At the end of January, some of the secondary indicators started to move from 'tailwind' to 'headwind'. Sentiment (measured several ways) became exceedingly bullish. Then, macro data started to disappoint versus expectations. Both of these often lead price.
In the past two weeks, three new headwinds developed. First: actual $SPX earnings implied flat growth in FY13 versus expectations of growth of 10%. Second: markets outside the US, in both $EEM and Europe, declined and closed under their 20-dma. Third: breadth in US markets narrowed as price rose, creating a bearish negative divergence.
Which brings us to key changes this week:
- Trend: This is the most important factor in the summary and for the 13th week out of the past 14, a majority of US indices/sectors closed >13 ema. However, the trend is weakening. You can see two trend downgrades on the summary chart below.
- $SPX, our focus, closed under its 2013 trend line this week.
- Moreover, half of the 6 cyclical sectors closed <13 ema. In February, defensive sectors are leading the market, a bad sign.
- Cyclicals appear to following ex-US markets, which continue to weaken further. This week, $DAX, $HSI, $SSEC and $EEM, together with $6A, $6E, oil and copper, all closed < 50-dma. All of these correlate well with US indices.
- Bonds, which have based during the past month, closed near a monthly high and > 13 ema; something to watch this week.
- Breadth: This is the second most important factor and we have noted that $NYSI has been slowly declining. This week, however, a day after a new high in indices, the market experienced its first 90% down day since November; a major distribution day (MDD). When these occur at new highs, selling momentum normally carries over. Read further here.
The bottom-line is this: US indices and sectors are, for the most part, still trending upwards and, again, strong uptrends like this do not typically end abruptly. We would expect, based on past performance, for the indices to make at least one higher high. If you like patterns, think of a 'head' or 'right shoulder'; if you prefer waves, think of a 5th of 5 wave uptrend. But the trend is weakening and most of the other factors are now headwinds to further appreciation.
As a result, the risk/reward is becoming much less attractive. You could swing and hit the ball, but it will be low and outside, not a fat pitch.
The next area of resistance, from the 2007 peak, is 2% away (reward). Meanwhile, a 38% retracement and the 50-dma are 3% below (risk). In January 2011, $SPX rose 7 weeks in a row and then experienced a MDD, just like this week. Over the next year, upside was a further 5% (reward) while downside was 12% lower (risk).
This week, among other things, look for whether cyclicals and ex-US markets change behavior or continue to underperform. Also, a second MDD would be a major watch out that sellers are taking control. Finally, watch whether Mr Bond can move above its recent base. All of this while the sequester approaches.
