Reaching higher

Since its peak in February, the S&P500 has traversed a rather healthy consolidation, despite a correction of nearly 7% on higher volume in mid-March while the earthquake in Japan heightened market fears. A recovery and new basing pattern suggests resilience on the part of the bulls (we may even see some technicians call a "head and shoulder's bottom" as noted on the chart below). I will refrain from such a conclusion as I have seen many such formations turn into continued consolidating patterns prior to a breakout (or breakdown).  Regardless, it appears that the S&P500 would rather rally toward a new high (soon) than breakdown.

We are seeing continued resilience in the Nasdaq and strength in small caps and growth stocks, further indicators of health in the market. As a trend-follower, our strategy remains "with" the trend but not leveraged on the bullish side for the reasons noted next.

Vix has taken a plunge into the sea of complacency. This is an opportunity to buy cheap puts to protect longs, or cheap calls to participate in a potential breakout to new highs.  See the chart below, as Vix has fallen to a new short-term low near 15.

Two further cautionary signals include the outperformance of Staples vs. Discretionary stocks, and continued weakness in financials.  As the chart below shows, Staples took a relatively large leap vs. Discretionaries and bears watching for the potential resumption of the "risk-off" trade. 

As for financials, their underperformance vs. the S&P500 is approaching the lows seen in December 2010. The positive light on this relative weakness is that financials as a sector have fallen into a trading range (see the grey line in the chart below) rather than a distinct downtrend.  Financials underperformance is not alone, as materials have also taken a backseat to strength in Staples and, to a lesser extent, utilities.

Long-term US Treasuries saw a bounce last week and may have formed a short-term (double) bottom. See the chart below:

Sector rotation into more conservative plays (staples, utilities, bonds), low Vix readings and the "sell in May and go away" mindset may be pushing the smart money to the "risk-off" side of the ledger, after reviewing our various Market Tour indicators. An upside break in the major averages on higher volume is needed to reduce our cautious stance and lighten up on our long positions.

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