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Equity Markets Continue to Lift Despite a Lack of Clear Confirmation From Other Asset Classes


Stocks say "yes" while bonds, currencies, and commodities are saying "maybe" at best and "hell no" at worst.

The equity market continues to levitate toward a test of the early April high of 1,597.35, despite the wailing and gnashing of teeth on the part of the bears. From an academic / analytical standpoint, we should be in for a correction in equities (even, as I've noted here previously, in the most bullish of long-term scenarios). However, as most of us have learned, theory doesn't always translate to riches in the market. In fact, many very high IQ types have had their dreams crushed by the market due to an insistence on the high accuracy of their analyses despite the market evidence telling them they were wrong.

The most relevant analysis of this market, in my humble opinion, was given to us by David Tepper a while back when he noted that (and I'm paraphrasing) the play was to buy stocks because either the economy would improve and stock prices would rise, or the economy would remain subdued and the Fed would continue to liquefy the system, thereby causing prices to rise. In either case, he noted, stock prices were very likely to continue to rise. The only caveat I would add to that rather logical (and profitable) analysis would be in the case of an unexpected exogenous event. We did see a bit of selling after the recent terrorist attack, but look where things are now. The type of event that would cause a more substantial sell-off would be something where traders / investors felt the impact would be longer-lasting (some kind of potentially transformational event). Outside of something like that happening, all the evidence in the world that the bears may bring to the fore will seemingly be outweighed by the simple (yet critical) fact that the global central banker cabal is working in unison to reflate the global economy, starting with paper assets. As long as that is the reality and we have an absence of transformational exogenous events, dips are likely going to remain shallow (and buyable).


The S&P is just below last week's highs as well as the early April peak; a more substantial correction is still my call.

The daily chart of the S&P 500 (INDEXSP:.INX) is shown below. Clearly, the market is right at a critical juncture where it will either explode higher or stop on a dime and turn lower. The early April high was 1,597.35, and a close above that level into month's end would be a big, flashing green light for the bulls. Any failure to conquer that level, though, leaves open the possibility that a long-term triple top formation is the reality.

As you may know already, in this situation, I like to seek out bullish confirmation or bearish divergences – whatever the market is offering – to either build up or knock down the surface case for equities. Sometimes that is done by looking at the other asset classes (which I'll do later in this report) and sometimes it is done by looking at different parts of the equity market. Let's take a look at what other parts of the equity markets are telling us now.

Small caps are lagging large caps on a macro basis, despite a short-term bounce in relative strength.

The chart below shows the iShares Russell 2000 Index ETF (NYSEARCA:IWM) versus the SPDR S&P 500 Index ETF (NYSEARCA:SPY) on a relative basis using a spread ratio line (red line). Clearly, there's been a little upswing in the line in the very short-term, but the overall condition of this chart is one of relative weakness for the small caps, which traditionally has been a "risk-off" signal for the markets.

The QQQ ETF has shown a little strength versus the SPY recently but still lags on a macro basis.

This chart shows the NASDAQ-100 Index ETF (NASDAQ:QQQ) versus the SPY, again using the spread ratio as our indicator. It appears to be the same story here as with the IWM comparison: relative weakness on the part of QQQ on a macro basis despite a potentially bullish turn higher in the very short term. More evidence is needed to call this one a "win" for the bulls.

Emerging markets are lagging the EFA, which is traditionally a "risk off" signal.

The next chart shows the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) versus its international cousin, the iShares MSCI EAFE Index ETF (NYSEARCA:EFA). This chart is less ambiguous; it's straight up bearish for EEM. This, too, has traditionally been a "risk-off" signal for investors to heed. However, can we really say that developed markets – especially in Europe – are "safe" compared to emerging markets / economies? The answer is probably still "yes" – although it's not as clear a "yes" as it used to be.

Plus, here's a look at Sea Change's Leading Index of equities / ETFs and how the components look technically versus the S&P.

My firm monitors a list of what we consider to be "leading" stocks in terms of when they top and when they bottom versus the broader market. Any clear divergences in this list can sometimes be a good indicator of things to come for the broader market. Take a look at the list and see my comments in the right column and below.

In terms of determining "leaders" and "laggards" on our Leading Index, I basically like to see is a trend in relative outperformance by the components to classify them as "leaders." A trend of underperformance will keep the "laggard" tag on the component even if – as in the case of Apple (NASDAQ:AAPL), for example – the short-term performance would indicate otherwise.

Right now, only three of the Sea Change Leading Index components have charts that are more bullish than the S&P 500. Meanwhile, eight of them still have to be considered "laggards" versus the market, some despite some short-term strength.


So, despite the rise in the indices, just about every indicator I look at in the charts above tell me that things are just not "there" for stocks – at least in my book. Based on this information alone, I would still be calling for a correction in equities in the short term. Let's look at some of the other asset classes to see if they are singing a bullish or bearish tune.
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