PUTTING THE PULLBACK INTO PERSPECTIVE -- RISK INDICATORS TURN NEGATIVE -- UTILITIES AND REITS CONTINUE TO ROCK -- WHY SO MANY NEW HIGHS IN XLF? -- XLY TESTS SUPPORT AS HIGH-LOW PERCENT TEETERS

PUTTING THE DECLINE INTO PERSPECTIVE... Link for today's video. The financial markets have been quite risk averse lately and the US stock market has been quite defensive over the last few weeks, but the S&P 500 is still less then 5% from an all time closing high. On a closing basis, the S&P 500 fell around 4.75% from its late December high to Thursday's close. In contrast, the S&P 500 Equal-Weight Index fell around 5.2% and the Russell 2000 fell around 5.5% during this same timeframe. Volatility certainly has increased since early December, but I am not ready to turn bearish after a decline that looks normal on a long-term chart. Chart 1 shows the S&P 500 with a 4% zigzag in pink. This is the seventh 4+ percent pullback in the last two years. The index went on to new highs after the prior six. I am not saying a top is impossible right now. I am, however, suggesting that the bigger trend is still up and this decline is not enough to alter that trend. First, new highs happen in uptrends, not downtrends. Second, the S&P 500 and S&P 500 Equal-Weight Index have not even broken their mid December lows. Truth-be-told, I think the long-term uptrend could even weather a break below the mid December lows. This is why I am marking long-term support in the 1900 area for the S&P 500 and in the 3000 area for the S&P 500 Equal-Weight Index.

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Chart 1

RISK INDICATORS TURN NEGATIVE... Even though the S&P 500 remains in an uptrend and the January decline still looks like a normal pullback on the long-term chart, choppy trading could continue because the risk indicators are negative. I use five indicators to measure the risk environment in the stock market. Two are stock specific, one is a stock-bond hybrid and two are bond specific. Having an odd number insures a simple majority one way or the other. Four of the five were positive (risk on) in early January, but recent price action has reversed this count. Four of the five indicators are negative (risk off) right now.

Chart 2 shows the S&P Consumer Discretionary Sector ($SPCC) relative to the S&P Consumer Staples Sector ($SPST) using the price relative ($SPCC:$SPST). This ratio was rising as consumer discretionary outperformed consumer staples from mid October to late December. The ratio plunged in 2015 and broke below the mid December low. This means consumer discretionary is underperforming consumer staples and this is negative for stocks overall. Why? Consumer discretionary includes several industry groups that are important to the economy, such as retail, autos, restaurants and homebuilders. Relative weakness in this sector points to risk aversion in the stock market. Chart 3 shows the equal-weight S&P 500 underperforming in January, but still outperforming since mid October. The equal-weight S&P 500 represents the average stock in the S&P 500 and provides a better idea of what is happening to the market as a whole.

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Chart 2

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Chart 3

Chart 4 shows the SPY:IEF ratio breaking down, which means the S&P 500 SPDR is underperforming the 7-10 YR T-Bond ETF (IEF). The preference for Treasuries over stocks points to risk aversion in the financial markets.

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Chart 4

Chart 5 shows the High-Yield Bond ETF (HYG) relative to the Investment Grade Bond ETF (LQD). The HYG:LQD ratio started moving lower in July and the decline accelerated in late September. Relative weakness in junk bonds points to risk aversion in the corporate credit markets. Note that around 15% of junk bonds in HYG come from energy-related companies.

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Chart 5

In another sign of risk aversion, the 5-year Treasury Yield ($UST5Y) plunged below its 2014 lows and the 2-year Treasury Yield ($UST2Y) broke its December low. I was not concerned about the decline in the 10-yr yield as long as the short end of the yield curve remained in an uptrend. The 5-yr yield is clearly not in an uptrend and the 2-yr yield is also falling. This means money is moving into short-term Treasuries, which represent the ultimate safe haven.

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Chart 6

UTILITIES AND REITS CONTINUE TO ROCK... The market is clearly looking for yield because we are seeing relative strength in the Utilities SPDR (XLU) and the REIT iShares (IYR). Chart 7 shows XLU with a consolidation breakout in mid December and a throwback in early January. While the S&P 500 moved lower the last two weeks, XLU found support just above the breakout zone and moved back above 48. Chartists can mark first support in the 46-46.5 area and key support in the 44.5-45 area. The indicator window shows XLU High-Low Percent ($XLUHLP) moving back above +5%. Note that this indicator has not been below -5% since December 2013 and has been in bull mode since January 2014, which is when it first moved back above +5%.

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Chart 7

Chart 8 shows the REIT iShares (IYR) and this is perhaps the strongest stock-specific ETF right now. Why? Because IYR hit a 52-week high this week and not many stock-specific ETFs can make this claim. There are plenty of bond-related ETFs hitting new highs though. IYR is in the midst of a moon shot and getting overextended, but shows no signs of letting up. The lower trend line of the Raff Regression Channel and late December low mark support in the 77 area. The indicator window shows the S&P 500 with an example of relative "chart" strength. Note how IYR held its November low as SPY broke its November low in December. This show of chart strength foreshadowed the January surge.

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Chart 8

WHY SO MANY NEW HIGHS IN XLF?... The Finance SPDR (XLF) was hit hard this week, but XLF High-Low Percent ($XLFHLP) held positive and only dipped below +10% once. There are two reasons for this. First, banking stocks were strong in December with several hitting new highs in December (GS, BAC, C, JPM, MS, WFC). Even though XLF and many of these stocks are down sharply in January, they did not hit new lows and we have yet to see an expansion of new lows. Second, there are at least a dozen REITs in XLF and 85 total stocks. If nine REITs hit new highs and there are no new lows, High-Low Percent would be above +10%. REITs are responsible for some many new highs in the finance sector. Chart 9 shows XLF breaking below the mid December low. This is negative, but I still think the bigger trend is up on the weekly chart. Chart 10 shows XLF within a Raff Regression Channel and well above long-term support.

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Chart 9

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Chart 10

XLY TESTS SUPPORT AS HIGH-LOW PERCENT TEETERS ... Chart 11 shows the Consumer Discretionary SPDR (XLY) hitting a new high in late December and then falling sharply in January. With this move, XLY is again testing the broken resistance zone, which held in mid December. A close below 68 would forge a lower low and be negative. The indicator window shows XLY High-Low Percent ($XLYHLP) turning negative, but not yet breaching the -5% level. Another sharp decline in the ETF would likely trigger a bearish signal in this indicator. Chart 12 shows the Equal-Weight Consumer Discretionary ETF (RCD) testing its mid December low and the SmallCap Consumer Discretionary ETF (PSCD) with support in the 48-49 area.

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Chart 11

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Chart 12

HOME CONSTRUCTION AND RETAIL WEIGH ON CONSUMER DISCRETIONARY ... Home construction and retail are important to the consumer discretionary sector and both ETFs remain above their mid December lows. Chart 13 shows the Home Construction iShares (ITB) hitting a new high above 26.5 last week and showing relative chart strength from late December to early January. Notice how ITB moved higher as SPY moved lower the first two weeks of January. This strength did not last long because ITB reversed on Tuesday and fell sharply on Thursday. While this move is certainly short-term bearish, it is not enough to negate the early November breakout. This breakout zone turned support during a successful test in mid December. With this week's decline, a big test is in store and the breakout hangs in the balance.

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Chart 13

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Chart 14

Chart 14 shows the Retail SPDR (XRT) hitting new highs in November-December and then falling around 5% the last five days. A 5% decline in five days is certainly sharp, but the overall trend here is still up and XRT has yet to even test support, which is 1-2 points away. XRT also appears to be moving lock step with SPY the last few months and does not show relative weakness yet.