Technical indicators point to a vulnerable stock market

US equities presented more or less the same picture as in prior months: market internals continued to weaken, but the S&P 500 Index (SPX) held up fairly well.

The resilience of the broad large cap index can be attributed to a rotation into defensive sectors: Utilities and consumer staples have been the top performers again. That’s not a sign of a healthy market and I prefer to stay on the sidelines as much as possible.

Since the beginning of the year, the S&P 500 Index (SPX) has moved more or less sideways and it is important not to get chopped up in this action.

The list of concerning market internals has been getting longer: charts of stocks that have led in the past have been completely broken. Take Amazon (AMZN) for example: the stock lost over 25% so far thisyear and, in my opinion, it will take months of constructive price action for AMZN to set up again on the long side.

The S&P 500 is telling only a part of the story: the major action has been in small caps and technology: the Nasdaq Composite (COMP) as well as the Russell 2000 (RUT) have been forming dangerous topping patterns in the last months and are trading at critical support levels. The Russell for example needs to stay above 1,100 in order to not complete a major “head-and-shoulders” top.

One can argue that equities are simply experiencing a rotation into other sectors, which is normal in a bull market. However, the 2014 weakness of consumer discretionary stocks is most concerning: the sector has been leading since the end of the financial crisis, but lost around five percent this year.

Similar to Nasdaq and Russell, (XLY), the Select Sector SPDR Consumer Discretionary ETF, is technically in a difficult phase.

A key economic sector in America are homebuilders. Unfortunately, US housing stocks have been struggling since mid of 2013 and many of them are still heavily shorted. So are they leading the way again, similar to2007? Time will tell, but we keep this sector on top of our watchlist.

Housing data in April has been surprisingly weak and suggested that poor winter sales has not been due to bad weather. Another problematic sign: rising volatility. The “Average True Range” (ATR) measures how much a stock or index fluctuates each day.

Larger ranges are often a sign of nervous investors and sometimes precede major declines. The ATR for the major indices has been rising in 2014. A  similar pattern occurred during the first half of 2011–volatility rose, the markets finally broke down and lost over 10 percent at the beginning of August. In addition, markets are entering a weak seasonal period, so extra caution is warranted.

For the Technical Swing portfolio, our goal is to keep trading light. The risk is to get caught in frustrating sideways action. For technical traders, no trend is worse than a downtrend.

The Active Momentum portfolio has also moved to a more defensive stance: for example, XLU, the Select Sector SPDR utilities ETF is one of the positions going into May. So overall, I am obviously not too optimistic for the next months.

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