DEFENSIVE LEADERSHIP SHOWS INVESTORS ARE STILL IN DEFENSIVE MOOD -- RELATIVE WEAKNESS IN SMALL CAPS AND TECHNOLOGY IS A SHORT-TERM WARNING SIGN -- SO IS THE DOWNTURN IN APPLE SHARES
DEFENSIVE LEADERSHIP ... Despite the ability of the U.S. stock market to reach the highest level since 2007, investors still appear to be in a defensive mood. Over the last week, for example, two of the market's strongest groups were healthcare and consumer staples. Charts 1 and 2 show the Healthcare and Consumer Staple SPDRs hitting new highs. More importantly, their relative strength lines are rising. Chart 1 shows the XLV/SPX ratio rising since mid-September and near a new high. Most of those gains have come in biotechology and pharmaceutical stocks. Chart 2 shows the XLP/SPX ratio turning up for the first time since mid-July. That's another sign that investors are turning more nervous about the market's short-term direction.
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Chart 1
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Chart 2
SMALL CAPS AND TECHNOLOGY SHOW RELATIVE WEAKNESS... At the same time that investors are turning back to defensive stocks, they're starting to lighten up on small caps and technology shares. Chart 3 compares the S&P 500 (black bars) to the Russell 2000 Small Cap Index (red line) over the last three months. The slippage in the RUT over the last month can be seen by the weaker red line. The relative weakness in small caps is even clearer in the falling RUT/SPX ratio below the chart. That's normally a sign of investor nervousness. So is relative weakness in technology stocks which were the week's weakest market sector. Chart 4 shows the PowerShares QQQ Trust ending the week on a down note. It's RSI line (above chart) is threatening to drop below the 50 line which would suggest more selling. In addition, it's MACD lines (below chart) have already turned negative. The purple line on Chart 4 is a ratio of the QQQ divided by the S&P 500. The ratio has fallen sharply over the last month and is now at the lowest level in three months. It's normally not a good sign for the market when technology stocks are underperforming. The trend is still up for the QQQ. For that to continue, however, it's important that it hold above its 50-day average (blue arrow). Any drop below that support line would signal more selling.
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Chart 3
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Chart 4
OVERBOUGHT APPLE LOOKS VULNERABLE ... When looking at the Nasdaq market, it's important to see what Apple is doing. That's because Apple is the biggest stock in the Nasdaq and has a big influence on market direction. At the moment, an overbought Apple stock looks ripe for some profit-taking which has already started. The weekly bars in Chart 5 shows Apple (AAPL) having recently hit a new record high. Over the last week, however, the stock has closed below its 10-week average (blue line) for the first time in five months. At the same time, the 14-week RSI (top of chart) is weakening from overbought territory over 70, and shows the most recent RSI peak to be lower that the RSI peak formed during the spring (see falling trendline). That lower RSI peak (red arrow) has created a "negative divergence" in the RSI line, and is usually a sign that an uptrend is vulnerable to a downside correction. The daily bars in Chart 6 show Apple closing below its 50-day line for the first time since July. Downside volume (red volume bars) also picked up as the stock slid (see circle). The daily MACD lines (below chart) are decidedly negative (red arrow). All of which suggests that Apple has risen too far too fast, and is vulnerable to more profit-taking. Given its size and influence, that would have a negative impact on the Nasdaq market and the market in general
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Chart 5
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Chart 6
TIPS AND GOLD RELINK AFTER QE3... Two of the top performing assets since the September 13 launch of QE3 have been Treasury Inflation Protected Securites (TIPS) and gold. That makes sense considering that both are used as hedges against inflation. The fact is that both markets have had a strong correlation over the last decade. Chart 7 compares the performance of gold and the Barclays TIPS Bond Fund (TIP) over the last six years. That visual link between the two markets is confirmed by the Correlation Coefficient (below Chart 7) which was well into positive territory between 2007 and 2011. Their correlation weakened during 2012 (down arrow). Chart 8 shows the two markets diverging over the last year. While TIPS continued rising, gold prices fell. Gold's weakness appears to have been the result of a rising dollar (top of chart). The Correlation Coefficient (below Chart 8) turned up during September and has turned positive. Both markets are rallying together again. A lot of that has to do with QE3. The two purple lines show the launch of Operation Twist last October (first line) and QE3 on September 13 (second line). Both markets turned up during August in anticipation of QE3, and were two of the biggest gainers when it was launched. TIPS hit a record high during September, while gold broke a major down trendline. QE3 also weakened the dollar which gave a boost to gold and other commodity markets. Another effect of quantitative easing has been to push Treasury bond holders into higher-yield assets like high yield and investment grade corporate bonds and dividend-paying stocks. Meanwhile, Treasuries have become the weakest part of the fixed income group. That's due to historially low Treasury bond yields and fears of inflation further down the road. That's why investors are buying TIPS and gold.
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Chart 7
