Bulls Put on a Show Last Week—Need Confirmation

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The markets hit new highs for the year last Friday. There was a favorable reaction to the employment news prior to the open and we traded higher throughout the day. The market has rallied to start the year much like last year. We have seen the market rally to start the year and then seen severe pullbacks the past few years. Time will tell if that is the case this year.

The technical picture of the market remains in great shape. There are some potential divergences that are developing that could lead to our first pullback of the year. Better than 80% of the stocks on offer now are in either basing or advancing patterns. The NYSE daily and weekly advance-decline lines hit new all-time highs Friday. With the technical picture of the market so strong, unless things change dramatically, pullbacks will remain controlled and rotational.

Some technical measures in the market were somewhat surprising last week. After a huge spike higher you would expect all measures to show signs of being severely overbought. This is not the case. Typically we would see the call/put ratio spike to at least the 1.70/1.80 range at this stage of an advance. With people becoming more optimistic it would make sense to see a lot more calls bought than puts. That was not the case last week. The call/put ratio is at a rather low 1.12. Also, the large block ratio, a measure of institutional buying, is not at extended levels. This is a sign that a large portion of major market players are expecting a large pullback to give them an opportunity to add to stocks. Remember the true goal of the market is to make as many people as possible look silly.

The small cap Russell 2000 index has already moved to all-time highs. In order for the market to move higher the Dow, S&P 500 and NASDAQ will have to confirm that move higher. The all-time highs for the Dow and S&P are 14,198 and 1576 respectively. Clearly those levels will provide significant resistance. With the number of positive sectors and individual names the bulls are clearly in control.

Now let’s talk about some of the potential negative divergences that are developing in the market. With the advance-decline lines moving to new highs we need to see the major averages confirm those moves to new highs to avoid a negative divergence. First we should keep an eye on the NASDAQ. A close on the NASDAQ above 3200 would be a signal that the market is going to continue its move higher and the Dow and S&P 500 will then be the next two averages to make a move on their respective highs.

If the above averages can’t confirm the moves in the advance-decline lines than we will see a move lower. Support levels for the Dow/S&P 500/NASDAQ/Russell 2000 are 13,850/1495/3130/893. If these levels give way then we will see our first sustained pullback in the markets. With the technical condition of the markets so strong any pullbacks should be controlled.

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About Thomas J Smith CFA

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