Small-Caps Are Pointing the Way

 | Apr 04, 2013 | 5:30 PM EDT  | Comments
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IWM

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aapl

As you know, at various times, different indices move in and out of leadership positions in terms of calling the turns for the overall market. It's often the S&P 500, and more often than not, it's  the e-mini futures, which call the turns by either creating a gap or filling one. 

On Tuesday, the S&P 500 played a key role in marking a top, as it stalled just two-and-a-half points from its all-time high of 1576.09. Since early February, I have been talking about that level as an upside target. Finally, earlier this week, that level was just about tagged -- the high of 1573.66 was just 2.43 points shy. And from there, we've now had a sharp selloff.

Why not? The market has a memory, and it remembers that the last time up here in 2007 marked the prior high, and the market collapsed from there. So, no big surprise, the market didn't just go popping through there this time as if it were no big deal. It was a very big deal back in October 2007, and it could be a big deal this time as well. One thing for sure: It has already marked a short-term top.

SPX Turning Down
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Something else telegraphed a top earlier this week (and I'm not talking about the saber-rattling out of North Korea), and that was the failure by the Russell 2000 to confirm the higher highs in the SPX and Dow. The Russell 2000 is often a leading index. When the big boys (the Dow and SPX) make new highs that are unaccompanied by a higher high in the RUT, that's often the sign of a pending top.

That's what we saw earlier this week as the Dow hit an all-time high and the SPX reached multi-year highs. The RUT stalled shy of its March 28 high, which was below its March 25 high, which was below its all-time high of March 15 at 954.00. Not only did the RUT fail to confirm the higher high in the major averages, it continued its series of lower highs. That was not a good sign, and from there the market has tanked.

The Russell 2000 has been hit especially hard during this pullback: a drop of about 4% from the highs. It has now returned to levels not seen since its big gap-up opening on March 5 from 916.68 to 920.08. Speaking of that gap, it's no coincidence that yesterday's midday low was 916.84, just 0.16 from the bottom of that gap. So the gap was almost filled, but not quite. From there, the RUT bounced back up above 922. Then, late in the day on Tuesday, when the Dow and SPX made lower lows, the RUT held above its earlier lows.

That was a near-term positive sign suggesting that it might be safe to return to the shark-infested waters. And so I did. I used that weakness to write some distant May puts in the iShares Russell 2000 (IWM), added to my positions in the Russell 2000 at Guggenheim Investments and also added to my bullish bets in the Emerging Markets Fund. I'm still leaving plenty of powder dry (I'm currently invested up to a maximum of 50% levels) in case that support at the bottom of that March 5 gap gives way. So far, as of 1 p.m. Eastern, yesterday's low just above that gap continues to hold.

RUT Bouncing Off the Gap
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Another reason I am leaning toward the bullish camp is that, for the first time in weeks, the McClellan Oscillator reached a legitimately oversold reading below -100, closing at -161.58. That's the most oversold it's been since last November. I like that.

As for the Volatility Index (VIX), I'd prefer seeing it closer to recent highs near the 19-20 level, but I'll take what I can get, and right now, a pop to the high 14s may be about it.

VIX Popping, but Not Much
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As for Apple (AAPL), I am still holding bullish short puts (though hedged) going out to January 2014 at the $300 and $310 strikes. There remains that gap from the day after the low (yes, this is also a March 5 gap!) at the $420.05 level, and I will be adding to my bullish bets if that gap gets filled or close to it.

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