Relative Strength Is Telling Us To Stay Long

Sometimes we look at the major averages and can't come up any strong conclusions about the short-term direction. There isn't always a brilliant setup in terms of risk/reward. And that's OK, there isn't supposed to be. I see people constantly driving themselves nuts trying to decide whether to go long or short the S&P. But if you don't know, chill out a bit and take a quick look under the hood.

We like to look at the components of the stock market to see what kind of information we can gather. If the market has rallied hard, and one might call it "overbought", we want to see if the defensive names are showing some signs of a rally or bottom in terms of relative strength.Typically if the S&Ps are going to roll over and correct, you'll find the defensive names rallying relative to the rest of the market. But we're not seeing that strength yet in Utilities, Staples, or Healthcare - sectors that would outperform during a correction. In fact, we see weakness and zero signs of a bottom:

The bearish divergences that showed up in early summer helped with our bullish conviction on the overall market. If the stock market today was about to correct, we would expect to see the opposite occurring - but we don't. $XLU $XLP & $XLV relative to the $SPY are showing oversold readings (bearish characteristics), new lows relative to $SPY (bearish characteristics) and no bullish divergences, just confirmations of downtrends (bearish characteristics). This is a good thing for the stock market.

Now turning it over to the more offensive sectors like Financials, Tech and Energy, we're seeing bullish confirmations:

After the bullish divergences this summer, we now see overbought readings in RSI and multi-month highs in relative strength. All good things that tell us to stay in.

Sure, some may say that we're overbought in the market - and we might be. But remember - that's a good thing. This means there is clear evidence of an extreme amount of buyers. Is that such a bad thing?

So until we start seeing some divergences, we don't see any reason to get bearish stocks as an asset class.

Tags: $XLU $XLP $XLV $XLF $XLE $XLK $SPY