The Good, The Bad & The Ugly

There is a lot happening around the world that I think is worth noting this weekend. Some things are good, some bad and some are terrible.

Let’s start with the Good. Obviously price pays, and prices in the USA are still making new highs. The S&P500 closed Friday at yet another 52-week high. The Russell2000, Mid-cap 400 and Dow Jones Transportation average all closed at all-time highs. The Nasdaq100 tried joining the party as $AAPL appears poised to fill that gap helping the $QQQs reach the highest level since October.

All good.

2-9-13 spx

Now the bad.

Rotation is terrible. There’s no better way to put it. One of the things that we pride ourselves on is looking at the internals of the market. Who is it that is taking us to these all-time, or 52-week highs? Is it the Financials and Discretionaries leading us? Or is the more defensive areas like Consumer Staples and Utilities that tend to outperform in corrections?

Well, our sector rotation model that takes all this stuff into account turned red earlier this week for the first time since October. It doesn’t always nail the top to the day, but it usually gets the area right. Moreover, Bloomberg’s Relative Rotation Graph shows clearly that the leaders are Staples and Utilities. Unfortunately for market bulls, it appears as though Financials and Discretionaries, which have been weakening for a few weeks, have a date with the lagging quadrant. (click chart to embiggen)

2-9-13 RRG

And very quickly, let me touch on the Ugly.

I think the ugly has to be what we’re seeing out of Europe. Right from the start of the week, these countries’ averages got smacked in the face. Italy, Spain, Poland….all of our favorite spaces the last few months – crushed. Greece tried bucking the trend, but seems extremely vulnerable up here. We’ll get confirmation this week, but Greece looks like it has False Breakout and Bearish Divergence written all over it. Europe as a group got creamed as well, if you look at the Euro Stoxx 50. Trendlines being broken and divergences showing up are not a healthy combination.

The way I look at it, assets in bull markets don’t get crushed that quickly. Some down 5-6% overnight near fresh highs. Definitely not on my list of bull market characteristics.

Here is Europe flirting with that trendline from the summer lows with bearish divergences in momentum that are screaming at us to get the hell out of the way:

2-9-13 FEZ

So the stock market bulls to me, still have a fighting chance. This correction in the US could be through time, and not necessarily through price like Europe. Remember markets can correct in a number of ways. And prices in the US are still at new highs. But I think it’s worth pointing to the internals and intermarket relationships that help supplement what we’re seeing out of US prices. When you combine that with the unusually bullish sentiment readings that we’re seeing around The Street, there are some red flags that I personally can’t ignore.

Let’s see what this week shall bring. I’m sure if prices correct, the headlines will find some sort of excuse that has nothing to do with what is mentioned here, but we’ll know the truth. Also, as my friend Alex Tarhini @tarhinitrade put it, the same top callers this whole way up will be the same ones picking a bottom during the correction, and the cycle will just keep repeating itself….