Keystone's Weekend Reconnaissance 3/2/13

Volatility is the number one driver of the broad indexes right now. The VIX 15.65 level will identify if the bulls (under 15.65), or bears (over 15.65), win come Monday morning. The VIX is up 8.4% during the week while the SPX is up 0.2%. One of these is wrong and Monday will tell the tale. With a VIX up over 8%, the SPX should have sold off about 2% or more last week but instead moved higher.  With the SPX up, the VIX should have been flat to down and at the 13.5 and lower level (two points lower than the close at 15.36). Commence head-scratching.

Tech and small caps lagged the broad indexes during the week but tech recovered late in the week. AAPL is finally down into the 420-440 area that Keystone targeted. The RUT was negative on the week. Many stocks and indexes are at their 20-day MA’s so use this as a gauge for next week. Watch the RUT 20-day MA at 912.43 and COMPQ 20-day MA at 3169.24. The Nasdaq closed at 3169.74 so the move up or down in tech will dictate broad market direction at the opening bell.

The behavior this past week is one of the oddest in memory. Oil, copper and commodities all broke down.  Copper fell through the sideways symmetrical triangle highlighted this week. WTIC crude Oil came down to test 90 support with 88 likely in the coming weeks. The euro dropped to 1.30 and even under for a time. The 10-year yield dropped to 1.84% closing at 1.85%. The ocean shippers are weak and the Baltic Dry Index remains in the cellar. China manufacturing is at a standstill. All the drivers of the broad markets line up to send equities lower but at the end of the week, the SPX and Dow Industrials are higher. Go figure. Traders are simply ignoring the bad news and lack of raw material demand, and instead opting to drink from the Fed punchbowl as Ben pours more booze, offering up a toast to rising equities while standing around the printing presses. The markets are pumped on the easy money, it is as simple as that. The trading philosophy now is to dance while the music is playing and then run out the door when the music stops. This is not a healthy market.

The move higher in utilities, staples, healthcare and other defensive-style stocks last week is notable. The Dow Industrials outperformed the other major indexes.  The long traders are thinking that even if a market pull back occurs, dividend stocks are a good place to hide. Likewise, people always need toothpaste, soap and toilet paper, so stocks such as PG are pumped higher, since traders figure they will be safe here as well. Ditto the utility stocks. Retail traders are much more savvy these days and thinking that if selling occurs, the staples and dividend stocks, as well as blue-chip Dow stocks, will get hit, but not as bad, and then the upside party will continue again courtesy of the Fed.  At the same time, tech, small caps, and materials are weakening; the sectors that should be leading the broad market higher. The financials are maintaining leadership but are topping. Ditto the retail sector which should drop at anytime. Traders are searching for yield and slowly ratcheting up into new areas as the easy money bloats and creates asset bubbles in the dividend stocks, high-yield area and REIT’s, all of which should roll over at any time.

An intermarket divergence continues, which is a fancy way of saying all the indexes are not making new highs. The Dow outperformed last week printing a high at 14149.15, only fifteen bucks away from the all-time October 2007 high at 14164.53. The SPX remains well below its 2007 all-time high and the Nasdaq far below. For the week, the DOW closed at another new high, but the Trannies ($TRAN) did not. TRAN needs to close up above 6020 to point the way higher for the broad indexes.  Over the last two weeks, the COMPQ, RUT and SPX all remain below the mid-February highs. What does it all mean? It means watch your wallet.  These are not your Grandfather’s markets. The Fed manipulation is likely distorting price discovery now after over four years of intervention. The race to debase is occurring around the world so the Fed’s actions may have less punch moving forward. The dollar has jumped from 79 to over 82 in the last month, the opposite of what happened during the prior Fed actions. Gold sells off. The broad indexes may be in the greater fool stage right now. As long as a greater fool exists, the party continues.

Bears are looking for a 5 to 10% sell off but if the markets gain another 5% upside first that will obviously create some unhappy bears.  The upside target area that is almost universal in consensus is SPX 1550-1565. You know what happens when everyone thinks the same; either an obscene move far above there occurs, or, these are the market highs right now. Even on the bear side, no one talks of a 20% correction or more, the consensus is a 2 to 5% pull back. A surprise would be the 10 to 20% pull back.  The consensus next week is that the Dow will handily reach the new all-time high. If so, that could provide the bull fuel for SPX 1550+.  Monday’s are all down days this year thus far so watch to see if that streak continues, or not. These markets require independent thinking. An overnight event is definitely something that few are expecting and could have profound effects by the time the U.S. markets open. There are circuit breakers in the indexes for a reason. The copper, oil and commodity weakness, as well as the lower euro and higher dollar, should have caused selling in the equity markets. Perhaps Monday will provide clarity. The small caps (RUT) did sell off by a smidge last week.  There are no easy answers in these markets. Simply keep your mouse close, and your keyboard closer. Stay alert. VIX 15.65 and SPX 1520 will likely tell the story at Monday’s bell.