5/11/2014 11:21:10 AM

Market Summary

The current bull market is on pace to becoming the fifth longest ever. As long as the current market doesn't crash before this upcoming Memorial Day, the fourth place market to beat is the one that drove stocks higher between 2002 and 2007. The big daddy is the 1987 to 2000 bull market; the current market would have to continue until at least 2021 to threaten the longest bull market. Since the current bull market kicked off five years ago, we've had about 20 earnings seasons according to Adam Sarhan of Sarhan Capital, says he's "hard-pressed to find one or even two that people were excited about." And as he points out, the S&P 500 soared over 180% and hit a new record high during that time. Sarhan says one of the hallmarks of a bull market is to see stocks rally on both bullish and bearish news. "At this point, the market is digesting last year's very strong advance, and the S&P 500 is just below its record high. That is very healthy action," he says. Click here to get the previous article http://www.stockbarometer.com/viewarticle.aspx?articleid=10427

Our May 4th Weekly Setup explained "There is a dramatic divergence between the higher-quality stocks represented by the S&P 500 and Dow, and the lower-quality stocks represented by the Russell 2000 and Nasdaq. The sector rotation in 2014 is rather obvious to see. Since the S&P 500 hit its second peak in mid-January, it's managed to tack on close to 1%. Over that same time frame, utilities have gained 12%. Energy is up more than 8%. Consumer staples and basic materials are each up approximately 4%. It is positive that the DJIA and S&P 500 are up year-to-date, but this good news is mitigated by fact that defensive sectors are leading the charge. It's this rotation to 'risk-off' stocks that we interpret to mean upside potential is limited over the next few months.The high-quality stocks are percolating towards new highs while the lower-quality issues continue to struggle. In technical language, this is called a "bifurcation," which means that there is a major split in the broad market of stocks..." This concept is illustrated in the updated graphic below which clearly shows the Russell 2000 small cap index and Nasdaq technology index lagging behind the larger capitalization S&P 500 and Dow Jones Industrial Average indexes. This reflects investors' concern about the overall economy and whether the highflying momentum stocks in the Nasdaq 100 and Russell 2000 are overvalued compared to projected future economic growth.

To further emphasize how dramatically the market has bifurcated, look at the performance chart below which shows last year's results for the major indexes. What a difference a year makes as the small cap and technology indexes clearly overshadowed their larger cap brethren. According to the Stock Trader's Almanac it is considered a relatively unique situation where the DJIA and S&P 500 are outperforming both NASDAQ and Russell 2000. In 43 years since 1971, DJIA and S&P 500 have bettered NASDAQ and Russell 2000 just eleven times (Russell 2000 eight times since 1979) over the course of the full year. Seven of those eleven years were flat to downright ugly. Only 1975, 1986, 1989 and 1997 were above average years.

Market Outlook

A previous Weekly Setup talked about "hearing the talking heads on the financial news channels debate the veracity of the "Sell in May and go away" trading philosophy. Trading volume normally starts diminishing this time of year with recent volume at approx. 78% of the normal amount. Lackluster volume is typically a sign that the major institutional players are less active and as we have forecast in recent articles, don't expect a major move up or down." Click here to get the previous article http://www.stockbarometer.com/viewarticle.aspx?articleid=10427

We also opined "The long-term trend is still in a bull market, the intermediate trend is sideways, and the short-term trend is up. Higher quality stocks and defensive sectors utilities, energy and consumer staples are breaking to new highs, the overall market will not follow unless we get a pick-up in trading volume..The mere fact that January was down is bearish enough by itself as every down S&P 500 January since 1950 was followed by a new or continuing bear market, a 10% correction or a flat year... seasonal pattern suggested a March top for S&P 500 and negative full-year performance. Historically, the end of April and first week of May tend to be strong.The same cannot be said for the next 3 weeks that follow. On the S&P 500 since 1950, the period from the May 5th close to the May 25th close has produced an annualized return of MINUS 15%. That's 24 percentage points below the average annualized return throughout the year of 9%. Some of this historical weakness could be attributed to profit taking as earnings season winds down..." Selling in May and going away is not really a trading methodology, actually it should be viewed as more of risk management strategy. The graphic below suggests that compared to other times of year, the next few months offer the highest probability the overall stock market will being in negative territory.

Since the market crash, May has been the lousiest month for the S&P index. It would probably be a bad move to literally cash out of your stock portfolio in May and buy back in later in the year - as you will be selling near the lows and buying back in at higher prices. Obviously, at this time of year you need to carefully manage long positions with tight stops and size limits. Also, if you have losing positions now might be a good time take the loss and reposition those funds in more profitable shares. Holding cash is a viable strategy and smart decision compared to trading for the sake of trading in a risky environment.

Previous Weekly Updates discussed "The VIX is recognized as indictor of expected market volatility. This premium in options can be loosely defined as risk. Like other forms of insurance, the greater the risk the higher the premium, and the lower the risk the lower the premiums. When the options premium fall the VIX falls and when premiums rise the VIX rises. The buyers and sellers move the option prices, more buyers and the premiums go up, more sellers and the premiums go down." The updated chart graph below shows investors do not feel there is significant market risk as the VIX hovers near its low point.

We have discussed how "The updated AAII Sentiment Survey results continue to work as a reliable contra-indicator for stock price moves.lot of financial analysts have a very strong appreciation for the American Associate of Individual Investors (AAII) sentiment survey as a reliable contra indicator of market direction. Based on the perception that most retail investors usually are on the wrong side of the trend, sentiment extremes usually signal the market will do the opposite. you can see the bullish percentage in the graph is still relatively low with most individual investors expecting a neutral trend." you can see the current survey is overwhelming neutral with individual investors not expecting a major move up or down. But the bullish percentage is significantly lower than the norm which suggests if stocks do make a sharp move up, individual investors will probably jump in and chase prices even higher.

Previous Weekly Setup articles mentioned "The National Association of Active Investment Managers (NAAIM) survey of investor manager sentiment survey appears to synchronize with the individual investor survey (AAII) ... The green line shows the close of the S&P 500 Total Return Index on the survey date and the purple line depicts a two-week moving average of the NAAIM managers' responses." This NAAIM member exposure average is approx. 75% which is a moderately bullish level, but significantly lower than the ready reading from a few weeks ago. NAAIM President, Dave Moenning. said "Risk has clearly increased in the market recently due to worries over the emerging markets. As a result, NAAIM's active risk managers adjusted their overall exposure accordingly."

Trading Strategy

To recap recent Weekly Setup comments "Our analysis predicting stock price movement between all-time highs and recent support level is playing out as advertised. Displayed in the S&P 500 index chart below, strength and momentum are flat within the identified trading range.If stocks continue to avoid broad-based selling and maintain during earnings season, this should bode well for the near term market... If the current market action is merely sector rotation and the consolidation of overbought conditions from recent highs a few weeks ago, a good move is to identify and monitor stocks you like but were too expensive in the past.avoid the recent high-flyers that are now tanking, that would probably be a bad move because of the risk involved. if this is a price pause before moving higher we can map out some bullish trades where you also have downside protection in case a move higher is just a counter-trend action and stocks continue downward. The best bet is probably range bound trading with prices fluctuating between recent highs and wherever prices bottom out...setting up potential market neutral trades is a good move in case this is what the price action will be... With the major stock market indexes in a neutral position, options traders should return to a neutral weighting between bullish and bearish positions. Bullish in the event that stocks regain their upward momentum, and bearish in the event that economic data translates into equity weakness." We also said "This analysis has played out as advertised" and until we get signals of an impending trend change we believe this should be the near-term trading strategy with a specific plan to execute trades that benefit from the current range-bound environment.

This is a rehash of what we discussed above, but the May 4th Weekly Setup stated "The large capitalization DJIA index below reflects a moderately bullish tone as the DOW reached new all-time highs this past week.Compared to its larger cap brethren, the Russell-2000 Small Cap index chart below is in a confirmed downtrend with lower lows and lower highs. As discussed above, the momentum for the riskier small cap and highflying tech and biotech stocks is on the negative side." The chart below confirms our analysis that the high momentum 'hi mo' stocks that led market higher last year are no longer in vogue. These 'hi mo' stocks are a major component of the Nasdaq 100 index and similar to how they catapulted the technology index in past, they are now dragging it down.

Similar to our analysis of the risk related to trading Nasdaq 100 index stock above, the same caution applies to the Russell 2000 index. The chart below is basically a mirror image of the one above, the small-cap high-growth stocks that fueled the RUT last year is weighing it down this year.

The Stock Trader's Almanac discussed how generally the Russell 2000 and NASDAQ tend to be comprised of U.S. orientated companies of smaller size which tend to be more sensitive to local economic conditions. Poor performance from these companies is suggestive of either a weak U.S. outlook or current weakness. Valuations could also be an issue, but capital isn't exactly flocking to the DJIA or S&P 500 at the moment, they are underperforming compared to last year also.

The chart below makes another major point about the current market. There was a perception the FMOC winding down its QE programs should presage higher Treasury bond rates. That has not happened yet as treasuries continue climbing higher from the end-of-last-year lows. Gold would normally surge from a higher rate environment but as interest rates stay low, gold remains subdued after crashing last summer. Also, low interest rates adversely impact financial stocks which benefit from higher interest rates

As we have said recently "The current trading environment is turning into an excellent opportunity to profit from the right option trading strategies. "stock market will send out definitive signals on whether the trend is up, down or neutral, you have to be disciplined to wait your turn and have your trades ready. The market has played its hand the past few weeks and we know how and what to trade to make money." As stock prices have stabilized we expect it will be easier to manage risks and more trade opportunities should be available.

Regards,