A Selective Uptrend

Despite a rise in volatility, with daily gains and losses of 150 points or more on the Dow becoming more commonplace, the uptrend in equities remains intact. One particular change that appears is growing divergence across international markets and sectors (i.e. the underperformance in emerging markets and more pronounced weakness in Financial stocks), which suggests that should the uptrend continue, a more selective stance may be warranted.

The S&P500 and the Nasdaq both found support at the "50" line of their respective relative strength indicators; in an uptrend, support is typically found in the 40-50 range (with highs over 80). See the chart of S&P500 below, where the blue vertical line denotes the spilt between a bearish trend with RSI lows below 40 (to the left) and a bullish trend.

We have been carefully eyeing the Nasdaq relative to its 2007 peak. That peak, at 2861, represents resistance to the uptrend, and the break-through of price through this level (or deflection from it) would provide another clue to the sustainability of the uptrend in equities in general.  See the weekly chart of Nasdaq below:

Interestingly, the Nasdaq has been underperforming the S&P500 since mid-January. Looking back 20 years, we find the Nasdaq outperforming the S&P500 at market bottoms (it surged decisively following the 2002 bottom for 15 months, and did the same at the March 2009 bottom). In both cases, its relative underperformance was not an omen for a general market decline, but simply a favored rotation to other sectors and asset classes. All the more reason to be more selective should this uptrend in equities remain intact.  See the weekly Nasdaq/S&P500 chart below:

Money continues to be flowing toward commodity-driven indices and sectors. Canada (ETF symbol EWC) and Russia (ETC symbol RSX) are two such markets that sport a wealth of natural resources (and are increasingly driven by demand growth from China).  On the flip side, emerging markets feeling the inflationary pinch from rising raw materials prices are underperforming. See below:

Silver, gold and oil ETF's maintain their lead with silver (the "poor man's gold") outperforming its yellow cousin. At some point, these asset classes get crowded by traders and investors, only to relinquish their gains to other interesting plays.

Relative strength continues to be shown by semiconductors, as SMH has outperformed the broader Nasdaq.
See below the chart of SMH relative to the Nasdaq. It is noteworthy that the semiconductor space has underperformed the Nasdaq since late 2003 and has only broken out in relative performance since Q4 2010.

Other sectors and asset classes displaying bouts of relative strength include the following (in no particular order of significance):

1. Inflation-protected bonds
2. Oil, Gold, Silver, most agricultural commodities
3. Resource-rich economies (Canada, Russia)
4. Healthcare and Utilities (potential risk-averse plays)?
5. Currencies such as the Canadian and Australian dollar (their natural resource-driven economies playing a role in their strength).

As the rally in equities matures, it behooves the trader and investor to identify those asset classes and sectors exhibiting relative strength and to allocate funds to those areas.

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