Earnings lend support to the ongoing uptrend

Positive earnings reports (approximately 70% of earnings announcements have beat estimates) continue to support the uptrend, supported by generally positive economic statistics. The upcoming test will be whether the S&P500 can decisively break through the 1340 level where peaks in February and April marked short-term tops:

The Nasdaq closed a mere 41 points from its 2007 high and likewise is closing in on the potential of a breakthrough of resistance:

In fact, Nasdaq relative weakness (vs. the S&P500) that we have noted here in the past has been resolving itself, thanks in part to strong tech sector earnings. We like to see the Nasdaq showing leadership to help support a positive environment for equities:

As for financials, the same old story of underperformance continues to flash a warning sign:

VIX too has reared its ugly head of complacency as the index has reached a low (under 15) not seen since July 2007. See the chart below:

We view this low level of volatility (as noted in VIX) as an opportunity to hedge long positions with inexpensive puts. There's no sense shorting a strong market like this, as growing participation from retail investors and the "follow the herd" mentality has damaged the shorts while this uptrend continues.

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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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Trend-following indicators remain positive for equities

Despite minor setbacks for the S&P500 and for the Nasdaq last week, our trend-following systems and indicators continue to support long positions in equities.  

Several new bullish developments that emerged last week include the following:

• A surge in relative strength of Asian equity markets vs. the S&P500 (Hong Kong, Taiwan and China were particularly strong on the week). This reverses the trend that has been in place since October, when the S&P500 led Asian equities. See the chart below:

• Steepening of the yield curve. Not a good omen for inflationary expectations, but positive nonetheless at this juncture for equities.
• A rally in corporate bonds vs. treasuries as seen in our LQD (corporate bond ETF) /IEF (medium-term treasury bond ETF) ratio.
• Continued uptrend in small caps relative strength vs. large caps.
• Likewise, strength in growth vs. value is favorable for equities.
• The New York Stock Exchange McClellan Oscillator, an indicator of advances versus declines, strengthened last week and continues to flash a bullish signal for equities:

Bearish indicators include the following:

• Gains in US indices on weaker volume (note however that Friday's sell-off was on lighter volume).
• Continued weakness in financials vs. the S&P500.
• Gains in relative strength of Staples vs. Discretionary stocks.
• A decline in VIX as complacency picks up and Investor's Intelligence sports continues toppy bullish sentiment readings:

Our trend-following indicators continue to support equities as earnings season is upon us and seasonal risk (the "sell in May" mantra) begins to emerge.  With volatility (VIX) once again at low readings, a long equity portfolio with index put protection may be a sensible strategy as we head through April and into May.

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