Another pullback is likely headed our way, which will clear out some of the excess bullishness, set the stage for a new rally, and give investors a better entry point. The important thing right now is to avoid chasing and wait for the next refreshing correction, writes MoneyShow's Tom Aspray.
The market was hit with some early selling Friday, but rallied sharply in the last hour, and all the major averages closed higher for the fourth week in a row.
The S&P 500 had its sixth higher close in a row, which has not happened in some time. Those that feared another repeat of last year’s late July plunge in stock prices are no longer voicing their gloomy forecasts.
As of Friday’s close, the Spyder Trust (SPY) was higher than it was at the end of April, so those who sold in May are either frustrated or confused. Even the mixed to slightly negative economic news has not dampened the stock market’s slow, steady climb.
Even the weaker than expected economic news that China’s exports grew at only a 1% rate from last year was interpreted by some as being bullish, as it will give the government more reason to stimulate their economy.
Investors are apparently banking on a fix from the Fed and/or the ECB, should the global economies weaken further, or if the Eurozone crisis heats up again.
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The VIX, or “fear index,” peaked in May at over 28, and has been in a steady downtrend ever since. It hit the 16.5 level last week, not far below the March low of 15.5.
The widely watched sentiment numbers show that bearish sentiment is now quite low. Only about 25% of the financial newsletter writers are bearish. More than 43% of individual investors were bearish just three weeks ago, according to AAII, but that number has dropped to 27.3%.
I have been discussing the weak action of the market internals for a few weeks, as fewer and fewer stocks appear to be pushing stocks higher. The intermediate-term analysis, on the other hand, does point to higher stock prices going into the end of the year
As I review hundreds of individual stock charts, I see that many—such as the oil stocks I discussed last week—have reached significant resistance. Technically, they appear to need a pullback before they can move to significantly higher levels.
There has been some improvement in the weekly technical studies, but a drop in the S&P 500 to the 1,360 area would reduce investor complacency and create the environment necessary to set the stage for a further stock rally. The first sign of a correction would be a close in the S&P 500 below 1,391.
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The most signficant change in the yearly performance chart of stocks (SPY), gold (GLD), and bonds (TLT) has been the decline in bond prices. It is thought that some of the recent strength in stocks was due to funds flowing out of bonds.
TLT was up 9% for the year on July 25, but has given up over half those gains, as TLT is now up just 3.6%. Bonds did firm up on Friday.
Stocks are still the clear leader, with SPY up 11.8%, while GLD has improved recently to reach 3.5% for the year to date. As I discuss later, GLD does not have to move much higher to complete its bottom formation.
There was good news last week from the housing sector, as both Freddie Mac and Fannie Mae reported nice profits last week, and are actually paying a dividend back to the government.
The economic calendar is quite heavy this week, with producer prices and retail sales starting us off on Tuesday. On Wednesday, we get the Consumer Price Index, industrial production numbers, the Empire State Manufacturing Survey, and the Housing Index.
On Thursday, in addition to the weekly jobless claims, housing starts and the Philadelphia Fed Survey will be released. The week finishes with consumer sentiment and Leading Indicators on Friday.
NEXT: What to Watch
|pagebreak|WHAT TO WATCH
The selling on Friday was well absorbed, as the close was strong again. There are still no signs that a short-term top is in place. As I discussed earlier, the sentiment still seems too bullish currently to push the market well above the April highs.
As I discussed Friday, the daily Advance/Decline lines are sending a mixed message. The NYSE A/D line has been able to break out above long-term resistance (line d), but not by much.
A day of strong A/D ratios early next week could improve the outlook, as it will reaffirm the breakout and might be enough to start a new uptrend. The A/D line has short-term support at line e, and if it were broken, I would expect the longer-term support (line f) to hold.
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The daily chart shows that the NYSE Composite is still testing strong converging resistance, with more important levels at 8,100 to 8,300. A drop back to the uptrend in the 7,650 to 7,700 area would not be surprising.
The S&P 500, Dow Industrials, and Nasdaq-100 A/D lines are still lagging the price action, which is consistent with a failing rally. These divergences could be resolved if prices can accelerate to the upside.
The volume analysis is also mixed, as the daily on-balance volume (OBV) on the key sector ETFs looks weak, although the weekly OBV does look much more positive.
Since I will be leaving tomorrow and will be off the grid for a couple of weeks, I am comfortable being just about 50% in stocks. (Click here to see the current Charts in Play Portfolio.)
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S&P 500
Since the ranges were quite narrow at the end of the week, there was not much change from Friday’s column in my outlook for the Spyder Trust (SPY).
There is next resistance at $141.66 to $142.21, which are the highs from early in the year. The upper trend line on the weekly chart (line a) is in the $144 area.
A drop below $139.56 will be the first sign that a correction is underway, with the 20-day EMA now at $137.75. The rising 20-week EMA is at $123.70.
Using Monday's high at $140.92, the 38.2% Fibonacci retracement support is at $135.66, with the 50% retracement support at $134.03.
The weekly OBV has moved above the April highs (line b), and its WMA is now trying to turn up.
Dow Industrials
The weekly chart of SPDR Diamonds Trust (DIA) shows a potentially bearish rising wedge formation (lines c and d), with the upper boundary in the $135 area.
The 20-day EMA represents first support at $129.38, with more important levels at $127.51, which was the August 2 low. The weekly chart has good support in the $124.25 to $125.25 area.
The weekly relative performance is trying to turn up, as it is just barely above its WMA. The weekly OBV moved through its downtrend (line f) in the middle of July, and has made new highs for the year..
The Dow Industrials A/D line (not shown) is still lagging the price action, so it is giving a different picture from the OBV.
NEXT: Nasdaq, Sector Focus, and Tom's Outlook
|pagebreak|Nasdaq-100
The Powershares QQQ Trust (QQQ) has traded in a narrow range over the past few days, with a high of $66.91 and a low of $66.28. There is additional resistance from late April in the $67.63 area.
The Nasdaq-100 A/D line (not shown) is holding above its WMA, but is still below more important resistance.
There is initial support at $65.25 to $65.50, with the rising 20-day EMA at $64.92. From last Tuesday's high at $66.92, the 38.2% Fibonacci retracement support is at $64.29,with the 50% support at $63.47.
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Russell 2000
The iShares Russell 2000 Index (IWM) gained 0.7% for the week, but is still below the converging resistance in the $80 to $81 area (line a). In July, IWM had a high of $82.
The weekly relative performance has turned up, but still shows a pattern of lower highs and lower lows, with resistance at line b.
The weekly OBV has been holding above its WMA, and did improve last week. The OBV is well above its uptrend (line c).
The Russell 2000 A/D line (not shown) is still below long-term resistance. There is first support at $78.59, with more important support at $76.25.
Sector Focus
One of the surprisingly strong sectors last week was the Select Sector SPDR Materials (XLB), up 1.5%. The weekly chart shows the strong opening and the close that was just below the weekly downtrend (line c). There is further resistance in the $37.65 to $38 area.
The weekly relative performance is now testing its declining WMA, with major resistance at line f.
The weekly OBV is still below its WMA, and as I noted in late July, it had broken strong support in May. I may have been too negative on this sector a few weeks ago, and it would be a very positive sign for the global economies if this sector can bottom.
Last week, I took a look at all of the major sectors and how they have done so far this year. I also picked those that I thought would do the best for the rest of 2012.
The iShares Dow Jones Transportation Average Index Fund (IYT) continues to act weak, as it turned lower in the middle of last week after testing light resistance in the $91.50 area.
NEXT: Oil, Metals, and Tom's Outlook
Crude Oil
The October crude-oil contract was lower early Friday, but closed near the day's highs. The October contract closed almost $2 higher for the week, indicating that crude oil has completed an intermediate-term low.
There is next resistance at $95, with much stronger levels now in the $97.60 to $98 area.
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Precious Metals
The SPDR Gold Trust (GLD) is still locked in its narrowing trading range (lines a and b).
A strong close above $158 to $159.20 will be a sign that GLD has bottomed in line with its strong seasonal pattern. The first support now waits at $153.60 to $155, and then $152.20 to $152.50. A break of these levels should signal a decline to the $150 area.
The daily OBV is back above its WMA, but still has key resistance at line c. If this is overcome, it would be very positive.
For the iShares Gold Trust (IAU), the daily OBV is acting a bit stronger. The close on Friday was just below the key resistance level at $15.90 to $16. Support for IAU now sits at $15.20 to $15.40.
The Week Ahead
It was another week of struggling gains, but there has been some improvement in the weekly technical studies. So maybe, the correction will be smaller and shorter than I have been expecting.
I would continue to favor stocks in the strongest sectors, but would only look to buy on weakness. If the stock is in a solid uptrend, then look a pullback to the rising 20-day EMA as a potential buy level. But be sure to control the risk—if you have to risk more than 5% or 6%, look somewhere else.
By October, I would expect stocks to be higher than they are now. But because September is historically such a weak month, I would still look for an increase in bearish sentiment and a pullback in the major averages to create a more favorable risk-reward entry. If instead, we continue to grind higher, the stocks in the Charts in Play Portfolio do show good relative performance.
I will be on vacation for the next two weeks. The next Week Ahead column will be published on August 31.
- Don’t forget to read Tom's latest Trading Lesson, Spot Market Leaders in Any Time Frame
