An Important Stock Market Chart

Most technical analysis indicators are used in forecasting price action but provide little information about the dynamics that drive it. The indicator in the chart below is unique because it offers a different perspective about stock market action.

The chart below shows closing daily prices for the low volatility and high beta S&P 500 ETFs, SPLV and SPHB. The indicator shows the count of same return signs for both ETFs in a rolling 252-day window. Specifically, if both ETFs fall or rise on a certain day from the previous day on a closing basis, the count is increased by 1, otherwise it stays at the same value.

The following are deduced from the above chart

  • From 2012 to October 2015, the indicator was range-bound between 170 and 201
  • After October 2015, the indicator has dropped about 30%, from 195 to a minimum of 135 last March.
  • The indicator has recently rebounded slightly to 145.

What can we infer from the above chart? Note that SPLV represents investment in low risk large cap stocks and SPHB in higher risk large cap stocks.

  1. Risk-on/Risk-off are alternating at a much higher frequency recently
  2. We do not attribute the higher switching frequency to indecision but a control mechanism
  3. This control mechanism is probably implemented and executed by large passive funds that do not want a large market correction
  4. The funds alternate between Risk-on and Risk-off to mainly prevent machine learning algos from generating signals that cause a correction
  5. This scheme will work until valuations exceed certain levels
  6. This control mechanism was implemented because of rising interest rates and reduced Fed support for the stock market
  7. Algos may be able to arbitrage this scheme but machine learning models are not so intelligent yet to figure it out (now they may.)

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Charting and backtesting program: Amibroker

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