Technically Speaking

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I wanted to discuss some technical relationships I’m starting to see in the market that might shed some light on recent events. The goal is to help us identify corrections and rotations in the market between various assets classes and stock sectors. Normally I try to discuss some of the market catalysts and drivers while supplying few charts; and at other times, I like to delve 100% into technical analysis. This is one of those times because I’m sure many are starting to wonder if a correction is at hand, and/or whether we still have more upside to stocks. Let’s look at all of the angles.

When technical analysts begin to discuss their outlook, it’s always important to discuss it in the context of time. Long-term, intermediate-term, and short-term are all frames of reference in discussing market cycles and trends. If I say we’re going to have a market correction, what’s my time frame? Two weeks? Three months? One year? That could make a big difference in you trade such a call.

Short-term Outlook

Over the past few weeks, I’ve been talking about the setup for a correction (2-4%), which was an overextended and overbought stock market that had finally setup some bearish divergences last week. I believed the correction would be short-term oriented and the chance to buy more stock. I believed that stocks that had broken out of major bottom formations would finally retest those breakout levels and we’d have the setup for a stronger trend (especially in energy services and semiconductors). In addition, I advised that extended positions should be trimmed, especially if they were near extreme resistance zones.

I bought puts on Wednesday last week when the FOMC minutes were released and it appeared that the S&P 500 was breaking below 1524. I sold those puts on Tuesday morning when the S&P hit fresh lows, yet the VIX failed to reach higher highs. Once the downtrend from Monday’s selloff broke, I began buying stock again. The short-term correction was likely over and buyers on the sidelines would chase stocks again. The S&P 500 finished Tuesday at a key technical level. It needed to get back above 1498. That was accomplished early Wednesday morning on good economic data – and away investors began to chase stocks.

The correction has completed what it set out to do: to reset bullish sentiment and release excess buying pressure. Just look at the recent AAII Investor Sentiment bullish readings. Bullish sentiment has reset:

sp500 sentiment 2011 to 2013

Buyers aren’t in the “all clear” zone just yet. For that to happen, we need to break through resistance. I see two setups for the current correction: 1) an ABC correction, three movements, that has already completed or 2) a sideways, aka triangle formation, that typically forms by 5 movements in the market (ABCDE). So far, both are viable possibilities until the stock indices break through to higher highs and confirm that the correction is over.

On the negative side of things, the bearish divergence in momentum (RSI) on the daily chart for the S&P 500 is a concern. In addition, the daily MACD signaled a sell trigger some weeks ago when it crossed the short-term moving average. It’s starting to twist up over the last few days, but the short-term trajectory is still down. In addition to these signals, there were 43 new 52-week lows last Thursday on the NYSE.

The rally from Tuesday morning has broken through a key resistance level at 1498. That was a key battle on Tuesday afternoon and early on Wednesday morning. Fortunately, positive economic data in durable goods and pending home sales helped push us back above that level. 1498 was the neckline in a head & shoulders top formation that completed on Monday. The whipsaw below that neckline yesterday creates a failed bearish pattern, and failed bearish patterns are bullish.

spx 28 feb 2013 short term

Speaking over the very short-term, the more the S&P 500 trades between 1515 and 1520, the more we develop a bullish flag formation, that once completed, could see the S&P 500 target 1542.

spx 28 feb 2013 flag
(edit) – as I continue to write today, it looks like this flag was broken.

Intermediate-Term

It’s positive that the S&P 500 is trading back above 1498. It’s positive that all of the popular stock averages are still trading above their respective 50-day moving averages. The S&P 500 itself came within 7 points of the moving average on Tuesday. While the NASDAQ Composite fell below it briefly on Tuesday, the rally mid-day helped to close the tech index above it to prevent any intermediate sell signals. Typically, when you have a strong trend, the first touch with the 50-day moving average is a touch and go. It looks like we got that on Tuesday. Momentum indicators have reset to neutral readings, yet are moving higher now, as the buying opportunity is now behind us. It’s bearish that the weekly chart for the S&P 500 is near resistance and momentum indicators are elevated for the MACD and the RSI.

spx 28 feb 2013 resistance

The percentage of stocks trading above the 50-day moving average within the S&P 500 triggered an early signal last week when the percentage dropped below 82%. It also broke trend from the October rally (blue line in the chart below). However, as you’ll see, we’re right back above the key 70% level and we can remain there for some time again. The recent stint below 70%, I believe, is a warning shot.

spxa50r 28 feb 2013

Yet despite these negative issues, it still feels like there is a lot more going for the current trend than is wrong with it and we still may have another movement higher for the current trend. We continue to see higher highs and higher lows since October 2011. Powerful uptrends don’t end over the course of one week – they’re a process. If a major top is in the process of developing, as it did in 2011 and 2012, it will likely take more volatility and sideways action in the stock market for that to develop, seeing as we did not rise in parabolic fashion.

There has been much discussion about the payroll tax and higher gasoline prices weighing on the pocket book of the consumer. I believe that has been the case and you’ll want to continue to watch the dollar stores and Wal-Mart for development of that story, but the wealthy are more concerned about asset prices. The wealth-effect as Bernanke calls it. For now, retail stocks as a whole continue to outperform oil. As I’ve said, the Federal Open Mouth Committee continues to do an incredible job managing inflationary expectations and keeping speculation in commodities in-check.

xrt vs. wtic 27 feb 2013

Long-term outlook

Many of the technical analysts I follow have been targeting 1550 on the S&P 500 since late December. I too have been targeting that level due to the bullish breakout and reversal of the November correction last year. It’s bullish that the S&P 400 mid-cap index, the Russell 2000, and the Dow Transports have traded at all-time highs in February. The Dow Jones Industrial Average broke out to new highs yesterday when it closed at 14,094. The Industrial Average, like the S&P 500 is also at long-term resistance, but is within only a few points of an all-time high.

indu 28 feb 2013

Merely touching 14100 intraday on Wednesday was enough to signal a buy signal on the Dow Jones Industrial Average using a point & figure chart (P&F). This type of chart doesn’t care about time or volume like bar, line, or candlestick charts do. It merely is concerned with price and whether price can break above or below previous turns in the market to create signals, no matter how long it takes. There are also methods to target how far a breakout might go like the horizontal count or triple top breakout. The current P&F chart for the Dow Industrials shows a breakout with the intraday move to 14100 Wednesday as shown below. The target for such a bullish pattern is 14750 according to StockCharts.com’s math:

industrial p and f pattern 27 feb 2013

A breakout to all-time highs for both the Dow Jones Transports (already) and the Dow Jones Industrial Average would signal a new secular bull market. One, Jim Puplava has been alluding to since the 2nd half of 2012, to the chagrin of many fellow inflationists and gold bulls. But really, when you think about the effects of money printing and currency devaluation, all tangible assets tend to rise.

Conclusion

The short-term correction is behind us. It offered a very short-term buying opportunity. I’m expecting to see January trends continue as far as performance with strength in risk-on investments. Recent real estate data over the last week has been bullish for homebuilding and construction material stocks. Recent economic data has been bullish this week and suggests continued strength. That would be good for the financials, industrials, and energy stocks. Stocks within healthcare and staples continue to show me great charts with positive trends, but I believe higher beta areas will outperform over the next month or two.

The recent weakness in February has shown some rotation out of risk investments. The drop in breadth as represented by the number of stocks within the S&P 500 trading above their respective 50-day moving average has signaled a shot across the bow for the current trend. We’ll need to watch that closely on the next leg higher for this trend and it will be time to seriously watch the percentage of stocks above the 200-day moving average. When that rolls over, we could finally expect to see a bull market correction between 8-10%, the likes of which we’ve seen at least once a year to reset bullish sentiment. Eventually, the Fed will have to be less accommodative and remove QE. That could initially startle investors as it did last week. However, if we replace Fed monetization with better economic strength later this year, that would be a good thing and a catalyst for the secular bull market to continue. That would be great, but long-term, having fiscal policy at odds with monetary policy isn’t that conducive towards a new secular bull market. If we merely work through mediocre growth over the next year, I expect more volatility and trading action in the markets for 2013, despite recent all-time highs.

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About Ryan Puplava CMT

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