After two days of U.S. equity market rally after the bloodbath in the momentum stocks, where are we now?
Market facing technical resistance
Here is my take on the current technical position of the market. As the chart below shows, the SPX bounced off support at 1840 and rallied for two days. However, the rally was on declining volume, which is never a good sign, and the index is approaching a couple of technical resistance levels. One is shown by an uptrend that stretches back to early February; and the other is a well defined resistance zone at the 1874-1884 level.
If you are scoring this at home, chalk one up for the bears.
Risk appetite is rolling over
The recent carnage in the high flying Biotech and Social Media stocks are well-known, but the technical effects of the damage is likely to be long lasting. The chart below shows a composite index that I built based on an equally-weighted long position in the NASDAQ 100 and Russell 2000 (high beta risk-on index) minus an equally weighted short position in the defensive sectors of Consumer Staples, Telecom and Utilities (low beta risk-off index), where the composite Risk Appetite Index is set at 100 on December 31, 2011.
As the chart shows, the Risk Appetite Index has violated an uptrend and has started to roll over. This picture of fading risk appetite forms a negative divergence when compared to the SPX, which remains in an uptrend.
Score another for the bears.
CapEx Index still constructive
I wrote on Sunday that in order for the bull market to continue, we need to see an acceleration in capital expenditures at this part of the cycle and the acid test will come this Earnings Season (see What equity bulls need for the next phase). While it is still very early, the initial report by Alcoa (NYSE:AA) was well received by the market.
My CapEx Index, which is composed of an equal weighted relative return index of the Industrial sector (NYSEARCA:XLI) and the Morgan Stanley Cyclical Index (CYC) against SPX, remains in an uptrend, which is a constructive signal for the stock market. For now, Mr. Market is giving the cyclical recovery story the benefit of the doubt.
Score one for the bulls.
Game not over
So far, the score is Bears 2 and Bulls 1. The bears have the upper hand, but the game is by no means over. In order for the correction to continue, we need to see a combination of further technical deterioration, such as a decisive violation of the 1840 level, a downturn in the CapEx Index or some exogenous event, such as further tensions in eastern Ukraine or heightened fears of a China crash.
The bulls, on the other hand, need to sidestep these risks and convince the market that a cyclical acceleration of growth is indeed at hand. Their cause could be helped by further dovish pronouncements from the Federal Reserve or news of a decisive stimulus program out of Beijing.
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui's blog to ensure it is connected with Mr. Hui's obligation to deal fairly, honestly and in good faith with the blog's readers."
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