Weekly Technical Market Outlook 11/3/2014

The S&P 500 closed out last week up 1.17% while small caps ($IWM) fared better, up 4.94%. and International stocks ($EFA) had a good week as they bounced 2.76%. With the strong recovery back to new highs seven of the nine S&P sectors are back above their respective 50-day Moving Averages. Materials and Energy remain the laggards, still trading below their intermediate MA.

Trend

As the V-shaped recovery pushed the S&P 500 to a new high, we now have the ingredients for a new positive trend in stocks. I had been watching the prior trend line off the past series of higher lows (dotted green line) and whether it would act as resistance on the bounce, it did now as stocks powered higher. Price is now firmly back above the 100-day Moving Average and 20-day MA.

trend

Breadth

When the market makes a new high, what do you not want to see? Breadth not confirming the high by still being under its own previous peak. As measured by the Common Stock Only Advance-Decline Line and the Percentage of Stocks Above Their 200-day Moving Average, breadth is continuing to diverge from price.

One positive note to make about breadth, is that the S&P 500 A-D Line (not shown) has confirmed the new high in stocks. So which is more important, the NYSE Common Stock Only or the S&P Advance-Decline Line? The price action over the next couple weeks will likely let us know.

breadthNew 52-Week Highs

While the Breadth chart above shows a bearish divergence and a lack of confirmation, how many stocks in the NYSE did in fact try to confirm the new high in the major index? A pretty large amount, 521 to be exact. This is the most issues on the NYSE to hit a new 52-week high since May 2013 and before that it was 2010. During the bull market off the ’09 low, when we’ve seen this many stocks hit a new high we’ve seen the S&P pull back on a short-term basis.

While a lot of traders have been comparing this market to the peak in 2007, myself included in the post from October 15th, We Haven’t Seen a Market Top Yet. However, this spike in new highs puts another arrow in the quiver for the bulls, as this set of data created a large divergence back in ’07, not showing the strength we saw on Friday.

new 52wk highs

Momentum

The downtrend in the Relative Strength Index (RSI) is nearly over with the momentum indicator testing the prior high around 68 and has broken above its falling trend line.  The Weekly RSI is still showing a series of lower highs, as last week’s rally did not push hard enough in getting momentum higher. The Money Flow Index is now ‘overbought’ and may be signaling for a short-term decline in stocks.

momentumBond Market

If you believe that bond market is ‘smarter’ than the equity market, this next chart has likely kept you out of stocks for the bulk of 2014. Traders have continued to show a preference for long-dated Treasury bonds over High Grade debt, pushing the ratio between the two into a down trend. The same can be said for the 10-Year Treasury Yield.

There use to be a time where bonds would confirm the moves made in stocks and this would make traders feel nice and cozy inside, but that time has passed. Either the correlation between stocks and bonds is changing or traders no longer feel High Grade bonds deserve to be price like stocks.

Bonds

60-Minute S&P 500

It’s hard to not appreciate the level of aggressive traders had during the recovery off the October low in the S&P 500 ($SPX). Gap ups have gone unfilled and momentum has remained elevated for the majority of the advance. We now have a level of support in the Relative Strength Index by connecting the lows. A break of this support zone will likely act as a ‘tell’ for an intraday decline. While there is a slight divergence in the MACD, the strength in the RSI in my opinion outweighs it. When these two momentum indicators tell different stories, I often find myself relying more heavily on the RSI, but that’s just me.

60 minSector Relative Strength

We’ve seen quite a bit of improvement on the Relative Rotation Graph. Five of the nine S&P sectors are now in the ‘leading’ category, although Consumer Discretionary ($XLY) is close to falling into the ‘Weakening’ category as its trend  and trend strength both appear to be losing steam. Materials ($XLB) and Energy ($XLE) continue their trek deeper into the ‘Lagging’ category, unable to get a good footing to improve relative the S&P 500.

RRG sector

International Relative Strength

Traders have continued to show preference for U.S. equities over their international brethren. It’s been five weeks since we last saw a foreign market in the ‘Leading’ category. While a handful of countries are strengthening  in the momentum of their relative trend, only one, the Netherlands ($EWN) has been able to break into the ‘improving’ category.

Intl rrg

Sector Performance Off the Low

Understanding sector leadership off a low can help us better understand of the strength the move in stocks had. The best performing sector off the October 15th low was Health Care ($XLV) followed by Industrials ($XLI). Consumer Staples ($XLP) which held up well during the down turn, being the second best sector, was not shown a positive bias on the march back to new highs.

sector off low

Sector Performance Year-to-Date

Not much as changed for sector leadership for 2014, with Utilities ($XLU), Health Care, and Technology ($XLK) still holding the top three spots. Energy ($XLE), Consumer Discretionary, and Materials have been the worst performing sectors YTD.

sector performance ytd

 

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Head & Shoulders Pattern in Small Caps

There seems to be a lot of discussion about the current bearish pattern that’s taking place in the Russell 2000 ($IWM). While there are likely tens if not hundreds of price patterns found throughout technical analysis, few are as popular or often discussed as the Head & Shoulders pattern. There is good reason for is this as it has lead to some major declines in financial markets. For example there was a Head & Shoulders pattern that lead to the peak in the Dow back in 2007.

Should we be concerned about this bearish pattern? Does it hold any relevance? One good resource is thepatternsite.com, which does a great job looking at the data of varies candlestick and price patterns. According to Bulkowski’s analysis, the Head & Shoulder pattern ranks number 1 among 21 well-known pricing patterns. This is based on the 4% failure rate and 22% average decline calculated by Thomas Bulkowski.

So it appears we may have good reason to take these types of setups seriously, so what defines a Head & Shoulders top? There are few better resources to turn to than Robert Edwards and John Magee’s, Technical Analysis of Stock Trends – often considered the bible of Technical Analysis. Edwards and Magee seem to agree with Bulkowski stating in their book, “This [the Head & Shoulders] is one of the more common, and by all odds, the most reliable of the major Reversal Patterns.”

They continue in their writing to define what they believe is the “ideal” Head & Shoulders top:

A. A strong rally, climaxing a more or less extensive advance, on which trading volume becomes very heavy.

B. Another high-volume advance which reaches a higher level than the top of the left shoulder, and then another reaction on less volume which takes price down to somewhere near the bottom level of the preceding recession.

C. A third rally, but this time on decidedly less volume than accompanied the formation of either the left shoulder or the head, which falls to reach the high of the head before another decline sets in.

D. Finally, decline of price in this third recession down through a line (the “neckline”) drawn across the Bottoms of the reactions between the left shoulder and head, and the head and right shoulder, respectively and a close below that line by an amount approximately equivalent to 3% of the stock’s market price. This it he “confirmation” or “breakout.”

We now know what we are looking for with respect to the bearish reversal pattern in $IWM. Now lets see if the latest price action meets the above mentioned criteria. Below is a daily chart of the iShares Russell 2000 ETF ($IWM). I’ve marked the two shoulders and the head as well as the horizontal neckline at $108.

In the bottom panel we can see that volume has been declining with the formation of the head and right shoulder. Based on the work done by Edwards and Magee, we would need to see a breakdown to roughly $104.76, which would be 3% under the neckline. Volume on the break can also be an important ‘tell’ as bears will be looking for a strong move on heavy volume to help confirm and complete the pattern.

IWMWith this type of pattern we can calculate the expected measured move by looking at the distance from the head of the pattern to the neckline. This would take us nearly 10% low down to $98. However, it’s important to note as Bulkowski stated, only 55% of the patterns actually complete their expected measured move.

While these types of patterns garner much attention nothing matters until the neckline is broken, which Edwards and Magee point out that roughly 20% of necklines are “saved,” meaning the pattern is not 100% completed. Going forward I’ll be watching the $108 level and see if we get a break on heavily volume and if price is able to drop to $104 to confirm the move is not in fact a false breakdown. But until then we must be a patient.

Source: Technical Analysis of Stock Trends by Robert D. Edwards and John Magee (ninth edition)
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Weekly Technical Market Outlook 9/8/2014

It has been a couple of weeks since I’ve written a Technical Market Outlook, so it’s good to get back to updating these charts again. Last week the S&P 500 ($SPX) finished 0.22% higher, the Russell 2000 ($IWM) ended the week down 0.15%, and Emerging Markets ($EEM) had a strong finish, closing out on Friday up 1.75%.

Trend

As the S&P 500 continues to head higher and hit new highs, the trend is of course still positive. We remain above both the 20-day and 100-day Moving Averages as well as the long-term trend line.

trendMomentum

As the equity market has been strong over the last couple of weeks, we have seen momentum apparently hit some headwinds. A small divergence has developed in the Relative Strength Index as well as the MACD indicators on the daily time frame. While the momentum indicators have not begun turning lower, they have also not confirmed the new highs seen in price.

Momentum

Treasury Yield

On July 10th I tweeted the below chart showing the divergence that was taking place between the 10-year Treasury Yield and the ratio between the U.S. Dollar and Emerging Market Currency Bonds. Jeff Gundlach once said that he watches the relationship between the U.S. dollar and emerging market’s as a leading indicator for the direction of U.S. Treasury yields. Back in July the ratio between the Dollar and Currency Bonds was heading lower, which ultimately followed by the continued drop in the 10-year Yield to.

Now we are seeing the correlation between the 10-year Yield ($TNX) and the ratio once again break down as the dollar strengthens against Emerging Market Currency Bonds with $TNX not responding in-kind. While the 10-Year Treasury Yield has found support at the 100-day Moving Average, I’ll be watching to see if it begins to react to the rise in the dollar against emerging market currency’s or if this divergence becomes more severe.

usd emerging bonds

Breadth

Like momentum, we have a slight divergence in the NYSE Common Stock-Only Advance-Decline Line, which has yet to take out its previous high. However, I will note that the S&P 500 ($SPY) Advance-Decline Line (not shown) has confirmed the new high. We are also not seeing much strength in the Percentage of Stocks Above Their 200-Day Moving Averages, as the indicator remains under 70%.

Breadth

60-Minute S&P 500

Looking at the intraday price action of the S&P 500 ($SPX) the strength in price does not appear to be being confirmed in the RSI or MACD momentum indicators. We last saw an example of this in Late July which led to price dropping a couple of percent and eventually creating a bullish divergence in momentum and sending price right back and to a new high. 1990 has acted as support recently, so that’s the level I’ll be watching if price does weaken this week. If we can’t hold on to that then price may see some more selling.

60 min

Small Caps

Dana Lyons has become one of my favorite follows on Twitter and Tumblr accounts to follow. Dana produces some really interesting research and is someone definitely worth a follow. Last week Dana wrote an interesting post looking at the duration of the divergence between small and large cap indices. While this topic of lack of confirmation in small caps has gotten discussed quite a bit this year, the length of time of the divergence, based on the work done by Lyons’, actually doesn’t lend itself to a complete bearish argument. Dana writes that  the “Long-duration S&P 500-Russell 2000 divergences have not led to the calamitous types of events one often hears warnings about. 10 of the 11 such historical precedents have led to only moderate hiccups in the market. The two most similar to our present divergence, however, have had split results, including a bear market.”

The chart below shows the previous examples of previous 100+ day divergences between small and large caps while the large caps were making new 52-week highs.

Small cap divergence

Last Week Sector Performance

Once again, Utilities ($XLU) lead the way last week, followed by Consumer Staples ($XLP) and Financials ($XLF). The Energy ($XLE) sector was the big under-performer for the week, followed by Materials ($XLB) and Technology ($XLK).

sector week

Sector Performance Year-to-Date

While Utilities had faulted a couple of weeks ago, it has moved back to being the best performing sector YTD as it just barely beats out Health Care ($XLV). Consumer Discretionary ($XLY) and Industrials ($XLI) round out the bottom of the pack.

sector YTD

Source:  Is the duration of the small cap divergence a concern? (Dana Lyons)

 
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.