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Minyanville's T3 Weekly Recap: Market Pares Losses, but Major Red Flags Remain

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Balance your book with longs and shorts based on the relatively simple principles of relative strength and weakness.

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The indices were able to pare most of their sharp pre-market losses during today's session, but major warning signs remain that have me feeling like this market is headed lower. A dismal jobs report triggered most of the pre-market selling. The US economy created only 88,000 jobs in March, compared with expectations of 190,000. The unemployment rate, meanwhile, ticked down from 7.7% to 7.6% as more discouraged workers left the labor force. Labor force participation, in fact, dropped to 63.3%, the lowest participation rate since 1979! Despite all of that, the S&P (INDEXSP:.INX) rallied for most of the session and accelerated into the close to finish off just 0.44%.

With the unprecedented steps taken by the Federal Reserve over the last several years, in today's stock market bad news is almost perceived as good news. The Fed has a dual mandate: targeted inflation and full employment, and Chairman Ben Bernanke has made it clear that his office will continue to pump liquidity into the system until the jobs picture improves dramatically. Quantitative easing is inflationary, inflating the prices of risk assets like stocks and commodities. Thus, the market, despite a bleak unemployment outlook, has been making all-time closing highs.

While open-ended QE is bullish for stocks, there were signs today that this market may be headed lower in the short-term. One major red flag today was the price action in the bond markets. Many commentators have been touting the potential great rotation from bonds into equities, and those assets generally have an inverse correlation. Today, though, you saw the 20+ Year Treasury Bond (NYSEARCA:TLT) post a huge gain, 2.04%, and hardly tick down at all during the session, while the equity markets were able to drift higher. The divergence in the TLT and SPY (NYSEARCA:SPY) tells me the market is headed for a deeper correction sooner rather than later.

Gold (NYSE:GLD) is another asset that gave some interesting clues today. This week aside, GLD has sort of become a pure fear indicator for the market. Any time we have gotten sell-offs this year, GLD has ticked higher (and that hasn't been often). Yesterday GLD traded lower into major macro support, but today opened higher as turmoil hit the market. I talked this morning about watching the price action of GLD closely during today's session, and if it holds higher I think it could be poised for a major bounce. That's what happened today after some brief weakness just after the opening bell, and I think you would be well-served to diversify a portfolio with some gold at these levels. On a macro chart, the recent two-year consolidation in GLD could be viewed as nothing more than healthy digestion after a massive decade long move.

On Tuesday I made the case that although we were making new closing highs on the S&P and Dow (INDEXDJX:.DJI) I felt much more inclined to lean to the short-side. The faulty signals were starting to add up in the Russell 2000 ETF (NYSEARCA:IWM), Transports (NYSEARCA:IYT), and Homebuilders (NYS:XHB) that I thought were too significant to ignore. Today, those sector ETFs were able to snap back from extremely oversold levels which prevented a potentially bigger sell-off in the broader markets. I do think that after today's bounce, you could potentially look to re-short these index ETFs at key levels.

While this market remains remarkably resilient in 2013, it still feels like there is an underlying malaise. On one hand it seems foolhardy to be somewhat bearish on a market that gained 10% in the first quarter and is making all-time highs, but on the other hand I believe it would be even more foolish to ignore the warnings signs that are out there. I think either way, you should balance your book with longs and shorts based on the relatively simple principles of relative strength and weakness.



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