All major U.S. indices closed significantly higher last week. With one exception, the market has advanced every week since October. 

The good news is that the rally was led by the tech-heavy Nasdaq 100, which gained 4.1%. The bad news is that the small-cap Russell 2000 once again brought up the rear, gaining a comparatively weak 2.5%. This index has underperformed the S&P 500 since July.  

#-ad_banner-#The relative outperformance of technology stocks has managed to keep the broader market hovering near the breakeven point for most of the year. But strength in small caps has been lacking — and it is necessary to power the broader market to new highs.

Asbury Research’s own ETF-based metric shows the biggest inflow of sector bet-related assets over the past one-week and one-month periods went into financials. So it is no accident the sector has been one of the best performers recently.  

The Financial Services Select Sector SPDR (NYSE: XLFS) has gained 5.1% over the past 30 days, outperforming the S&P 500 by 2.2 percentage points. As long as these positive asset flows continue, financial stocks like Metlife (NYSE: MET), which I highlighted in the Nov. 9 Market Outlook, are likely to remain strong.

The table also shows the biggest outflow of assets over the past one-week and one-month periods came from the energy sector. This warns of more upcoming weakness in energy prices and related assets. This is especially true considering recent weakness in economically sensitive copper prices, as discussed in last week’s issue, keeps the threat of global deflation alive.

The Good News: The Market Holds Support

In last week’s report, I was looking for signs of investor optimism where I could find them since major indices had failed multiple attempts to break to new highs. More specifically, I had my eye on the S&P 500, which was testing minor support at its 2,021 Sept. 17 high.  

The index stopped on a dime at 2,021 on Nov. 16 and proceeded to rebound by 3.5% into Friday’s close.

This is good news and a great first step, which keeps my 2,135 near-term target alive. However, until the major indices start rising above overhead resistance levels — particularly the 5,133 tech bubble high in the Nasdaq Composite, which I have been focusing on in the Market Outlook for months — it’s too early to assume we’re in for smooth sailing into next year. 

The Bad News: Overhead Resistance Still Looms Large

Although my focus has been on Nasdaq 5,133 for simplicity’s sake, more than a half dozen key U.S. indices and positively correlated overseas indices, as well as key individual stocks, are also testing major overhead resistance levels.  

One worth paying special attention to is Apple (Nasdaq: AAPL), the largest U.S. stock according to market cap and a Nasdaq Composite constituent. It began this week situated just below its 200-day moving average at $121.96 after testing and reversing lower from it on Nov. 4.

The 200-day moving average is widely viewed by investors as a major trend proxy and, according to that metric, the August decline turned the major trend bearish. The failed attempt to get back above the 200-day on Nov. 4 indicated the downtrend is still intact. 

AAPL has a positive correlation to a number of major indices, including the Nasdaq 100 and Composite and the S&P 500. Until it can launch a sustained move back above $121.96, new long positions are fighting the trend in the stock itself and may be premature in the broader market as well.

Use Volatility To Play Good Defense

In this week’s Market Outlook, I have pointed out an encouraging rebound in the S&P 500 that targets a retest of the 2015 highs, but I’ve also said the bulls should not let their guards down until some key overhead resistance levels are broken.  

I recommend remaining cautiously bullish until this inflection point between minor support and major resistance is resolved. The next chart will help you protect your downside while waiting for a Santa Claus rally to kick in.  

The lower panel plots the Volatility S&P 500 Index (VIX) with its 50-day moving average, which I use as a baseline to differentiate between near-term investor fear and complacency. As long as the VIX remains below this moving average, which has been the case since early October, the market is complacent enough that long positions can be held with relatively low risk.

If the VIX can move above the 50-day, currently situated at 18.36, it would indicate a level of investor fear that has historically coincided with broader market declines, most recently the one that took place between Aug. 19 and Oct. 2.

Another Reason For Longs To Be Careful

In the Nov. 9 Market Outlook, I said the aggressive late-October rise in 10-year U.S. Treasury yields represented a bet by the typically prescient bond market that U.S. economic conditions were improving. 

Since then, however, these yields have retracted a bit — finishing last week at 2.26% — while the 2-year/10-year yield curve shown in the next chart has flattened to 133 basis points, its narrowest level since the end of March.

A flattening yield curve means the spread between 2-year and 10-year yields is narrowing, which typically indicates inflation expectations are declining. In this particular case, I believe the recent flattening is due at least in part to the recent acceleration in the year-long decline in commodity prices like economically sensitive copper, which I discussed in last week’s report. This warns of global deflation and a worldwide economic slowdown.

If and when the major resistance levels discussed in this report are broken to clear the way for a new one-to-two-quarter stock market rally, it will ideally be accompanied by a steepening yield curve. That would indicate the bond market is betting on a strengthening U.S. economy to help make the rally sustainable.

Putting It All Together

This has been a year of dichotomy as steadily declining unemployment, an improving housing sector and recently rising long-term U.S. interest rates have suggested an improving economy. Yet stalling equity prices, collapsing commodity prices and a flattening yield curve warn of more trouble ahead. 

My near-term bias on the stock market will remain cautiously bullish as long as the S&P 500 can hold minor support at 2,021 while the VIX remains below 18.36. If those levels hold, I anticipate a Santa Claus rally that hopefully breaks nearby major resistance levels. 

However, I am apprehensive about deploying any new capital until the Nasdaq Composite gets and remains above 5,133, ideally on stabilizing commodity prices and a steepening U.S. yield curve.

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This article was originally published on ProfitableTrading.com: Apple’s Chart Warns Traders Should be Cautious