BLAME XLY AND TLT BEFORE EEM -- FEBRUARY PATTERNS SHIFT FOR THE S&P 500 -- ADDING A TIME DIMENSION TO THE CORRECTION TARGETS -- BREADTH INDICATORS PULLBACK WITHIN BIGGER UPTREND -- NET NEW HIGHS DIP TO PRIOR REVERSAL ZONES

BLAME XLY AND TLT BEFORE EEM... Link for today's video. There is certainly a lot of blame to go around for the recent weakness in the stock market. First, the employment report missed expectations at the beginning of January and this kept a bid in the bond market. Second, the Fed started tapering late last year and stuck to its guns at Wednesday's meeting. Third, emerging market stocks were hit hard this week and currencies in Argentina, Russia and Turkey moved sharply lower. Fourth, there were a few big misses this earnings season as Best Buy, IBM, UPS, Apple and Amazon disappointed. Sounds like a perfect storm.

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Chart 1

Even though these fundamentals may get the credit for this two week decline, truth is stocks were quite frothy coming into the year and ripe for some sort of correction or pullback. The Consumer Discretionary SPDR (XLY) provided the first internal signal when it began underperforming the S&P 500 on January 2nd. Treasury bonds provided the first external signal when they started outperforming on December 31st. Relative weakness in the most economically sensitive sector suggested that something was amiss in the stock market. Relative strength in Treasuries indicated that money was looking for a relative safe haven. This correction could extend further until these two negatives end. In other words, we need to see consumer discretionary start outperforming and Treasuries start underperforming.

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Chart 2

FEBRUARY SEASONAL PATTERNS FOR THE S&P 500... Even though the S&P 500 is down around 4% from its highs, we can hardly even call this a correction yet. The decline is a mere two weeks old and the index hit a new all time high just eleven days ago. Before getting too bearish too soon, note that the S&P 500 moved higher in February and March each of the prior four years. Chart 3 shows the Seasonal chart for the S&P 500 going back to 2010. Even though four years is not a long time, there are some strong tendencies at work here. Notice that the index has advanced 100% of the time in February, March and December (2010 to 2013). Chart 4 shows the seasonal patterns from 1990 to 2009 (the prior twenty years). February was a coin flip during this larger timeframe (50%).

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Chart 3

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Chart 4

ADDING A TIME DIMENSION TO THE CORRECTION TARGETS... I put forth some correction targets for the S&P 500 SPDR (SPY) last week and John Murphy put forth some targets for the Dow on Saturday. With today's weakness, these targets remain in play. Today I would like to add a time dimension for a "potential" correction. Keep in mind that price and time targets are not based on an exact science. They are, admittedly, guestimates. Chart 5 shows the S&P 500 in a long-term rising channel since October 2011. Despite an advance from 1100 to 1850 (68%), there have only been three corrections. The two decent corrections occurred in 2012 and lasted around nine weeks. The third correction occurred in mid 2013 and lasted a mere five weeks. Talk about a strong uptrend. The current correction is just two weeks old, which suggest we may have another three to seven weeks. Also note that the index is only down less than 4% from its high, which suggest that we could have another three to six percent downside ahead. On the price chart, the December lows mark the first support zone and the index has yet to break even this zone. A break here would argue for an extended correction with the next support zone in the 1625-1650 area. In all likelihood, the index will probably stop somewhere in between (say 1700).

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Chart 5

In addition to testing support in the 1770 area this week, the Commodity Channel Index (CCI) is testing the zero to fifty zone for the third time since June. CCI held this zone in June and August. A break into negative territory means we may have to wait for an oversold reading before expecting a low in the S&P 500. Chart 6 shows the S&P 500 Equal-Weight Index ($SPXEW) with similar support zones. The indicator window shows the equal-weight version of the S&P 500 outperforming since the summer of 2012. This is basically small-caps relative to large-caps. The price relative ($SPXEW:$SPX) has yet to exceed its September high as the equal-weight version lagged a bit the last two months. I would not, however, become concerned unless the price relative breaks its November low to start a downtrend.

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Chart 6

BREADTH INDICATORS PULLBACK WITHIN BIGGER UPTREND... The S&P 1500 AD Line ($SUPADP) and S&P 1500 AD Volume Line ($SUPUDP) broke short-term support levels with sharp declines the last two weeks. These declines, however, are still within larger uptrends. Chart 7 shows the AD Line hitting a new high just last week. Even though the breakout failed to hold, this new high confirms a long-term uptrend. Chart 8 shows the AD Volume Line failing to hold the mid January breakout and moving below the January lows this week. This is a short-term bearish signal, but the indicator is not even close to its December low, which marks long-term support. Also notice that bearish divergences did NOT form ahead of these short-term breakdowns. The absence of a bearish divergence indicates that breadth was strong ahead of this pullback and a major top is unlikely.

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Chart 7

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Chart 8

NET NEW HIGHS DIP TO PRIOR REVERSAL ZONES... Chart 9 shows the S&P 1500 High-Low Line ($SUPHLP) in the main window and High-Low Percent in the indicator window. High-Low Percent equals new highs less new lows divided by total issues. The High-Low Line is a cumulative measure of High-Low Percent. First, notice that the High-Low Line has been above its 10-day EMA (rising) since November 2012. This is an extraordinarily long time and the last flattening occurred in late August. Second, notice how High-Low Percent dipped into negative territory in late June, mid-late August and mid December. The indicator almost dipped into negative territory in early October, but not quite. Subsequent dips and moves back above +2% provided opportunities to partake in the long-term uptrend. In other words, a dip to the zero line signaled a correction within the uptrend. Another bullish signal triggered this week as High-Low Percent moved back above 2% on Thursday. Before getting too bullish, notice that there was a double dip in August as the market produced one more leg lower during the August correction.

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Chart 9

MONEY CONTINUES ROTATING FROM STOCKS TO BONDS... The decline in Treasury yields and rise in Treasury bond prices is weighing on stocks. Keep in mind that Treasury bond prices and yields move in opposite directions. Yields rise as prices fall, and yields fall as prices rise. Chart 10 shows the 20+ YR T-Bond ETF (TLT) finding support just above 100 over the last five months and moving above the October high. A double bottom took shape and this week's breakout at 108 is bullish. Even so, I still think the bigger trend is down for TLT and expect resistance below the 115 level. First, notice how TLT formed lower highs from July 2012 to April 2012. Second, notice how the ETF broke a major support level with the decline below the February-March lows. The eighteen-month trend on this chart is down and this is why I think the current advance is a bear-market rally. Broken support in the 112-114 area turns first resistance.

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Chart 10

Further strength in TLT (towards 112-114) would weigh on stocks because stocks and Treasuries are negatively correlated for the most part. The indicator window shows the Correlation Coefficient ($SPX,TLT) spending most of its time in negative territory over the last three years. The indicator peaked in mid November and moved back into negative territory in mid December. Correlation is trending down as TLT and S&P 500 go their separate ways this year. This means money is moving into relative safety and out of relative risk. Further strength to the 112-114 area would suggest further weakness in stocks. Chart 11 shows the 10-YR Treasury Yield ($TNX) hitting its first potential support level. Broken resistance and the October low combine to mark key support in the 2.4-2.5% area (24-26 on the chart). Also notice that RSI is moving into its support zone (40-50).

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Chart 11

OIL LOOKS POISED TO EXTEND ITS DOWNTREND... Spot Light Crude ($WTIC) bounced over the last three weeks, but this bounce looks like a bear market rally for now. Chart 12 shows weekly bars over the last three years. Notice how oil has moved above and below the 95 level dozens of times. This is the mid point of the three year range. Oil is back above 95, but below resistance from the December high and still in a downtrend since the breakdown in early October. The indicator window shows the Aroon Oscillator in negative territory.

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Chart 12

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Chart 13

Chart 13 shows the USO Oil Fund (USO) over the last seven months. The ETF bounced with a pretty impressive move to 35 this week, but fell on Friday and a lower high may be forming. Notice that the trend line extending down from early September marks resistance here. The three week swing is still up with support marked at Wednesday's low (34.30). A break below this level would reverse the upswing and call for a continuation of the bigger downtrend. The indicator window shows MACD poking its head above zero this week. A move back into negative territory would turn momentum bearish.