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Need More Proof

Last week we stated that any rally would need to prove itself for us to expect new highs.  Over the past week, we didn’t get quite enough proof.  The S&P 500 Index (SPX) had a strong three day rally intra-week, but we didn’t see confirmation of the move in many of the indicators that we follow.  Most of our core market health indicators declined even as the market rose.  One positive is that our market risk indicator pulled back from its warning signal and is now in an area that would probably take a couple of strong days of selling before warning again.

The price action of Nasdaq and the Russell 2000 Index (RUT) were also encouraging as they both regained and closed above their 50 day moving averages. This indicates that market participants used the recent dip to buy technology and smaller cap stocks which often lead rallies. In addition, the number of stocks making new highs on Nasdaq has recovered quickly indicating that technology is being bought at higher prices too.

Measures of breadth are mixed with longer term measures such as the percent of stocks above their 200 day moving average and the bullish percent index holding up fairly well during the recent consolidation.  We don’t generally get too worried unless these two indicators fall below 60%. A breach of that level often brings accelerated selling.  One thing that concerns us a bit is the percent of stocks above their 50 day moving average isn’t recovering as quickly as we’d like.  This suggests that investors are being selective about which stocks they are willing to purchase at higher prices.  We want to see this indicator rise sharply if SPX moves above its own 50 dma as that would indicate broad based buying.

Our Twitter sentiment indicator for the S&P 500 Index (SPX) did not confirm the move in price over the past week.  The daily indicator printed mostly flat readings as the market rallied on Tuesday, Wednesday, and Thursday.  It took a move in SPX up to its 50 day moving average that wasn’t sold aggressively to convince traders that the rally might stick. This allowed a modestly bullish print of +12 on Friday.

Smoothed sentiment declined throughout the week, but caught at the upward sloping trend line it’s been painting since February.  This suggests that the uptrend in price out of the November 2012 lows may have more room to run. A break in smoothed sentiment above its downward sloping trend line would reconfirm the rally, while a break below the uptrend line would create a consolidation warning.  We should see one of those signals over the next week as we’re very close to the apex of the triangle created by the converging trend lines.

Support and resistance levels generated from the Twitter stream tightened this week with major support at 1600 and last week’s lows at 1560 on SPX. The first major resistance level is 1620. A break above 1620 will most likely bring with it a lot of buyers currently sitting on the sidelines. The other levels traders are targeting are 1635 and 1650.

Sector sentiment continues to give a slightly mixed picture that is improving. Technology and consumer discretionary stocks regained a positive bias this week.  They join financials and energy that were already positive. The defensive sectors of utilities and health care also showed strength.  Utilities were so oversold that the positive reading may reflect buying the dip rather than rotation to safety. Consumer staples are showing weakness which is another positive for the market.

Overall sentiment is constructive, but not showing the strength we’d like to see coming out of a short term low.  Support and resistance levels are tightening around obvious price targets (recent lows and recent highs) which suggests market participants will pile on to any break below 1560 or above 1650 on SPX. The triangle being painted in smoothed sentiment also suggests a willingness to wait before taking action.  We have to give the edge to the bulls since smoothed sentiment is above its uptrend line and technology and consumer discretionary stocks show improving sentiment.

The market is still in an uptrend, Nasdaq and the Russell 2000 are above their 50 day moving averages so we have to give the current action respect even though we didn’t see strong confirmation of the rally over the past week.  We definitely need to see better internal readings if the rally continues into next week or we’ll become concerned.  In short, the market needs to prove itself, but we’re willing to give it time to do so.

 

 
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