The stock rally is showing signs of fatigue

The S&P 500 Index (SPX) closed the first quarter of the year at record high. Time to celebrate? Not really. Technically, major indices are trending and there are no direct technical signs of a mark top, but I believe “under the hood” the rally has weakened:

  1. Fewer stocks have been participating in the rally, as measured by the number of NYSE stocks making new 52-week highs.

  2. High-beta stocks have started to underperform: the PowerShares S&P 500 High-Beta ETF (SPHB) failed to record new highs while the general market rallied.

  3. Copper prices have not been participating at all. “Dr. Copper” has often demonstrated his ability to predict market turns. However, the equity/copper divergence has been going on for almost a year. Either copper prices will have to turn up or stocks have to decline at some point. The divergence cannot persist forever. Overall, cheaper copper reflects weaker demand from key economies such as China, which is not a positive development. In addition, Copper is in a very difficult technical position.

  4. International markets have decoupled: while US stocks are rallying, international markets have been weakening: EZU, the iShares MSCI Emu ETF, as well as the iShares MSCI Emerging Market ETF (EEM), are down 4% for the year. These are not the developments we want to see when global economies are in recovery mode.

On the other side, there are still many positives: sentiment is not overly bullish. I believe there are probably still potential buyers left, who missed the strong first quarter and are now chasing stocks higher. Liquidity remains strong since the Fed continues to support equities with QE3. Finally, US stocks are still not overly expensive, in my opinion.

In my opinion, the mixed environment creates trading opportunities on both sides – long and short. Some stocks are trending nicely. One current example in my portfolio is Cray Inc. (CRAY). Other names are directly related to weak macro themes: Deutsche Bank (DB) is a current short to benefit from the issues in Europe. Another short, Freeport Mcmoran (FCX) is highly correlated to copper, so the portfolio gains from weakness in that area.

Overall, I cannot predict when the rally will end, but I do not want to trade too aggressive from the long side at this point.

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The investments discussed are held in client accounts as of March 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.