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JAKE MERL: Welcome to Trade Ideas. I'm Jake Merl sitting down with Frank Cappelleri, chief market technician at Instinet. Frank, it's great to have you back on the show.

FRANK CAPPELLERI: Thanks so much, Jake.

JAKE MERL: So you were last here talking about the 10 steps for a sloppy market. As you noted last time, the market was stuck on step 3. Can you please review what you actually mean by sloppy market? And then can you also give us an update? Are we still stuck on step 3?

FRANK CAPPELLERI: Sure. Well, the whole point of the exercise was to show you can put a system in place to help remove motion from the environment. And I think that's especially interesting and helpful as we extend it higher. Now back then, we were only at 2,800 for the S&P 500. But we had reviewed that. We were stuck on step 3. And what those were was, again, step 1 was just to fail resistance, step 2 was to have a downside to follow through, and 3 was to have a bearish pattern form.

Now the most important thing we never got to was step number 4, have that bearish target hit. And so up to that time, the end of February, we had a handful of bearish formations come and go at that point. And getting back to 2,800 is round number significance. The S&P had fell there numerous times over the last year or so. And it seemed like a really interesting spot to maybe take some profits without shorts. But we had to see a little bit more action on the downside for that to occur.

And so actually, the S&P had a little bit of trouble over the next few weeks, and on March 22, fell about 1.9%. It looked like we're going to get that downside target hit. Did not, of course. And we had a really substantial bear trap reversal. And from that point, there were then two other bearish patterns form and two other fail bearish patterns. So because of all of that, the uptrend remains intact.

And so the thing to remember about this is sometimes it's very difficult to see this in real time. Not everyone is looking at 15, 30, 60 minute charts like I have the luxury of doing. So what I did was, toward the end of that last presentation, show this in oscillator form. So we take the 10 steps and actually make an oscillator from to 10. And we can see that on the chart that it's remained between and 3, and we like to call that the "tame zone." It's just a fun way of saying that bearish patterns have not been successful.

And as long as that occurs, we have to remain on the right side of the trend. And so we have that dotted line there to show where it actually could occur. And if you go back to September and October of last year, that's exactly what happened, where we tried to remain on the side of the trend until it ended. And of course, it had improved violently at that point, but we never got back below 3. And so it was able just to stay then on the bearish side. And that's where we're at right now, still stuck on 3. And as long as we're there, we're remaining on the side of the current prevailing trend, which is currently up.

JAKE MERL: OK, so as you mentioned, the Instinet Bear Oscillator has not changed since February. But has anything else caught your eye that investors should be worried about?

FRANK CAPPELLERI: Well I think you have to look at as the market rises, volatility obviously goes down. We know the VIX is now below 13, so it's obvious. I don't think we have to review that. But I think it's important to take a look at what's caused that to happen. So we look at intraday and look at the intraday ranges, for instant, right? On a five-day rolling basis, we just hit 40 basis points over the last few days, which is really low.

Compare that to February, we were at about 80 or 90 basis points. Take that all the way back to December, there's 350, 400 basis points a day. So it's really extreme. So if you look at that from extremes, we're at the very end of the other side of the pendulum at that point. And so that could suggest that we're due for a pretty substantial reversal.

If I would look back to what happened in April through September last year, we were hovering around those points for a long time before anything mattered. And look through the entirety of 2017, we had intraday ranges 30, 40 basis points all year before something occurred. So we have to look at this and realize, why does Instinet Bear Oscillator continue to go to 3? Because there's not been negative momentum strong enough to change any of this. So I think you have the intraday ranges that's going to change at some point. That's going to probably eventually have one of these bearish patterns hit.

The other thing is that volume has been obviously shrinking. Yesterday on Monday, April 15, was the lowest volume we've seen for a full day since the day after Labor Day 2018 in September. You look at the five-day rolling average of volume. This is the lowest level we've had since September 20 of last year. September 20 is, of course, important because that was the last all-time closing high that the S&P had. So all these things are together.

We know we're at levels where typically things reverse. Timing that is very difficult and very challenging, also frustrating because anytime you see a big selling effort, whether it's because of the Fed or something else, you want to say, that's it. And obviously we can't. We see more downside follow through and finally see a bearish pattern hit. So I'm relying on Instinet Bear Oscillator for as long as it works.

JAKE MERL: So, Frank, what about under the surface? Have you seen any cracks in any key sectors or groups?

FRANK CAPPELLERI: That is an important point because it's very rare that you have everything moving in unison together at the same clip and making highs at the same time. But I would say that this period had a lot of them working together. But there are two areas I think that we continue to have to watch that gave some trouble over the last few weeks, the one being the financials, in particular the regional banks.

So recall the week of the Fed meeting in March, Carry ETF got crushed down 10%. Now renew all the stats, but that was the largest weekly decline for the Carry ETF for 10 years, going back to 2009. So worse than anything we saw in the volatility of 2018, worse than the correction in 2016, the correction in 2015, and the crazy volatility of '11, right?

So when that was out there, the Fed having this now dovish stance and rates going down as much as they did, there was real alarms going off. And this was going to set former top of the S&P. That was the big talk about that time. And on March 22, the end of that week, the S&P did fall 1.9%. What happened the next week? Everything flipped, right? So that was actually the chance that you could have a bearish pattern hit. Never happened. Carry was up a lot the next week.

And the other thing was at Russell 2000, the small caps. Now they've done fine from the low on the way up. Actually up a little bit more than the S&P 500. But keep in mind, they came down so much harder and topped out in August of last year before the S&P did. So the big, I guess, gripe about that was it hadn't retraced as much. And because the Russell is 20% financials with 10% regional banks, they kind of do move together, especially when the banks are doing so bad. So same type of thing. From, say, late February to late March, both the Russell and Carry were having trouble and both rallied.

Now I think the important part to look about and to talk about this is, what are native diversions? Why do they work sometimes and not the others? Well in healthy markets, native divergences just lead to rotation, right, other areas doing well. In sloppy markets, native divergences lead to a lot more pain for a much broader base so divergences get affected. Again, we can see that exactly is what happened from August to September. So it's not something that we'll see happen immediately, but that's something obviously we're looking for. So far, divergences have been temporary. They've been isolated. They haven't mattered. At some point, that's going to change.

JAKE MERL: So, Frank, with all these things happening-- bearish patterns never playing out, small ranges, low volume, and these bearish divergences are now reversing-- how have investors' appetite towards risk changed at all?

FRANK CAPPELLERI: Yeah, I think that's probably one of the most important things to review. There's always an investor psychology cycle. And there's different versions of this, but one I've been looking at for a long time comes from this website called investorpostcards.com. As an aside, that website hasn't been updated in a number of years, but you can still find the cycle there.

And so what I did was take those terms and overlay them upon the S&P 500 over the last year, which I think is really interesting. Now this is a subjective exercise, so some people may disagree with where exactly we are. But I think it pretty much nails what's been going on, especially since the rollover. So let's review some of them over the last few months.

Back in December, I think we can all agree that the S&P, as it was going down extremely hard, there was a lot of fear, right, especially the beginning of December because actually December started up relatively OK. It had a few days higher, and then everything fell apart. That quickly turned into panic, right? Panic when the market was falling apart 2%, 3% at a day. And any type of a bid was instantly wiped away.

And so from that point, we get down to Christmas Eve. I don't think I even wanted to look at any screens at that point. I know I was there. It was very difficult to look at. And so fear turned to contempt, and I believe that contempt stuck with us, as people received their annual quarterly statements for January, right? So then we had a pretty good pop off the low, say 10% or so, into January, and people still weren't believing it. There's lot of doubt and suspicion there at that point, especially as the S&P approached 2,600.

Now remember, there was a lower part of that range that we saw from October and November. And I think a lot of people were looking to lay some shorts out around that point, take some profits. Obviously, that didn't occur. Had a few days of a pause and quickly got back up 2,800. And let's just review, at that point, it was probably even more of an interesting point for investors to look at. There was still not a lot of belief there.

And so we can see the next portion of this is called caution, and a lot of people talking about caution at that point. And they were right. For a few weeks, S&P paused. We reviewed how banks were doing relatively not that well, especially with Russell. But as we get through that 2,800 and with the 2,900, I believe that we went from caution to confidence. And at this point now, we're getting close to or above 2,900 or thereabouts. I believe we're getting to the point where confidence is turning into enthusiasm, with the next term being greed and conviction. And that's really where we're clearly at the end of the run from last year.

And so again, with this type of thing, we know we're at the other side of this, right? We're getting to a point where typically you see some sort of reversal. But the timing is the most difficult thing. Again, we look at 2017, even 2013, there was confidence, there was enthusiasm, there was conviction for many months up to that point. So again, we know where we are. We know the warning signs. We know how close we are to the highs and so forth and so on. We just have to see some real evidence of negative momentum come back to the picture before we can actually say this is the top.

JAKE MERL: So with all of this in mind and given all these factors, what's your trade idea for today?

FRANK CAPPELLERI: Well we want to talk about the IHF, health care providers. And if you ask me if that's a bullish pattern, I'm going to say absolutely not, right? So that's something that we have to identify. It also has a lot of headline news always with that sector. But I think I'm going to have to give it the benefit of the doubt.

And the reasons are this. Number one, it's really underperformed the S&P 500. We look at this from a chart, and over the last two months basically, from the end of February to recently-- now remember we can compare this to what the Carry looked like and the Russell 2000 looked like-- they rallied and continue to rally. This one has had some instances of bouncing along the way, but each one produced a lower high. And then we saw what happened last week. So we have yet to see one of these rallies change these series of lower highs, so that's important. So we have to be concerned for the next bounce because the same thing may occur this time.

But let's consider how bad it was recently, right? And so if you look to the last week, the health care providers ETF was down over 6%. That's the seventh worst decline we've seen in a weekly basis since its inception in 2006. That's pretty bad, right? And so we can see from-- we identified all of them on the chart there-- and you'll see that most of the time we did see a bounce. Sometimes a substantial bounce, lessened for a few weeks. Sometimes just a relief rally.

Now the thing that's concerning about this is that three of those happened since December. So any time you see a cluster of weakness or a cluster of something that's happened against the prevailing trend, that could be an indication that maybe things are changing. So I think that's something we have to be concerned about that's a risk, even as the IHF rallies that 10-year uptrend on that log scale.

I think a bigger risk is that on the weekly chart, the IHF is forming or has formed this monster topping pattern, a head and shoulders pattern that really started at the beginning of 2018 and extended today. And we can see the implications of this. If we break below there, it can have a lot of air beneath it, and it can obviously get to much lower prices quickly.

Now the interesting part about that is that if you look at that pattern, this is precisely what so many investors and traders thought the S&P would look like at this point, right? You had this big top formation. We saw the big rally. A lot of people thought it would be a bear market rally that would end, they say, 10%, 15%, 20% higher and then roll over and form this other shoulder. And it hasn't, of course. Now I guess the thing to be concerned about is, is this going to be-- the IHF-- the one that actually rolls over? And if that's the case, is the S&P finally going to notice?

JAKE MERL: So do you think this bearish pattern will actually crack?

FRANK CAPPELLERI: Well I think there's a real risk. But we have to understand how we got to this point, right? How bad the damage has been. And so I think a good way to look at that initially is to look at health care providers ETF versus the S&P 500. And now we can look at this chart that goes back to 2008, and we can see what's happened over the last number of months compared to the S&P 500. That's a relative line on top in blue. It has just gotten hammered to the point where the weekly RSI or that relative line is now sitting at a level of 22. And you recall that 30 is oversold. So 22 is extreme no matter what we're measuring at this point.

And so you look back over the last number of times this happened, not a lot to go by, by any means. But you can see that typically when we get down to oversold levels on this relative basis, the IHF has had ability to rally, and versus the S&P 500 especially. And you consider how deeply oversold we are now, I think there's a good chance of that happening again.

JAKE MERL: So is this something specific to just health care providers, or is this within all of health care?

FRANK CAPPELLERI: Well we've looked at the performance breakdown for the year for the sectors, and health care is coming in less at the moment, about 4% through April 15, versus, say, technology, up almost 24%. So there's been a discrepancy at that point. And we can look at pharmaceuticals as well. Not been doing that well.

But really the biggest drag on the sector is health care providers, and we can see that on the next chart looking at the performance since it topped out in November of 2018. Since that point, health care providers ETF is down about 20% versus a decline of 4% for the health care ETF itself. So it's a huge difference compared even within its own sector. And so we look at that even more so on a relative chart. So again, up at the top in blue is IHF, providers ETF versus the health care XLV.

And two things pop out of this. One, it took a lot to get this back down. And also, consider the fact that the previous rally on a relative