Caution Needed

This market needs to be treated guilty until proven innocent. While there was a solid bounce back attempt this week, we still have no confirmation that the recent breakdown was false. The media was awful quick to proclaim the rough patch over and now they want you to load back up. While the bounce back was comforting, this is what markets do when a trend shift is underway. Forming market tops are a process, meaning the trend will not shift in one day and crash, topping takes time. We haven't seen a meaningful correction in over 18 months and while that doesn't exactly mean we are going to start one now, it does mean that it's been long enough for most people to forget what a correction acts like. Just as during uptrends where counter-trend corrections are swift and violent, bounces during down trends are equally explosive. The bounce sucks in the overeager and emotional and then traps them as the next leg lower resumes. Just as uptrends shake-out nervous Longs on dips, down trends tempt dip buyers to chase swift reversal bounces.

While everyone is getting excited about this 4-day rally in the market, we still are not above the prior swing high on the daily charts in any US indexes.

The Russell 2000 and Nasdaq have nearly identical charts. These charts look bearish:

While the Daily bar charts are a shorter timeframe, they are the most widely followed by market participants, and this is clearly a downtrend in process. The consecutive lower highs and lower lows are the definition of a downtrend. There have been nice sharp little bounces, but each bounce is being sold quicker than the last and traders are looking to reduce exposure into any strength. As price has been showing this steady slide lower the RS trends for the "riskier" groups continue to show underperformance vs their large cap counterparts. This is also indicative of a downtrending, weakening environment. As long as prices are below the prior swing highs (RUT 1,160 and COMP 4,200) these bounces are to be sold, not bought. Bottom line, do not chase a bounce in a newly transitioning asset.  

 The SP500 looks better but still in a trend shift as well and still below its prior swing high.

That being the case, one positive is that we still saw ZERO downside follow-through on the weekly views of these indexes.

The longer term has the look of a retest scenario about to play out: both aggressive indexes (RUT and COMP) posted hammer formations with this week's trading and could be set to "throw back" to their broken trend supports. While this relief rally would be nice, it is still too soon to go brazenly jumping back full into stocks. I am of the opinion that this recent weakness has been the first wave of a corrective pattern unfolding and now that sentiment has soured even more, I think here we could see a wave2 or "B" wave rally forming from either a 5-wave correction or a smaller "ABC" pullback.

The SP500 continues to buck the overall downside and was able to put together a rather solid week. It is certainly in better shape than the other two leading indexes at this time. Do know though that there is a reason the Nasdaq and Russell 2000 are considered leading indexes. They are typically the canary in the coal mine indicators as they represent the risk appetite for investors. As markets transition these two tend to lead the transition and it is only a matter of time before the larger stocks follow suit.

 Only time will tell what plays out from here but let's not forget what the situation was prior to this week and still is the case:

1. Weekly (intermediate term) divergences in momentum indicators suggesting higher risk of downside continuation
2. The Fed continues to reduce its stimulus monthly and will end QE buy operations by Fall
3. We are approaching the seasonally worst time for stocks (historically)...May through October
4. The wrong sectors are leading the recent advance. XLU, XLP, XLE and TLT are leaders, while         XLF and XLY lag significantly.

The best course of action in this environment is to continue to ride what is working and avoid what is not. We never truly know what the market will do next so it is foolish to try and be an all-in/all-out investor. Its generally better to continue to let your winners run and cut your losers, let the market show its intentions by weeding out the weak and letting the cream rise to the top.

 We were able to take advantage of the rally this week through our remaining stock holdings as they showed resiliency and no downside follow-through.

PPG (2/3)

I am glad I gave PPG a one week grace period after its marginal break of support last week. They announced earnings on Thursday and showed once again another very strong quarter. The stock rallied over 4% or $8/share on the news and is once again at all time highs. Lets keep going as long as we can with PPG.

UNH (2/3)

UNH came into the week looking solid and well above its breakout levels. However earnings released Thursday morning took care of our nice cushion and gave the breakout level a solid test. Fortunately buyers came in at those levels and were able to recover much of the early damage. It's rarely a good sign for short-term price action when a company posts a poor quarterly report, but above $75.25 the uptrend is still well intact. If we break and close below this week's closing prices that will likely be enough to have us step aside.

PBW (1/3)

Speaking of marginal breaks, PBW is teetering on the line of seeing us exit our remaining shares. We are currently 1/3 invested which is our minimum holding, as the RS uptrend has been steady for the better part of a year. This week saw a little poke through the trend support, yet I'm willing to give this minimum holding one week's free pass to see if it can build on the solid intra-week turnaround it displayed. However if we continue to see indecision and movement below this week's close we will throw in the towel...But lets give it just a little more here to see what it can do.

WFC (2/3)

WFC continues to be in fine shape. After announcing solid quarterly numbers a week ago price has remained firm in the face of some hefty pressure from the Financial sector and broad market weakness. Our line in the sand on WFC is pretty clear as there is a confluence of support at the $46.50 level. A slice through that will see us reduce our exposure. Above that support though I still think its one to own.

CMI (3/3)

CMI continues to hold up well and is consolidating nicely above its breakout support. A break below $139 will see us reduce exposure, but the long term-picture is still quite bright for Cummins.

AEP (3/3)

AEP along with the Utility sector has been very strong year to date. We are getting very close to our base pattern target and price is also running into a key supply (resistance) area going back nearly two decades. This should be a big test for AEP ahead. We will need to see how it handles this all-time high area and continue to ride the strength above the $48.50 support.

TLT (3/3)

Treasuries held up surprisingly well this week during the market bounce, all except for Friday. After touching a new rally high Friday morning, there was a swift reversal that sent prices lower by over 1%. Year to date, Treasury Bonds have traded in a steady rising channel and Friday once again tested the upper range. It would not surprise me to see a pullback to the $108 area and retest the prior resistance zone; I would expect that to hold as support on this test. This retest looks to want to coincide with a wave2 rally in stocks, so thats a confirmation signal to suggest what is shaping up across the market. We want to continue to maintain Treasury exposure above $107 on the TLT.

The key to dealing with challenging markets and trend rotations is to not be too focused on the short term activity and follow the strength in the market. Running your winning positions and selling your lagging holdings generally keeps you aligned properly for any market environment. Let's stick with the plan. To get an idea of how challenging this market is right now, take a look at my chart of the week:

Chart of the Week

SP500 daily view

 Its a tricky market as you can see as it continues to fool anyone leaning too far in either direction. Multiple failed breakouts within a choppy period are not the type of environment you want to be trying to time for any new, aggressive positions. Stick with what you've got here and try not to get sucked into any overextended moves one way or the other.