Back on April 25th we posted our STA Risk Ratio Indicator which was then throwing off a sell signal. At that time we recommended raising cash and reducing equity exposure to the overall markets. As a reminder the risk ratio indicator is a weighted average for bullish to bearish sentiment, the volatility index, the rate of change for the S&P 500, and the new highs/new low ratio of the NYSE. The recent correction in the market during the month of May, and then the brutal sell off in the market on Wednesday, has not been enough to lower our risk indicator to a level that would warrant increasing equity “risk” exposure to portfolios. Currently, the outlook is still very bullish and is correcting, and, as a contrarian investment manager, this is a time to CONTINUE raising cash and hedging risk in portfolio on market rallies.
At the end of April the market was in an extreme bullish zone and was fighting to turn down over the previous couple of months as the markets were entrenched in the bullish trend during the seasonally strong time of the year. However, with the markets now entering into the summer months, combined with the potential lack of QE to boost the financial markets, we are closely monitoring market action and staying on alert for a potential repeat of the weakness that we witnessed last summer as QE 1 ended.
While this is not a failsafe indicator by any means it does provide a decent track record of warnings to increase and reduce risk from equity centric portfolios. We are continuing to recommend overweighting bonds and underweighting equities for the summer months until this indicator reaches a zone that warrants increasing equity exposure back into portfolios…or the introduction of QE3 – whichever occurs first.