Tale of Two Markets

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Last week I said a potential negative divergence was developing as two of the indexes I use each week did not break above resistance with the Dow and S&P 500. If that divergence was not cleared up favorably we would have a pullback. That is what happened. The pullback was controlled and we did not test the lows of the prior pullback, as I suggested, and we were off to the races with the good jobs data released on Friday before the open.

Another theme I have touched on over the past couple of weeks is the potential for improvement in economic numbers. Things are either getting better or they are getting worse. The market spiked higher to unsustainable levels earlier in the year. The peak in energy prices coincided with the peak in the market. The peak in oil came a little over four months ago. Typically a peak in energy prices spells trouble for economic numbers for the next several months. The higher energy prices act as a tax on all of us and things slow down. That lull in activity typically lasts for roughly four months before we begin to see things pick up. Well, we are at the time where we should see things begin to pick up when economic numbers are released over the next several weeks.

From a technical perspective the market remains split. 55% of the stocks in the S&P 500 are either in basing or advancing patterns. The other 45% of stocks are getting hit very hard. Several areas of the market remain in their own private bear markets. If there is a disconnect between your view on a stock and the markets opinion watch out. Stocks that offer poor guidance or miss earnings expectations are seeing sellers come in and aggressively push prices lower.

Last week I focused on the NASDAQ and Russell 2000 indexes. My concern was these indexes did not confirm the break above resistance by both the Dow and S&P 500. This action is consistent with the cautious outlook by investors. People are returning to the market. They are focusing currently on larger total return blue chip stocks. The outperformance by the Dow and S&P 500 are evidence of that. In order for the intermediate term picture to improve the NASDAQ needs to close over 2990 and the Russell 2000 needs to close over the 822 mark. As I write the NASDAQ is having a good day and is over its level but the Russell 2000 is lagging. If both of these levels are taken out it will show that the summer rally is gaining momentum. If a negative divergence develops the next pullback in the market will begin. If a pullback were to begin the intermediate support levels for the S&P 500, Dow, NASDAQ and Russell 2000 are 1324/12,845/2833/765. Keep an eye on how the market performs if these levels are tested. 

From a short term perspective 2990 on the NASDAQ and 822 for the Russell 2000 are my focus. If they are not taken out then we will likely see a more challenging environment. The 822 for the Russell looks like a long shot over the next few days. I’ll give 800 for the Russell as a signal that things are improving for small caps. A failure to close over 800 on the Russell, followed by a close over 822, signals a rest for the bulls. The low for the Russell last Thursday was 765.20. If we see things sell off this week that is an important near term support level for the market. The recent low for the NASDAQ in the 2890 range is near term support. Next support for the NASDAQ is 2840. If these levels can hold in the event of a sell off in the market, it would be a positive sign.

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About Thomas J Smith CFA