By LM Lupo, 2.15.2007, published by Financial Trader Research©

Still Bearish

The bull move continues to mature, with the Dow leaving its little sister indexes such as the Q's and the NASDAQ in the proverbial wake.  As we noted earlier, this is the classic sign of a finely aged bull market where risk continues to grow higher as the universe of stock leadership continues to shrink. 

Even the Dow itself has changed leadership, with GM and Alcoa leading the way higher.  GM?  If the models had not already exited the market for us, we'd be as frightened as devils on judgment day.  Apparently the street's thinking, if one can call it that, is that GM has turned things around, and we agree.  But the light at the other end of the tunnel is still a train.

Alcoa, a cyclical based commodity stock, has been another index leader wooing the Dow to the headlines of new highs based mostly on the slush of liquidity and acquisition potential:  a picturesque castle of prosperity, sand castle that is.  But markets are not rational and have been known to build on sand for as long as they have existed.

Volatility as measured by the VIX index reveals near record complacency, yet the media sages report nothing to worry about, volatility expands before a bear market.  That might be true if your time frame of investment is but a few hours, but then that is not an investment at all, but rather a trade. 

Traders are indeed safe for the next few hours running behind the blockers of GM and Alcoa, but investors are not. 

Conclusion:  Bonds continue to outperform stocks on a risk adjusted basis, and we believe soon on a capital gains basis as well.  We maintain our current model positions of mostly long the interest rate complex and out of equity exposure, but for a few select issues.

Prior Note 1.18.2007

Recession or Intermediate Top in Place for Equities?

          In a story that has been developing for some weeks now, the construct of the equities market has become increasingly weakened, as though termites were clandestinely deployed in the market's woodwork.  Its not surprising that our most recent reports were sells, which although rarely good for business...it is what it is:  a richly valued market fraught with more risk than reward by arguably any reasonable measure.

The timid response to positive earning surprises and the markets insistence on selling opening rallies have all the markings of topping action taking place.  The yield curve, both domestically and internationally, prophesies a near future tar and feathering of the current bull.

In addition, we noted in earlier stock index reports some of the divergences that were beginning to work their way through the market.  But what is most telling are the price divergences between the major indexes themselves.  For instance, recently the S&P 100 (OEX) has performed better than the S&P 500, which has performed better than the NYSE which has performed better than...and you get the point.  When bull markets mature, the large capital based indexes are usually the last to weaken.  Some of this has to do with foreign and domestic buying of known brand names as well as the actual stock make-up of the index.  The S&P 100 (OEX) is heavily weighted towards financials.  The out-performance of this index and the DOW to the market as a whole makes sense given the promising interest rate environment. 

Below, we have captured some of the more salient technical pictures of the indexes.

The weekly chart below shows the DOW Industrials, which is similar to the S&P100.  The chart by itself does not reveal any significant technical weaknesses save for a potential failed breakout from new weekly highs and diverging momentum as revealed by the weekly stochastics. The purpose of this graphic is so that one can perform a comparison and contrast with the other major indexes such as the S&P500 below and the QQQQ tracking index.

The daily chart of the S&P 500 tells a slightly different story as the market has been diverging for many weeks.  But oscillators often create meaningless divergences, so that is not the issue as much as the index itself has been diverging in price from the performance of the DOW.  We will discuss the stochastic ten cycle captured below in a tutorial section later, but for now, suffice it to say, it is fairly reliable in predicting trend changes when supported by the market conditions that exists currently. As we move away from major financial based major indexes, the picture becomes even uglier with the introduction of the tracking QQQQs below the S&P chart.

The QQQQ tracking index has been unable to close at a new weekly high for over a month now, while all the major indexes march on to new highs.  We now have price and momentum divergences in most of the major indexes in addition to reliable cyclical divergences.  As we have noted for the past several weeks, it often takes weeks and months for market tops to develop.  Its not obtaining the highest selling price that matters since no one (truthful) ever does.  But recognizing risk-reward ratios that are unfavorable for equity exposure does matter.

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