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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Cautiously Bullish

The weight of the evidence suggest a neutral to bullish bias, as the equity markets appear to be consolidating rather than correcting.

SPX sits at firm resistance near 1100; positives include climbing RSI (Above 50 now), and a bullish cross-over in both BPSPX and the McLellan Oscillator (see charts for these indicators). This resistance at 1100 has been a tough one to beat; it also marks a down trendline from the 2007 highs. Nasdaq looks stronger than SPX (and its bullish percentage crossed above its 10-day EMA). VIX remains in the doldrums (and bullish) and put/call is neutral. XLF (financials) have gained in relative strength. Staples have also fallen behind in relative strength compared to discretionaries, another bullish sign, and small caps have leaped ahead of large caps. Finally, a pause in the dollar's strength could bode well for stocks (continuing their recent inverse correlation). This evidence all points positively for equities.

A negative is advance/decline for both NYSE and Nasdaq, representing divergence from the flat to modest uptrend in their indices. This bears watching, but simply may be a sign of consolidation.

Note, there is a very interesting Elliott Wave alternative interpretation taking hold that suggests the rally from March 2009 lows is the start of a new secular bull market (meaning that an ABC correction ended at C in March 2009). This would suggest that the rally from the March bottom was (and still is) Wave 1 of a new impulsive 5-wave advance. This would also suggest that Wave 2 (corrective wave) would retrace a portion of this advance (perhaps we are in Wave 2 now). We are not fully convinced of this view, as secular bull/bear markets tend to last on average 16 years (this one could be viewed as 10 years-old from its start in 2000). We will respect this viewpoint but rely on our own objective chart analysis.

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Where to Seek Alpha?

So where do we go from here? The equity indices bounce from oversold seems to have played out as breadth and momentum indicators have now become overbought, while volume on the upside remained weak. Retracement levels from the early February lows are near typical turning points, even though the major indices have recaptured their 50-day moving averages (and sustained from falling below the 200-day). VIX has settled at support near 20 (where it has landed 3 times since Sept 2009).

It's encouraging (for bulls) to see the strength in small caps, a sign of some interest in more aggressive positions (this could be a play on a strong dollar, which would more negatively impact large caps). From a price relative perspective vs. large caps, small caps are near their highs last seen in September 2008 (and exceeding their September 2009 high). Value is also gaining on growth, as cautious investors seek to reduce risk. Another positive is financials (XLF) appearing to form a price relative bottom vs. SPX (a slight uptrend can be seen as RSI nudges toward 50).

The dollar looks ready to take a breather; although it had been moving inversely to stocks, that correlation has shifted of late (probably driven by higher interest rates). Although Treasuries are looking sick, higher rates would instill a positive aire as economic indicators continue to turn around.

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Breaking through resistance; mixed signals of strength

Although the major indices chalked-up a bounce last week, volume was tepid and the up/down profile as measured in RSI momentum struggled to make meaningful gains toward the "50-yard line."

The Nasdaq edged out SPX with the better bounce, as its price relative strength (vs. SPX) impressively closed near its high marked this past December. In fact, the Nasdaq had shown the lowest reading of stocks trading above their 50-day moving average, matching the level last seen in March 2009, and was (still is) ripe for short-term outperformance. The index (and most others) sit precariously between their 50 and 200-day moving averages, seeking short-term support at pullback levels marked during the climb from July through December.

VIX settled down (its RSI nudging slightly below 50) and Put/Call has moves to neutral territory. Similar to RSI performance noted above, the NY McClellan Oscillator surged from deeply negative levels without an impressive equity rally; its surge in late Oct/early Nov was met with a much more impressive, forceful stock market rally (click on the chart below).

The continued relative weakness in financials, and the renewed outperformance in staples vs. discretionaries (see below), flash caution.


Baseline Analytics remains neutral-bearish (with appropriate stops).

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