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Is the Market Rally Starting to Cool Off?


With stocks on track for their worst week in 3 months, it could be argued that this red hot market is about to cool off, but there's only one problem; the numbers don't bear it out yet.

While technically true, it is important to note that the weekly losses for the major U.S. indexes are less than 1%, which speaks volumes about the strength of the rally.

And yet, there is one area where the weekly decline is larger, more troubling and less nuanced; the Cyclicals (^CYC). However, it is early and a 3% drop on the heels of a 40% rally is nothing to freak out about, it's happening in almost perfect isolation from the rest of the market, and think that is reason enough to pay close attention.

"It is strange," says John Canally, investment strategist at LPL Financial, adding that he actually started getting a bit defensive about a month ago. As much as that cautious approach cost him some upside over the past few weeks, it's the resilience of the Consumer Discretionary sector (XLY) that's troubling him now.

"What I look at broadly is the dichotomy between the surging consumer sentiment that we get, and yet, surging gasoline prices too," Canally says in the attached clip. "Those two normally move in the same direction," he says, pointing out that one of them "has to give."

Until and unless the current dip gets more significant, like a 4% or 5% sell-off, he says he is not changing course.

As much as he's calm for now, the prospects of first quarter earnings season which is only a month away, look bad, and could be a downside catalyst.

"Q1 earnings season is likely to be the worst quarter for earnings in quite some time," he predicts.

As for Treasuries, he says they're "a little skeptical" on the recent rise in yields on the 10-year treasury, and believes the Fed will cut the rate rally short with QE3 which he predicts is ''coming down the pike" once Operatation Twist wraps up the end of June.