80 - 60 - 40 Rule Spells Correction

One of our favorite indicators of equity market conditions looks at the percent of stocks within a market that are trading above their long term moving averages (% above the 30 week MA). After hitting a recent high at over 86% in January the % above the  30 dropped to below 60% this week indicating that market breadth is waning.

According to work done by our friends at Dorsey Wright and Associates, of 17 occasions this occured since 1970, the indicator fell to below 40% before the correction had run its course in all but one of the instances. In some cases  this measure of market breadth ultimately fell to between 10 and 30% by the time it was done.

16 of 17 occasions over 40 years is a powerful statistic. This would indicate that there could be considerable room for this correction to run before we set up for the next sustainable rally.

Given this and other global equity risk indicators that point to correction, the various Barometer equity mandates currently are playing defence with a significantly reduced equity exposure and an elevated cash weight.

Counter trend rally not enough to become bullish

A More Defensive Stance

A sharp correction in small and mid cap risk assets globally has been well masked at


the index level by active rotation into more heavily weighted, large cap, defensive,

yield oriented, positions. We are now in the third year of a cyclical bull market and

there are rising concerns that the end to QE2, sovereign debt problems in Europe,

tightened reserve requirements in China and focus on deficit reduction in the US

could curtail the recovery. These concerns serve to put more emphasis on the value

of a steady stream of income. It is clear that investors continue to favor yield with

some inflation protection as we see continued strength in common shares with

growing dividends, reits and high yield bonds.



In the world of equities, commodities fell victim to coordinated hikes in margin

requirements which has driven liquidation across the complex. If the goal was to

cool speculative interest, it is clear that in at least the short run, policy makers are

having success.



As is our strategy, we don't fight the tape. Defense in risk assets appears to be the

path best followed until there is evidence to the contrary. Risk models for Canada,

Brazil, China, India and Australia have turned lower. Equity portfolios holdings are

focused in targeted large cap situations where there are catalysts driving rising

earnings estimates and likelihood of re-valuation. Sector exposures include industrials,

telecom, healthcare and consumer. Barometer sector risk models have moved us away

from metals, golds and energy that provided us such strong returns in Q4 2010 and

early 2011. When these factors are paired with weakness in the Nasdaq risk model,

it will be clear why we are operating with a reduced net long exposure across all equity

mandates.