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Chaikin Market Insights - May 24, 2014

|Includes: XHB, XLB, Energy Select Sector SPDR ETF (XLE), XLF, XLI, XLK, XLY

S&P 500 Closes Above 1,900…will the Market Follow Through?

The S&P 500 Index closed at 1900.53, up 1.4% on the week. It was a steady drift up for the stock market in the shortened holiday week with short-covering and bargain hunting driving the momentum stocks higher while the blue chip yield-oriented stocks continued to perform well. The two factors cited by the bears over the weekend, low volume on the rally and a diminishing number of stocks in the S&P 500 making new highs, are mildly disconcerting. The low volume can be explained by the pre-holiday sessions on Thursday and Friday, but the fact that only 23 stocks in the S&P 500 made new highs on Thursday is disturbing.

Seasonal patterns and the deterioration of internal market strength suggest that this rally will run into profit taking when traders return on Tuesday. After some early morning follow through on Tuesday, perhaps into Wednesday, the market should turn back down below 1,900.

It is possible that with the internal correction in the market, leading Biotech and high momentum stocks having failed to spill over into the blue chips, that the stock market can come through the next 4 weeks in relatively decent shape. I still err on the side of caution and recommend raising some cash on this rally, particularly in the high fliers which have rebounded.

The internal Power Gauge breadth for the major Indexes remains mixed with the OEX 100 representing old line blue chips showing the best readings with 30 bullish ratings vs. 13 bearish ones. The S&P 500 Index which closed at a new all-time had 103 stocks with bullish Chaikin Power Gauge ratings vs. 95 with bearish ratings, a further indication of market vulnerability, based on narrowing breadth. The Nasdaq 100 reading improved from last week as tech stocks rebounded with 17 bullish and 31 bearish.

Power Bars from Chaikin Analytics

ETF Sector Update

The Energy (NYSEARCA:XLE), Technology (NYSEARCA:XLK), Industrial (NYSEARCA:XLI) and Materials (NYSEARCA:XLB) Select Spyder Sector ETFs are leading the market higher. The Financial XLF and Consumer Discretionary (NYSEARCA:XLY) Sector ETFs are lagging the market.

As mentioned previously, the poor performance of the financial stocks is a drag on the market and supports our opinion that there is resistance at or just above 1,900 on the S&P 500.

There was a strong rally in the Home Builders (NYSEARCA:XHB) on Friday based on better than expected New Home Sales. This ETF still has a preponderance of bearish stocks:

and a number of stocks within the group should be sold on this rally, including Masco (NYSE:MAS), Toll Brothers (NYSE:TOL) and USG Corp (NYSE:USG).

What Would Cause You to Change Your Cautious View of the Market?

With 10 year U.S. Bond yield staying in the 2.6% area in the face of the Federal Reserve board cutting back on their bond purchases, the bond market has thrown us a curve ball. Bond market participants see a tepid growth economy and continuing low interest rates. The GDP growth projections for the balance of the year continue to be optimistic, leading to investments in blue chip stocks which would benefit from a rebound in the U.S. economy along with continued strength in the European economies.

What would change my cautious stance is the passage of time, better performance in the financial sector and a confirmation of the rosy GDP and 2nd quarter earnings expectations. Much has been blamed on the severe winter weather in the 1st quarter of 2014, now the market needs to see the anticipated rebound based on pent up demand.

For now I see a challenging end of May into mid-June. If the market escapes unscathed or pulls back mildly, then I'll get back on the bullish train.

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