Technical Talk: Shift from small to large caps under way?

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The comments below were provided by Kevin Lane of Fusion IQ.

“It is choice not chance − that determines your destiny.” Jean Nidetch

The market continues to march a bit higher but as David Tepper from Appaloosa so simply stated on CNBC the other day, each time you move higher there is obviously a bit more risk associated with investing. Now  neither Mr. Tepper nor Fusion is saying there is a top in place, but there is certainly a greater risk to a correction at 1,290 on the S&P 500 than there was at 1,150.

Recently key indices such as the transports and the S&P 500 have been all pushing up against resistance. As the chart below highlights, the S&P 500 is pushing up against resistance near 1,290 (gold line) while still within the context of a bullish rising wedge formation (green lines). If the Index can eclipse 1,290 there is still upside up until the 1,325 level. However, if the S&P 500 fails here for another day or so, the Index will likely slip towards 1,225 (red dotted line), which represents the recent breakout spot for the Index. The dividing line between respecting the present uptrend and the start of a deeper correction remains the 1,270 level.  As long as the S&P 500 stays above this we must respect the trend. Any move below this area would suggest it is time to get your defense on the field.

Like the S&P 500, the transportation index (as seen below) is also testing some key overhead resistance near the 5,225 to 5,250 area (red line), while key support remains in the 4,800 area (orange dotted line). If the Transports and S&P 500 continue to simultaneously stall at these areas, we think it raises the percentages that we will correct sooner rather than later.

Keep in mind we do think any corrective activity should be limited, absent any new data that unfold, to a minor corrective wave of 5 to 10%. However, the big shift we believe that will occur on this corrective wave will be the long-awaited emergence of large cap leadership after years of small cap outperformance.  The chart below is a ratio chart for the S&P 100 (OEX) versus the Russell 2000 (RTY) and, as it clearly highlights, large caps stocks are at their lowest level relative to small cap issues since 1983. That low level back in 1983 sparked a secular return to the large cap space. We truly believe every dog has its day and small caps have now hogged the spotlight since 1999, thus we suggest it is time to rebalance your holdings and get more large cap exposure.

That said, over the next few days we will be compiling a list of our favorite large caps names.

As we always say, there is never a good or a bad stock, just a right or wrong time to own it. You want to own it when the tape is in rally mode and not in corrective mode. Finding that transition point is always hard, so make sure you invest with a safety net (stops) at all times!!

Source: Kevin Lane, Fusion IQ, January 25, 2011.

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