One has to wonder whether there is more risk being long equities versus not being in equities at all, awaiting a pullback. Internal readings of price action underpin strength which has prevented the markets from surrendering even minor gains (on Friday, what looked like a potential down day recovered near the end of the trading session). In retrospect, staying long with some hedges (i.e. SPY puts as insurance) may have been the most prudent action since early September.  Adding to longs during intraday pullbacks is another option (as market participants appear to have been doing), as the potential downside of a minor setback may be worth the risk versus not participating on the long side as equities shoot for potential gains through early 2011. But beware: corrections have a habit of sneaking up on the markets (melt-ups too, as we have seen); November 2007 started strong only to surrender 7% before the start of a strong December. And complacency as noted in our sentiment indicators suggests caution.

Market breadth continues strong, as Advance/Decline ratios remain consistent with the price uptrends. Our McClellan Oscillator and Summation Index metrics reversed course and negated bearish signals printed early last week, as they remain in support of equities, although at extreme overbought levels. 

As for sentiment indicators, VIX and the Put/Call Ratio both flashed red alerts of complacency this week. VIX has fallen well below its 50-day moving average, and the Put/Call ratio, at 0.69, has in the past preceded market pullbacks at this level.

The dollar continues to downtrend, however, the Euro is pushing up against downtrend resistance and, should it fall back from this resistance, may lead to a dollar bounce (and potential clip in equity prices). It is noteworthy that the dollar, although hitting lower lows, has seen positive divergence with a rising RSI. This is an early indicator of a potential trend change in the dollar and a caution signal for long equity enthusiasts:

Gold and commodities continue to surge as the dollar weakens and emerging market growth remains enticing. Bonds settled a bit as long-term rates continued to rise, as optimism in the extended economic outlook rises.

As for stock sectors, there were more positive signs than negative this week. Financials broke out of their doldrums, a positive sign, Nasdaq held rather steady vs. SPX (despite a bit of a lag), and Staples took a hit relative to Discretionaries. As for style, small caps continue to outshine large caps, and growth continues to outpace value.

We expect that a correction in equities will leads to a correction in gold and commodities, and a bounce in the dollar and bonds. Although the near-parabolic rise in equities this week was in part a result of favorable FED and election results, and represented a breakout to new 2010 highs, sometime in this waltz of price action there will be a setback, and investors should be prepared to accept the consequences.

Click here for the updated Market Tour on StockCharts.com.

- Bob Palmerton; November 7, 2010