Concerns from Last Week / Why to Ignore Them

by Jay Pestrichelli on April 2nd, 2012

This past week showed two distinct behaviors. The first half was more of what this great quarter has given us with the bulls in charge. However, the second half told a different story. The bulls and bears fought it out and showed this rally isn’t unstoppable. And while we’ve been bullish over the long-term, there were a few signs from last week that gave me pause.

The first was the performance of some high profile assets like Oil and Apple. Apple pulled back from its all time high of 621 to end Friday at 599. It wasn’t the small pull back of 3.5% that concerns me as much as it happened during days when the broader market was up or down much less. The S&P 500 for example, over the same few days was down only 11 points to 1408, a less than 1% move. I’m always looking for the “canary in the coal mine” and if Apple investors start to take profit, it makes one wonder if it will cause a cascade effect.

Again, a 3.5% retreat is nothing to get unnerved about, and Apple has had moves against the market before. This past year it has felt a little like Gold in the fact that it can be its own market and ignored every other stock. So while I watch for the canary, its too early to tell if this is it. I would change my tune on this and pay more attention if we saw a larger drop exceeding something like 10% against the rest of the market.

Oil also dropped this week from 106.75 on 3/23 to 103.17 on Friday. Again, it’s not the pull-back of just 3%, but the move away from the rest of the market that it has lead ahead of the moves higher over the last year or so. Actually, the break from the S&P started as far back as 3/12.

Although this is on our radar, it’s worth noting that this has happened before, most recently from 1/3 to 2/2. At that point Oil was down 6% and the S&P up 5.5%. If that had spooked us to get out or sell the market, we would have missed the rest of this great quarter. Again, this is on our radar, but until Oil drops below it’s current up-trend on non-global news, we’ll back-burner this too.

The second concern was the strong performance in the Staples and Utilities sectors. These were some of the best performing sectors of 2011 as they were considered safe havens with their high dividends and low volatility. Actually, the Staple ETF, XLP closed at a new all time high of 34.08 on Friday.
As readers of the Buy and Hedge blog, you know we’ve been in Staples since October and think they’ve made their run. We posted a few weeks ago that we’re rotating out to Financials. We continue to have that bias and like nothing better than selling at a high. Although it rarely works out that way, we’ll consider letting some of our collared XLP positions get called away and book the taxable gain if it ends the options month at this level. We’re probably not the only ones thinking this way.

Add to this sector story that this is the end of a very good quarter. Profits will come off the table when that happens; its just what money managers do. We should also remember that some sectors are going to be out of balance. This means that underperforming areas like Staples and Utilities will see inflows from the strong performers like Tech and Financials. These rotations don’t typically last long so there may be a day or two left of this. If the rotation lasts much longer it could be a sign of larger move.

Despite these two concerns, I’m still encouraged for now that the bull run will continue; however, its hard to believe it will be as strong as it has been so far.

First reason for this is that volatility levels continue to be low. Despite the weakness of latter half of the week, the VIX, which closed at 15.50, has stayed at low levels and found resistance at the 17 level more than once. As a reminder, the VIX is a forward looking index intending to give an expectation of volatility over the next 30 days. While this can change on a dime, right now, the low VIX is telling us the speculators (bullish or bearish) aren’t willing to pay much for drastic equity moves.

The second reason that gives me confidence is the failed rally on Friday for US bonds. The fact that no one is running to the safety of treasuries, despite higher interest rates over the last few weeks tells us no one is looking to rotate out of equities. Europe may still have something to do with these as international assets may run to US-backed debt, however the tone of state-side investors seems to be showing no love to government bonds.

There was, however, a bump in corporates, as seen in the ETF of corporate bonds LQD these past two weeks. Look for the run to safety to show itself here first when it happens.

So to sum this up:
1. Apple and Oil could show preemptive signs of trouble, but not yet.
2. Staples and Utilities are high, but we like that since we’d like to sell those anyway
3. Money-manager may just be doing their Quarterly rebalancing and locking in some profits
4. Volatility has stayed low, so we’re not expecting any dramatic moves
5. It doesn’t appear anyone is running to bonds for safety.

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