Cautiously Bullish

The weight of the evidence suggest a neutral to bullish bias, as the equity markets appear to be consolidating rather than correcting.

SPX sits at firm resistance near 1100; positives include climbing RSI (Above 50 now), and a bullish cross-over in both BPSPX and the McLellan Oscillator (see charts for these indicators). This resistance at 1100 has been a tough one to beat; it also marks a down trendline from the 2007 highs. Nasdaq looks stronger than SPX (and its bullish percentage crossed above its 10-day EMA). VIX remains in the doldrums (and bullish) and put/call is neutral. XLF (financials) have gained in relative strength. Staples have also fallen behind in relative strength compared to discretionaries, another bullish sign, and small caps have leaped ahead of large caps. Finally, a pause in the dollar's strength could bode well for stocks (continuing their recent inverse correlation). This evidence all points positively for equities.

A negative is advance/decline for both NYSE and Nasdaq, representing divergence from the flat to modest uptrend in their indices. This bears watching, but simply may be a sign of consolidation.

Note, there is a very interesting Elliott Wave alternative interpretation taking hold that suggests the rally from March 2009 lows is the start of a new secular bull market (meaning that an ABC correction ended at C in March 2009). This would suggest that the rally from the March bottom was (and still is) Wave 1 of a new impulsive 5-wave advance. This would also suggest that Wave 2 (corrective wave) would retrace a portion of this advance (perhaps we are in Wave 2 now). We are not fully convinced of this view, as secular bull/bear markets tend to last on average 16 years (this one could be viewed as 10 years-old from its start in 2000). We will respect this viewpoint but rely on our own objective chart analysis.

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Where to Seek Alpha?

So where do we go from here? The equity indices bounce from oversold seems to have played out as breadth and momentum indicators have now become overbought, while volume on the upside remained weak. Retracement levels from the early February lows are near typical turning points, even though the major indices have recaptured their 50-day moving averages (and sustained from falling below the 200-day). VIX has settled at support near 20 (where it has landed 3 times since Sept 2009).

It's encouraging (for bulls) to see the strength in small caps, a sign of some interest in more aggressive positions (this could be a play on a strong dollar, which would more negatively impact large caps). From a price relative perspective vs. large caps, small caps are near their highs last seen in September 2008 (and exceeding their September 2009 high). Value is also gaining on growth, as cautious investors seek to reduce risk. Another positive is financials (XLF) appearing to form a price relative bottom vs. SPX (a slight uptrend can be seen as RSI nudges toward 50).

The dollar looks ready to take a breather; although it had been moving inversely to stocks, that correlation has shifted of late (probably driven by higher interest rates). Although Treasuries are looking sick, higher rates would instill a positive aire as economic indicators continue to turn around.

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Breaking through resistance; mixed signals of strength

Although the major indices chalked-up a bounce last week, volume was tepid and the up/down profile as measured in RSI momentum struggled to make meaningful gains toward the "50-yard line."

The Nasdaq edged out SPX with the better bounce, as its price relative strength (vs. SPX) impressively closed near its high marked this past December. In fact, the Nasdaq had shown the lowest reading of stocks trading above their 50-day moving average, matching the level last seen in March 2009, and was (still is) ripe for short-term outperformance. The index (and most others) sit precariously between their 50 and 200-day moving averages, seeking short-term support at pullback levels marked during the climb from July through December.

VIX settled down (its RSI nudging slightly below 50) and Put/Call has moves to neutral territory. Similar to RSI performance noted above, the NY McClellan Oscillator surged from deeply negative levels without an impressive equity rally; its surge in late Oct/early Nov was met with a much more impressive, forceful stock market rally (click on the chart below).

The continued relative weakness in financials, and the renewed outperformance in staples vs. discretionaries (see below), flash caution.


Baseline Analytics remains neutral-bearish (with appropriate stops).

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Short-term bounce; oversold equities seek support

Signs proliferated during the weekend that the recent sell off was aging: improving Nasdaq relative strength, extreme bearish readings in terms of the number of stocks below their 50-day moving averages, and a very high put/call ratio (closed over 1.2 Friday and remains elevated). Also, recent strength in the dollar has found price meeting up with its 200-day moving average, a possible area of resistance (the dollar settled back today), and a retracement of dollar gains may bode positive for equities in the short run. There is plenty of focus to sell (and short) the bounce, so perhaps (respecting contrary thinking) that some back filling will lead to modest gains or at worst a trading range market for equities.

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Short-term bounce anticipated

Signs that the recent selloff is aging include improving Nasdaq relative strength, extreme bearish readings in terms of the number of stocks below their 50-day moving averages, and a very high put/call ratio (closed over 1.2 Friday). Also, recent strength in the dollar has found price meeting up with its 200-day moving average, a possible area of resistance for the dollar (which has been moving opposite equities). A retracement of dollar gains may suggest a bounce in equities.

Our strategy is to sell the bounces as vibrant market gains since March 2009 unwind.

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Anticipated Bounce in Oversold Equities; Seeking Key Indicators for a Trend Change

Vast negative breadth, deeply oversold equities and declines on high volume underscore the risk with long positions. As expected, a modest-volume retracement of losses from the mid-January peak has proceeded. Wave theorists have labeled this recent decline as a start of a new impulsive downtrend, while simple trendline analysis shows mixed results. Historically, a surge in GDP, strong inventory rebuilding and generally positive economic indicators, following a recession, have been proceeded by a lead in the equity markets, only to settle for a retracement and often consolidation of those gains once initial economic strength has begun to surface in the headlines. We expect choppy market behavior favoring a bearish stance over the intermediate (30-60 day) timeframe.

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