There are two unanswered questions currently facing the equity markets. Will they be able to absorb the flood of new IPO supply and can they successfully complete the leadership rotation from “growth at any price stocks” to those priced on reasonable earnings without first making a 10% or more correction. While there some good reasons to think a correction is inventible the S&P 500 Index is holding up better than expected, however the same cannot be said about the NASDAQ where many of the “growth at any price stocks” trade.

Market Review

S&P 500 Index?(SPX) The tide turned once again last Monday when it made an inside range day and closed up 14.92 followed by advances of 12.37 Tuesday and 19.33 Wednesday as confirmed by the VIX futures premium that began the week at 2.08% finishing in solid green territory at 17.82%. As it moves back up toward 1880 watch for another reversal.

PowerShares QQQ??(QQQ) Using PowerShares QQQ or the “NASDAQ-100 Index Tracking Stock?”, an exchange-traded fund based on the Nasdaq-100 Index? for the NASDAQ since there are listed options with good volume and liquidity, we note it declined 8.84% from the March 7 high to April 15 low with 29 of the companies declining more than 20% from their highs. Now the challenge is back up at 89 where a reversal would set up a potential right shoulder of a new Head & Shoulder Top activated on a close below the neckline at 84.

The comparable decline for the NASDAQ was 9.7%, just about enough to qualify as a correction. Since the NASDAQ previously led the market higher and then declined faster and further it assumed the leading role and if activated by a close under the QQQ neckline at 84, it will take the entire equity market lower for the long overdue correction.

CBOE Volatility Index??(VIX) ?Declining 3.67 for the week, it solidly confirmed the change of direction for the S&P 500 Index. The VIX futures premium began the week in the lower part of the yellow zone at 2.08% finishing near the upper end of the green zone at 17.82%. Similarly, the implied volatility of at-the-money VIX call options declined from 107.25 to 66.15 adding confirmation to last Monday’s unexpected turn around.

iShares Barclays 7-10 Year Treasury ETF?(IEF) ?Last week’s?issue?included a chart making the case for an activated declining wedge with an upside measuring objective at 103.68. However, with Thursday’s dramatic .58 decline taking it well back into the consolidation pattern negating the breakout, it now indicates higher interest rates once again as IEF appears to be forming a trading range between 101 and 102.75. Back at 101, the equivalent interest rate would be 2.80%. The sudden decline along with improving equities further supports the view that “risk on” and “risk off” trading remains as important for interest rates as fundamental economic expectations.

Strategy Ideas

The sector rotation challenge is to identify where the proceeds from NASDAQ and other overvalued “growth at any price stocks” goes. Although it made a substantial .53 decline Thursday the?Utilities Select Sector SPDR?42.30 (XLU) is up from 37.11 or 15.66% since January 3 to Thursday’s Key Reversal high of 42.92. However, if 10 Year Treasury Note interest rates advance above 2.80% it would most likely end this current uptrend.

A second funds flow destination has been?Consumer Staples Select Sector SPDR?(XLP) 43.63 up 9.64% from the February 3 low of 39.83 to Thursday’s high at 43.67.

Further funds have been going into?Crude Oil?as the front month May futures contract (CL/14K) 104.30 advanced 14.9% from the January 9 low at 91.35 to last Wednesday’s high at 104.99. Checking?United States Oil?(USO) 37.66 we see the advance was even greater at 15.7% from the January 9 low of 32.68 to Wednesday’s high at 37.81. As we noted last week in?Digest Issue 15 “Goose & the Golden Eggs”?USO uses futures that are now in backwardation so every time they roll over the near term futures contracts they pick up some carry.

Finally as mentioned?last week,?the IPO frenzy appears to be partly responsible for the current wobbly market and is probably the most important threat since there are still more to come especially in the hard hit biotech sector. As previously mentioned, comparisons with the 2000 tech bubble are hard to ignore.

Checking the typical sector rotation chart we see energy and consumer staples in the late expansion and early contraction zones while capital goods, transportation and utilities appear misplaced assuming the market is in late expansion making rotation analysis easier said than done.

While the current upturn certainly appears strong enough to close short positions, we suggest watching the?S&P 500 Index?around 1880 and?PowerShares QQQ?at 89 for signs of turning lower once again as the equity markets appear to be living on borrowed time. IPOs remain a concern along with several others suggest late expansion is the most likely current market condition. To alter this view the S&P 500 Index?would need to close back above the April 4 high of 1897.28 along with the QQQ closing back above the March 7 high of 91.36 thus negating the current reversal patterns that appear to be forming.