Neutral bias

Market breadth was so excessively weak following Friday's sell-off, that even without the events in Europe, we would have expected a bounce in the near-term. Development in Europe accelerated that bounce in a convincing way. We expect the market to retrace a portion of this rise before moving higher.

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Marking Time

Equities continue to push toward new highs; advance-decline stats have improved as market participation in the uptrend widens. An interesting deterioration in growth relative strength vs. value suggests repositioning (we have not seen the move from small caps to large caps, but there has been much talk about that recently -- large-cap, dividend-paying equities). Put/Call ratio (particularly its EMA 13) has been downtrending while VIX remains in the basement, both cautionary indicators.

Gold and the Dollar have move in tandem (up) since early 2010, which in the past has preceded a decline in treasuries (which are looking wobbly these days as rates firm). Corporate bonds (LQD) have fared much better as retail funds have pushed into this sector.

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Risk/Reward favors caution

No doubt the equity markets have been on a bullish run that appears (based on market internals) fragile. We continue to favor tighter trailing stops on longs and partial hedges on short positions.

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Conflicting Signals

Although the equity markets have reached new recovery highs, our three major concerns of this rally are the following:

1. Advance/Decline line has fallen, diverging from the new highs (see NYAD and NAAD charts).
2. The NYA McClellan Oscillator, one of our favorite indicators, has fallen below its EMA 10, behavior that in the past has marked short-term market tops).
3. VIX remains complacent, well below its EMA 34. We have found that large "gaps" in VIX price vs. its EMA 34 have preceded market turns.

We cannot ignore the trend, and will not turn aggressively bearish unless price and volume action warrant. Picking tops and bottoms is a challenging exercise!

The recent strength in the dollar (our favorite bullish market right now), could wear on equities (as the two markets have been moving inversely to each other. This also bodes negatively for gold and commodities.

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Waning Rally

Divergences in Advance-Decline ratios (both NYAD and NAAD, as they have been declining as the averages reach new highs, as well as the continuing gap in VIX vs. its EMA 34, encourage us to hold off adding to long positions, and tighten stops (speculative shorts have been added). We don't plan to turn aggressively bearish unless the price action tells us to. Remember what Martin Pring says, "technical indicators should be used in the context of the prevailing trend."

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Siesta time for Bulls

A deterioration in market breadth, a complacent VIX reading in the teens, and overbought RSI readings all suggest that the reward/risk favors standing aside from pursuing long positions. We recommend tightening stops and establishing some short exposure.

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Neutral with a Bullish Bias

Not much change from our commentary last weekend. Building internal strength favors sticking with the trend, even though volume on the upside has been lackluster. Relative strength favoring small caps is encouraging for further upside, as traders embrace more risk. SPX approaches its January high near 1150. Nasdaq has exceeded its high as RSI peaks above 70 (price relative also excels). Our one major concern remains VIX, which settled at a low 17.4, as price falls well below its EMA 34.

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