There are three primary perspectives towards the market currently:
1) The Bull Perspective - The Market began a new leg up and will continue melting up to new highs with minor dips along the way, basically a market like we had from mid December to February.
2) The Bear Perspective - The market has topped and we are going to begin a pattern of lower highs and lower lows.
3) Neutral Perspective - The market remains in a trend less state, this is variously labeled as range bound, choppy, or a stock picker's market.
In this article, I will make my case for why I believe that the market is currently range bound.
Since April 23, the markets have been on a tear. The S&P500 from a low of 1360 (which was a retest of the April 10 low) in less than a week hit 1419 before backing off to its current level of 1402.
I wrote an article last week discussing the New York Summation Index and its nonconfirmation of the upmove. However, as this move has matured, the Summation Index is now confirming the advance, signaling that breadth is now confirming the advance in price.
Despite this bullish development, I remain reluctant to enthusiastically jump in on the long side due to qualitative concerns about the market climate. I am posting the following charts consecutively and then discussing them together, as they are all pieces of evidence supporting underlying weakness in the market, currently masked by the resilient indexes:
Huge price advances in which all sectors advance and continually make higher highs and higher lows are enabled by massive amounts of liquidity unleashed on the markets. The liquidity is always obvious in retrospect but in real time there are some footprints. The above charts reveal that the liquidity in this advance is not as powerful as mid December or of previous instances of big, sustainable price advances.
The performance of the small caps relative to large caps, which is shown in the ratio of the Russell 2000 to the S&P500, is one indicator of liquidity. It takes more liquidity and actual buying interest to move small cap stocks. The big uplegs of 2009, 2010, and 2011 were characterized by small caps outperforming; the high levels of liquidity keeps a bid under stocks.
Currently, we are seeing the ratio not really going anywhere despite price climbing higher. Contrast this with the powerful move in the early part of this year.
Another measure is the equal weighted S&P500 vs. the price weighted index. Again, this leads to the same conclusion as the previous chart. This is another effective tool to check liquidity levels in the market as it reflects individual buying vs buying the indexes. The same outperformance is seen in the early part of the year commensurate with the advance in price.
One note of mention is that both ratios lagged the initial portion of the move from December which is highly unusual, however I attribute this to end of year selling.
The final piece of evidence is the woeful underperformance of the European banks. First of all, they are not a vote of confidence that all is well in Europe. Nevertheless, the U.S. markets continue to defy the weakness of the European markets. However, I don't think that our markets will be immune if the euro banks continue on this path.
In addition to their woeful performance, the fact that they haven't rallied with the market is a sign of lacking liquidity. One of the most telling signs of a new leg up is that oversold sectors will rally hard, at least in the initial stages, even in the face of bad fundamentals. The shorts are squeezed as even a little buying power creates massive counter trend moves.
An example from the recent leg up is the performance of solar stocks and shipping stocks which were two of the worst performing sectors in 2011. Similarly, I would have expected if there were sufficient liquidity to kick off another leg up then we would have seen the weakest sector at least show signs of a short squeeze rather than a weak rally followed by a tumble to new lows.
I have spent many more words addressing the Bull Perspective, because frankly, they have a more compelling case to make here as the Dow Jones Industrial has already made new 52 week highs and the S&P500 and Nasdaq are 1-2% away. Essentially, the charts posted above indicate that there is not enough liquidity for prices to keep climbing weeks upon weeks. This liquidity is a prerequisite for a new leg up.
The Bear Case is also interesting and many are advocating that the weakness in Europe will infect the U.S. While this is certainly possible, I will defer to the impressive pattern of higher highs and higher lows that are intact all this year and the ascending breadth. Until this changes, I think for swing traders it is not wise to take short positions.
Finally, with the odds of a breakout and breakdown diminished due to factors discussed above, it leaves us in a trend less, range bound market. Stocks seem to be rising and falling on their own merits and the influence of the indexes has waned with correlations close to lows. Contrast this with the summer, in which the whole world basically traded like one stock with correlations at record highs.
I hope this article was of value and I look forward to comments.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.