Money & Finance

It’s probably time to start thinking about locking in a portion of our profits given the gains we have seen in January and thus far for February. The JSK Partners stock portfolio was up 13.3% in January and is up 9.4% month-to-date for February. Our near-term view is cautious and based on our behavioral model as well as certain other indicators; we think it makes sense for the market to consolidate and even pull back slightly. The likely culprit will be events stemming from Europe, more specifically Greece as they are less than a month away from default should they be unsuccessful in raising additional funds.

The one bright spot from Friday's market action is that the sell-off was not accompanied by aggressive volume. Nonetheless, we are on alert for continued market weakness.

The trigger line in our behavior model started lower last week giving us a “heads up” that the market rally may be coming under pressure (for a detailed explanation about our behavioral model, please see last weeks note) . We will be watching closely over the next several days and will take profits and go to a neutral position should the slope of the trend line go negative.

Bottom Line: Given the rally that we have seen thus far this year, it makes complete sense that the market should start to consolidate and temporarily soften from these levels. At the first signs of weakness in our behavioral model, we are prepared to start locking in profits.

Point and Figure

Part of our behavioral model consists of market analysis using point and figure (P&F) patterns. Taken directly from Stockcharts.com, P&F charts consist of columns of X's and O's that represent filtered price movements. X-Columns represent rising prices and O-Columns represent falling prices. Each price box represents a specific value that price must reach to warrant an X or an O. Time is not a factor in P&F charting. These charts evolve as prices move. No movement in price means no change in the P&F chart.

P&F charts provide a unique look at price action that has several advantages. P&F charts:

1 - Filter insignificant price movements and noise

2 - Focus on important price movements

3 - Remove the time aspect from the analysis process

4 - Make support/resistance levels much easier to identify

5 - Provide automatic and subjective trend-lines

We have provided a typical P&F chart in this report. A P&F chart is considered “bullish” if the most recent X in a new column exceeds the highest X in the previous column of X’s. Conversely, a P&F chart is considered “bearish” if the most recent O in a new column falls below the lowest O in the previous column of O’s. The chart to the right represents the P&F chart for the S&P 500. We have marked the new bullish patterns with green circles and marked the new bearish patterns with red circles.

We take this analysis one step further and track the percentage of companies in the S&P 500 that are in a bullish pattern. For instance, as of last Friday 83.2% of the companies in the index (416 out of 500) are in bullish formation. The proper way to interpret this model is to view it as a contrarian indicator. Typically, when the percentage of bullish P&F patterns exceeds 82.8%, it usually signals a near-term pullback for the stock market. When the percentage of companies in bullish P&F patterns falls below 25%, then it is a good time to enter the market.

Figure 4 shows our tracking of this percentage and as one can see, we have reached the point where one needs to be extra cautious about the markets lofty run. While peaks in this model do not necessarily predict major downturns or corrections in the market, this model is very useful in determining near-term market softness.

Bottom Line: With 83.2% of the companies in the S&P 500 in bullish P&F patterns, near-term market softness should be expected. Start adjusting the portfolio accordingly.

Pricing and Volume

We at JSK Partners have several proprietary models that we use to help navigate the market. One such model is our Volume Indicator. This model accounts for strength or weakness in market direction based on the amount of volume during the trading day.

More specifically, if the market is going higher but on declining volume, the bullish score will start to weaken, many times before stocks start to head lower. Separately, if the market is selling off on declining volume, the bullish score will start to strengthen, many times before stocks start to head higher.

This model is included in our overall behavioral model, but given the readings that we are collecting; we thought it wise to single out this model. When our volume indicator reaches a level of 102, which is one standard deviation from the mean, this is typically a warning sign that the market may experience some near-term weakness. As of last Friday, our model registered 107.2, a flash warning to be weary of the declining strength of this rally.

Bottom Line: We are getting multiple signs of caution that the market may experience temporary, near-term weakness. Stay prepared to adjust your portfolio accordingly.

Chart Analysis

Our specialty at JSK is to take a logical, probability centric view towards investing. That does not make us experts in technical analysis and chart reading. That said, we continually watch the chart trends for all the major indices. While not having a high level of finesse in the arcane art of technical wizardry, it sure seems the market has hit a round of resistance.

Bottom Line: In our opinion, the market will be testing levels over the next week that will either offer resistance and push the market downward (most likely) or break through these barriers on high volume thus creating a new floor for new higher levels. Either way, we will be watching closely and prepare accordingly.

Joseph S. Kalinowski, CFA