More disturbing is the gap down seen last week on the Nasdaq. In addition to the selloff on higher volume, the Nasdaq continues its clear downtrend in underperformance vs. the S&P500. Stocks trading above their 50-day moving average fell below the trough formed during the November setback, suggesting perhaps a further correction toward the August lows. See below:
We found similar underperformance in small caps versus large caps, suggesting asset shifts toward more defensive positions. Interestingly, financials caught a bid last week compared to the broader S&P500. There has also been clear movement into more defensive positions in healthcare and staples.
Our relative performance of copper (our proxy for the industrial economy) versus US Treasuries reversed gains from the prior week that took the ratio above resistance market by three highs achieved since 2006. Strength in this indicator has reliably identified bull markets in equities. See the chart below:
Similarly, our corporate bond/treasury bond ratio flashed a clear warning sign last week. Historically, when LQD (investment grade corporate bond index) leads IEF (7-year T-Bond), equities are favored. This uptrend (which has persisted since the November setback in equities) was broken last week, flashing a warning sign to equity bulls. See the chart below:
Equities are facing their biggest challenge to the uptrend since the August and November corrections. As price is the ultimate judge of the market's health, we will look for any break in the price uptrend as a signal to shift to the short side. This week, we lightened up on longs, established some partial shorts as hedges, awaiting either a clear signal to more aggressively join the downside trade, or to "buy on the dip" should price action suggest a basing pattern and establish new support.
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