resistance on its way to a longer-term technical objective at $144. The SPY-OEF spread is an indicator of investors' exuberance for stocks - widening as risk tolerance expands, contracting as punters pull back. Dips in the spread's momentum, evidenced by crossovers of its 50-day and 200-day moving averages, are early warnings of broad market weakness.

Presently, both moving averages are rising, so there's little apparent risk of a major wobble ahead. But there are indications that momentum is flagging.

If you take apart the S&P 500, setting on one side the most volatile (read: riskiest) stocks and on the other the least volatile issues, you'd see these groups move at different velocities. Luckily, you can delegate this dissection to a pair of ETFs: the PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA:SPHB) and the PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA:SPLV). Divide SPHB's price by SPLV's and you get a look at investors' appetite for risk. By plotting the ratio next to the S&P 500, you can see that the two metrics generally track each other. Generally. There are times when they diverge. When they do, stuff happens.

This is one of those times. Earlier this month, we wrote about the risk ratio moving apace with the blue chip index, but in the past few days, their trajectories have diverged. The S&P has raced upward to new highs, while the risk ratio has flattened. You can see this in the chart below.

That's a significant variance. Usually, a decline in the risk appetite ratio is a klaxon warning of weakness ahead.

That's not the only warning sent by the ETF market. Take a look at the chart below, which plots the paths of SPY and an indicator of market breadth derived by comparing the price of the Guggenheim S&P 500 Equal Weight ETF (NYSEARCA:RSP) to SPY.

RSP, giving equal weight to all issues in the S&P 500, more accurately reflects the entirety of market momentum, while SPY's market capitalization scheme plays up the influence of large stocks.

So, what can we take away from all this? Simply this: The stock market, to use the parlance of our times (thank you, Maude Lebowski), may have gotten over its skis. There's excess exuberance - dare I say "irrational exuberance"? - suffusing equities now.

Does this mean the bull market reverses itself? Nope. Not yet, anyway. But it is a warning of some volatility ahead.

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