A Grand Illusion

 | Oct 28, 2013 | 4:10 PM EDT
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The action was slow and the indices did nothing, but what made it even worse was that momentum stocks continued to fall apart. While the indices were boosted by dinosaur names like GE (GE), UPS (UPS) and Procter & Gamble (PG), the stocks that have led recently continued the struggle that kicked in Friday.

The bulls tell us that it is a healthy rotation and nothing is wrong with the indices, but they are wrong if they think that some big-cap defensive names are going to take the place of Facebook (FB), LinkedIn (LNKD) and Baidu (BIDU). The tricky part is that the indices still haven't done anything wrong. If you just glance at the SPDR S&P 500 (SPY) or iShares Russell 2000 (IWM), it looks like things are chugging along without a worry in the world. It is very deceptive if you consider what is going on in individual names. This action has pushed me into raising cash and taking a more defensive posture.

Apple (AAPL) earnings are coming up but it is no longer a leading stock. I don't expect it to generate much sympathy one way or another, although a good reaction will help the indices due to its weighting. Again, the issue isn't the indices but what is happening under the surface, and AAPL will probably help keep the illusion going.

Have a good evening. I'll see you tomorrow.

Oct. 28, 2013 | 1:29 PM EDT

Stay Out of the Way

  • This isn't healthy action, despite what the indices are doing.

If you have been trading the leading momentum stocks recently you are probably feeling a bit confused by today's action. There's a vicious rotation out of speculative and momentum stocks that have led the market for months into cyclical and defensive names that have lagged, such as Alcoa (AA) and Procter & Gamble (PG).

Sometimes rotation can be a good thing, especially if the market starts to broaden and new groups play catch-up. But that doesn't seem to be the case with this action as market players seem to be seeking safety as concerns grow over valuation of some of the strongest names.

The oddest thing about this action is that the S&P 500 is hitting new highs while the underlying action is very cautious and defensive. Usually, the move to more defensive holdings comes after a period of weakness rather than at the peak of momentum.

So far this year, the market has a very good record of finding its footing after a stumble. In fact, it is often said that there is no memory from day-to-day, but this weakness in leading stocks is a troubling change in character and if there isn't some support soon, it is going to affect the indices as well.

I'm staying out of the way and not betting on a comeback from the momentum names right now. This is not healthy action, despite what the indices may be doing.

Oct. 28, 2013 | 10:45 AM EDT

Churning Into Defense Names

  • I find this change in market character a bit worrisome.

The indices continue to hold up but there is churning action and a shift into defensive stocks. As I discussed in my opening post, we had a warning sign Friday as high-momentum stocks and China-related names lagged badly. There are a few bounces in those groups today but we continue to see weak action in recent leaders Facebook (FB), Tesla (TSLA) and Netflix (NFLX).

Breadth is slightly positive with leadership in precious metals and gold. Most notable is that the defensive names are leading today, such as Bristol-Myers (BMY), Procter & Gamble (PG), Kellogg (K) and others. The rotation into those names is helping the indices, but it is a change in character that I find a bit worrisome.

As I discussed Friday, I sold down quite a few positions because the poor action in speculative and momentum names was troubling. I've done very little this morning, although I'm eyeing FB as it approaches support at $50. The stock has earnings Wednesday and I anticipate that will give it a little support.

I do not like the action I'm seeing, so I'm staying defensive.

Oct. 28, 2013 | 9:20 AM EDT

Caution Levels Raised

  • Momentum stocks are weakening -- a troubling sign.

A competent leader can get efficient service from poor troops, while on the contrary an incapable leader can demoralize the best of troops. -- John J. Pershing

The major indices are set to gap up and continue the move into new-high territory, but market leadership has been under pressure. In addition, a number of negative developments aren't being reflected in the indices.

On Friday the indices looked fine, but if you had dug down you would have seen some problems. Breadth was negative on the Nasdaq, China-related stocks were hit hard and the big-cap momentum names were down and failed to confirm the new highs in the indices. IBD's list of the top 50 momentum stocks underperformed the indices with a loss of 0.5%.

The severe pressure on Chinese stocks was probably caused by fraud allegations against NQ Mobile (NQ), but this has been one of the hottest groups in the market for months and the reaction across the board was quite severe. Momentum traders bailed out quickly, and it may not be easy for this group to entice them back.

What's worrisome about this is that, when speculative action cools in one group, it often spreads to others that have been leading. Biotechnology, for example, has been another key group, but it has also shown some signs of slowing.

The bulls will shrug this off as just a rotational move into some new names, but when the new leaders are more conservative or defensive names, it's an indication that the character of the action is shifting. Of course, good earnings from the likes of Amazon (AMZN), Google (GOOG) and Microsoft (MSFT) are more than making up for some of the issues under the surface. There have been some good earnings reports, and expectations are high that the trend will continue as we hear from Apple (AAPL) and other key names this week.

Another potential driver this week is the interest-rate decision from the Federal Open Market Committee. It is widely anticipated, due to the government shutdown and the slow economic recovery, the Fed will further delay any tapering off of bond-buying. There is nothing the market likes more than a friendly Fed, and that looks to remain a source of underlying support.

In a nutshell, what we have are indices that continue to trend higher, but weak action in leading momentum stocks. The Four Horseman -- Facebook (FB), LinkedIn (LNKD), Netflix (NFLX) and Tesla (TSLA) -- are not hitting new highs as the indices are doing. Maybe a new group of leadership will emerge, but transitions of that sort usually don't come smoothly.

We'll see if the market can shrug off the weakness in momentum and China names and continue its trend higher, but this all has caused me to raise my caution levels. There is nothing overtly bad about the action, but warnings signs are appearing, and I'm already acting on them to some extent.

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