There are several long-term cross currents in the current U.S. stock market environment. On the negative side, measures of volume and participation of “smart-money” have been woefully lacking since the October 2011 bottom, and really since the March 2009 bottom. In his weekly column in FuturesMag.com, technical analyst Robert McCurtain maintains close tabs on several market indicators including cumulative volume, most actives advance/decline line, and the call/put dollar value flow line. His indicators do not support the long-term sustainability of these market levels and suggest some future massive bear market.
Shorter-term, there is no arguing the fact the market needs a rest after the S&P 500 index has run nearly straight up 18% from its mid-December bottom. The number of stocks participating in the rally has fallen off since early February, clearly evident in the performance of the broad Russell 2000 index verses the S&P 100 index.
Investor’s Business Daily notes the rally is under pressure following a recent cluster of high volume down days and stalling days in the major averages. From a fundamental standpoint, short-term weakness is also supported by recent declines in the Citigroup Economic Surprise Index, which shows economists became too optimistic into January and February and are now tempering their GDP growth views. A decline in this index often precedes a decline in the market. On a short-term basis, traders are well-advised to take some profits off the table at this juncture.
On the long-term positive side, four fundamental items support robust prices: the U.S. treasury yield curve is positive, the U.S. leading indicators index is sloping upwards, equity prices are somewhat undervalued looking at historic earnings multiples of the S&P500 and deeply undervalued using the Fed Model, and the availability of cheap credit is improving (see my recent blog “Is A Bear Market Around The Corner?“). Looking at sector leadership, the aggressive sectors — technology (XLK), consumer discretionary (XLY), and financial (XLF) – are leading the market higher and show little sign of rolling over. The chart below illustrates the strength in these sectors versus the S&P500. This is a sign of market strength and trend sustainability.
The early 1950s also offer some precedent: when long-dated Treasury yields started to rise in that era, stocks surged as investors fled falling bond prices for equities. The same may happen today.
While a focus on the chart behavior of individual securities leads to trading success, my current thinking is that aggressive positioning in new plays could pay off once the market consolidates its recent 14-week run. When the general positive factors discussed above degenerate (perhaps by the end 2012), I’d expect another generational bear market. After all, the federal reserve is out of bullets — they cannot lower short-term rates any further to help in the next (and inevitable) economic downturn.