Stock indexes to new highs, indicators don't confirm

"All the major indexes rallied to new highs and their best levels since March 2009 last week. Time for hats and horns, right?"

If you’re feeling festive, go for it.

"But there was overwhelming confirmation of the move by market indicators, wasn’t there?"

Nope.
"But higher prices are a good thing aren’t they?"

Yes, if they stay that way.

"So what’s the problem?"

Strength was not confirmed by Short-term Momentum, Cumulative Volume, the Call/Put $Value Flow Line (CPFL), or the Most Actives Advance/Decline Line (MAAD) not to mention upside indicator failures on the Intermediate and Major Cycles.

"Oops… Well, then what caused prices to go up? The Royal Wedding was a success?"

There were more buyers than sellers.

"Oh…."

In relative defiance of market internals, stock market prices continued higher last week with the S&P 500 Index gaining 1.9%, the Dow Jones Industrial Average 2.4%, the NASDAQ Composite 1.8%, and the Value Line Index 1.9%. Unfortunately, despite the party most of our Short-term indicators failed to show up. And the market is "Overbought" on that smallest cycle yet again. At the same time, Intermediate Cycle Momentum continues to exhibit an upside failure after peaking back at the mid-February index highs. So now the question is will the market continue higher unabated, or will those negative market internals soon begin to exert some downward pressure on prices?

First, we suspect that the rally that began after the mid-March lows could prove to be an A-B-C rally that could allow for index prices to appreciate another few percentage points to complete the "C" leg of the move. Upside targets to 1385—S&P, 12990—Dow 30, 2920—NASDAQ, and 3235—Value Line are possible. Given the fact market internals have confirmed virtually NONE of the this possible "C" leg rally, recent strength would be consistent with not only a Short-term high, but also with the end of the Intermediate-term rally that began last July.

Also, the fact that both CPFL and MAAD on the Minor Cycle have stubbornly refused to make new highs with the market is a negative divergence and is the first significant negative divergence by those indicators since the October 2007 highs. But there is also a marked disparity between Daily MAAD data and the Weekly MAAD series which rallied to new highs last week. While we prefer Daily data to Weekly stats because of the sensitivity of the shorter cycle, the longer-term MAAD cycle cannot be ignored. Also, it wouldn’t take much upside impetus in Daily or Weekly CPFL data to create new highs to underscore recent market strength.

Click chart to enlarge

There is also the lingering problem with Cumulative Volume (see accompanying chart) that has not only failed to make new highs with index prices since April 2010, but the indicator has also failed to make new highs into what we are calling the "C" leg of the rally that began nearly two months ago. Clearly the underpinnings of this upmove have continued to deteriorate. Question is when will the pedal of the indicators hit the metal of pricing?

As we suggested last week, for accounts which have been long the lion’s share of this market, exit strategies are somewhat easier. Strength can be faded using the Minor and Intermediate Cycle Price Channels (see table). It is the uncommitted money that faces a dilemma, however. Should an investor chase a mature rally, or simply wait for corrective action to develop?

Because we have always tended to view the stock market as a "cash cow" rather than as a conduit to the "ownership" of companies, patience has proven to be a virtue since opportunities have had a tendency to reappear over and over again. Nonetheless, for liquid investors we are inclined toward more defensive strategies, given the fact this rally is mature. One choice might be written call options that could allow an investor to take advantage of a market that has developed Momentum problems. Premium erosion could ultimately prevail and could produce profits even though prices might move marginally higher. If prices simply decline sooner than later, so much the better for the written call.

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