Unwinding the froth

Equities took a setback as expected (the challenge was to identify the timing of this setback) as an overbought market and extreme bullish sentiment by several measures took a breather. The percentage of stocks trading over their 50-day moving averages hovered in the 85-95 range (overbought) since early October and was due for a bit of back-peddling.  See chart below:

VIX had also seen recent lows, a sign of complacency, as its gap below its 50-day moving average warned of a decline in equities. This gap has since resolved itself, as noted on the chart below:

Put/Call ratio also leapt rather sharply on Friday, a sign of an extreme rush to caution. This is a bit of a positive (the change in Put/Call on Friday was a 34% increase from the prior day's close), although at 1.03 is not at an extreme (it would take a sharp sell-off and a reading near 1.30 to signal that a short-term bottom may be at hand).

One of our most reliable indicators, the McClellan Oscillator chart on the NYSE, printed a sell signal this week as the indicator fell below its 20-day moving average, and it cumulative cousin, the Summation Index, crossed below its 20-day moving average. The Summation Index had previously flashed a sell signal in late October but quickly reversed itself. Time will tell whether the current signal is valid or represents another whipsaw.  See chart below:

As expected, the dollar saw strength as equities and commodities took a hit on the week. Rates continued to climb as long-term treasuries took a hit (TLT, iShares 20+ Year Treasury Bond ETF,  fell 2.2% on the week).

Caution to longs as this correction sorts itself out. The strength of the uptrend, however, supports continued gains once this overbought condition unwinds further.

Click here for the latest Market Tour on  Stockcharts.com.