Risk Signals Building, But Tops Take Time to Build

A fast start to 2014 is unlikely, and bear signs need watching

   

As I wrote in my last piece, the outlier year of 2013 in which the S&P 500 trended smoothly higher throughout the year is over. Risk management is likely to be a more important discipline in 2014. Over the past few trading sessions, we saw some signs of increasing risk for the market. Let’s review a few intermarket relationships.

First, the ratio of stocks (SPY) to bonds (TLT) peaked at the end of last year and has been moving lower thus far in 2014. This risk-off behavior accelerated after last Friday’s weaker-than-expected payroll reported. The last time we saw any weakness of significance in this ratio was last September through October when the S&P 500 suffered a 4.8% pullback.

 Risk Signals Building, But Tops Take Time to Build

Second, the ratio of the consumer discretionary sector (XLY) to the consumer staples sector (XLP) has moved sharply lower over the past two sessions. When this ratio is declining it can be a precursor to economic weakness as the more cyclical discretionary sector tends to underperform during such periods.

 Risk Signals Building, But Tops Take Time to Build

Third, for the first time in months, we’re seeing minor signs of weakness in credit. The chart below displays the ratio of high yield bonds (HYG) to U.S. Treasuries (IEF). The ratio is still very strong overall but has moved lower in recent sessions.

 Risk Signals Building, But Tops Take Time to Build

To be clear, these signals are showing only short-term weakness and could very well reverse in the coming days. At the same time, U.S. equity markets remain in a strong uptrend with positive momentum in all time frames (see chart below). Also, as we have learned throughout the bull market that began in March 2009, while bottoms are often v-shaped, tops can take weeks or months to build. That said, if these negative signals were to persist in the coming weeks that would certainly be increased cause for concern.

 Risk Signals Building, But Tops Take Time to Build

Overall, another start to the year like 2012 and 2013 is highly unlikely. In those years the S&P 500 went straight up out of the gate and into April and May before a 5% correction took place. This behavior is very rare in a historical context. In fact, in half of the years since 1990, the S&P 500 has suffered a 5% decline that began with a top in the month of January. We may or may not be in the process of building a top here but increased vigilance is warranted given the above signs of intermarket weakness.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing


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