S&P 500 RECLAIMS 2K -- SMALL-CAPS RIP HIGHER -- SEASONALITY FAVORS SMALL-CAPS (LIVE DEMO) -- SHORT-TERM TREASURY YIELDS SURGE -- FINANCE SECTOR LEADS WITH NEW HIGH -- PUTTING RECENTLY VOLATILITY INTO PERSPECTIVE

S&P 500 RECLAIMS 2K... Link for today's video. Stocks may be short-term overbought and some of the indices may be near their prior highs, but the trends are up and the breadth indicators are bullish. These short-term overbought conditions could give way to a pullback or consolidation in the coming weeks. Longer term, the trends for the S&P 500 is clearly up and the seasonal patterns turn bullish in November. Chart 1 shows the S&P 500 moving back above broken support and surging to the September high. It is as if the support break never occurred. Breadth is strong as High-Low Percent broke back above +2% on 22-Oct and exceeded +10% the last five days. The AD Line held its early August low and surged to its September high. Chartists can now use the 1900 area to mark long-term support for the S&P 500 and the August-October lows for mark long-term support for the AD Line.

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Chart 1

SMALL-CAPS RIP HIGHER... Chart 2 shows the S&P Small-Cap 600 ($SML) surging over 10% with a move back to the early September high. SML broke support in early October, but this break did not hold as the index surged back above 630 last week. The surge continued this week with a move above the triangle break and 62% retracement. This area should have acted as resistance in a downtrend and did not. The strength of this recovery suggests that the long-term trend is up now for the S&P Small-Cap 600. The index, however, is short-term overbought and ripe for a pullback or consolidation. Breadth also improved significantly as High-Low Percent surged above 10% this week and the AD Line broke its early July trend line. The indicator window shows the $SML:$SPX ratio challenging the September-August highs, a break of which would signal a return to relative strength for small-caps.

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Chart 2

SEASONALITY FAVORS SMALL-CAPS (LIVE DEMO)... The next three charts focus on monthly seasonal patterns for the Russell 2000 and the Russell 2000 relative to the S&P 500. Before looking at these charts, keep in mind that these charts reflect the seasonal tendencies of the past and past performance does not guarantee future performance. For example, May to October is supposed to be seasonally weak, but the S&P 500 is up over 6% since early May. Chartists should combine these seasonal tendencies with other aspects of technical analysis for a complete picture. Having clarified that, chart 3 shows that the Russell 2000 has risen 74% of the time in November and 90% of the time in December. The average gain in November is 1.7% and the average gain in December is 3.6%. These bullish seasonal tendencies are quite strong and they support further gains in the stock market over the next two months.

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Chart 3

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Chart 4

Chart 4 shows the seasonal tendency for the Russell 2000 to outperform the S&P 500. Notice that the Russell 2000 outperformed the S&P 500 63% of the time in November and 74% of the time in December. Also note that the Russell 2000 outperformed the S&P 500 only 35% of the time in October, but is set to outperform the S&P 500 for the current October. October 2014 ran counter to the seasonal tendency.

SHORT-TERM TREASURY YIELDS SURGE ... Confidence continues to rebound from the October nadir as short-term Treasury yields surged. Chart 5 shows the 2-year Treasury Yield ($UST2Y) moving back into its rising channel. The prior plunge in yields reflected a rush in short-term Treasury notes that yield virtually nothing. Money came right back out of these safe-havens as the yield surged back above .45%, and back into the rising channel. An uptrend in short-term yields is positive for stocks and supports the current rally. The indicator window confirms this because the Correlation Coefficient ($SPX,$UST2Y) has been largely positive this year. Chart 6 shows the 5-year Treasury Yield ($FVX) for reference.

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Chart 5

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Chart 6

FINANCE SECTOR LEADS WITH NEW HIGH... The finance sector seems to be pleased with the surge in short-term yields and the end of quantitative easing. Chart 7 shows the Finance SPDR (XLF) with a wild October, a successful test of the August low and a surge to new highs this week. Breadth is also strong as High-Low Percent broke back above 5% on 22-Oct and the AD Line hit a new high this week.

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Chart 7

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Chart 8

Chart 8 shows the SmallCap Financials ETF (PSCF) surging to a 52-week high with a monster move over the last two weeks. This was not entirely unexpected because I highlighted relative strength and the support zone support in the Market Message on October 13th, just before the mid October breakout.

PUTTING RECENTLY VOLATILITY INTO PERSPECTIVE... The stock market sure was volatile in October. Or was it? The S&P 500 fell over 100 points the first two weeks of October and then surged over 100 points. These were indeed some big swings, but they still fit within the normal volatility range of the last few years. Chart 9 shows the S&P 500 with the 10-day Rate-of-Change in the indicator windows. The 10-day Rate-of-Change has not dipped below -6.5% since November 2011 and has not been below -5.5% since May 2012. The October decline hit the -5% area and then shot up past the +7% level with the strongest two week advance since late 2011. There are two takeaways here. First, the volatility range, as measured by the 10-day Rate-of-Change, is within the normal range for the current bull run (January 2012 to present). Second, the surge over the last two weeks is a sign of strength, not weakness. The S&P 500 may be short-term overbought, but this surge is like a rocket taking off and buying pressure is unlikely to dissipate overnight. Chart 10 shows the Russell 2000 with similar characteristics.

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Chart 9

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Chart 10

RETAIL SALES WEIGH, BUT ECONOMIC PICTURE REMAINS POSITIVE... The economic indicator table is complete for October. Except for initial jobless claims, the October reports reflect what happened in September. Also note that am showing the four-week average of initial jobless claims for the last reporting day of the month, which was this past Thursday. The economic, labor and housing numbers are positive overall, but retail sales remain a drag. The ISM Manufacturing and Services Indices are well above 50, and Industrial Production is strong. Auto Sales fell from very high levels, but remain above 16 million on an annualized basis. Retail Sales also fell and remains the only real negative for the economy. The ADP Employment Report and Non-farm payrolls are above 200,000 on average. Housing starts and building permits climbed back above the 1 million mark and new home sales rebounded the last two months. Overall, the economy appears to be growing at a modest pace, the labor market is improving and housing is at least stable.

Chart 11