The Week Ahead: Damn the Torpedoes ….

Since the Spyder Trust (SPY) closed on July 3rd it has rallied 2.36% and has regained about 50% of the decline from the June 22nd high. The rally has been more relentless than I expected as I thought that it was likely to stall last week.

The Spyder Trust (SPY) and the PowerShares QQQ Trust (QQQ) have exceeded the resistance levels that I outlined last week. The QQQ made new all time highs due in part to the strong performance of Google, Inc. (GOOG) which was up almost 15% on Friday. The rally in the small cap iShares Russell 2000 (IWM) is currently stalled at it’s key resistance.

Overall earnings were better than expected except in the energy sector. The continued decline in crude oil prices that was in line with the negative technical readings from the end of June. Even some disappointing economic reports did not deter the buyers who apparently decided they had sold too much because of concerns over Greece and the Chinese stock market.

Fig1

Farragut on board Hartford

But is now the time to Dam the torpedoes and go full speed ahead? This famous phrase is attributed to Rear Admiral David Farragut during the civil war Battle of Mobile Bay when he decided to steam the Hartford through an area of naval mines (torpedoes) in order to press his advantage and his decision turned out to be successful.

Even though the evidence is mounting that the correction is over it is not the time to chase prices as patience is one of the most important traits of successful investors. Let’s examine the evidence

The Markets

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The weekly close only chart of the Spyder Trust (SPY) reveals the six brief corrections since May 2013 with the change based on weekly close noted for each correction. The recent decline of 4.6% took six weeks and was one of the smallest of the recent corrections.

The correction last fall was the largest and a couple of weeks ago the market was sending out similar warning signals as it did last September. The 16% rally from the October 15th lows was much stronger that the 9.6% rally from the February 2015 low. A comparable rally from the recent lows could take the SPY back to the 2240 area. One simple measure of why this is not a good time to be chasing the market is that the SPY is now almost 2% above its 20 day EMA as it was 2.5% below it at the recent lows.

Fig3

The NYSE Composite was able to regain its former uptrend, line b, on Thursday but closed right on it Friday. It is still below the monthly pivot resistance at 11,061 (red line). The former downtrend is now at 11,130, line a. The daily NYSE A/D line has improved significantly over the past week as the short term downtrend, line d, has been broken.

The A/D line is also now above its WMA which is starting to turn up which is also a plus. A move through the bearish divergence resistance (line c) would confirm that the correction is over. A pullback to the WMA should be a buying opportunity. The daily OBV did form a bullish divergence, line f, at the recent lows and has now moved through resistance from early in the year (line e)

The German DAX Index has surpassed the late June highs which suggests that it’s correction may be over. There is first support for the average now in the 11,300 area which corresponds to the now rising 20 day EMA. The Shanghai Composite was up 2% for the week but there is still massive resistance overhead that needs to be overcome in order to indicate that the correction is over.

Fig4

The market is still significantly oversold based on the % of the S&P 500 stocks below their 50 day MAs. In late June and early July the 5 day MA of the stocks below their 50 day dropped below 29% which was two standard deviations below the mean at 60.8%. The downtrend, line a, is now at 58% and it could rally back to overbought levels in the 76-80% area.

On the sentiment side the %Bullish according to AAAI rose slightly last week but is still at relatively low levels. It never reached an extremely low reading consistent with a market bottom. The CNN Fear & Greed Index is at 32 and is back in fear territory but was much lower at 14 last week.

The Economy

Last Tuesday’s Retail Sales report was much weaker than expected as it came in at -0.3% while most were looking for an increase of 0.3%. The continued weakness in this data series is in contrast to the data on consumer confidence and sentiment which had been improving.

On Friday the mid month reading on consumer sentiment from the University of Michigan came in at 93.3 which was lower than the lowest estimate of 94.5. Continued weakness in the retail sales data will be a problem as we get into the fall when the economy relies more on consumer spending.

The continued lackluster numbers on manufacturing are also troublesome as both the Empire State Manufacturing Survey and the Philadelphia Fed Business Outlook Survey were lower than expected. It appears that June’s jump in the Philly numbers was an aberration.

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The best news on the economy came from the housing sector as the National Association of Home Builders as builder sentiment hit its highest level since November 2005. The HMI completed its bottom in early 2012 as it overcame resistance at line a. It still shows a solid uptrend, line a. Housing starts and permits also surged which supported the builder’s bullish sentiment.

This week we have Existing Home Sales on Wednesday, followed on Thursday by the Chicago Fed national Activity Index, Leading Indicators and the Kansas City Fed Manufacturing Index. Then on Friday comes the PMI Flash Manufacturing Index and New Home Sales.

The testimony by Fed Chair Janet Yellen suggests rates may be raised before the end of the year but aside from the jobs data the other economic data does not seem to support such a move. Though there are no early warnings of a recession the economic data over the next few months needs to get better in order to support a strong year end rally in stocks.

Interest Rates & Commodities

Yields declined slightly last week but are still in a short term uptrend after the rally accelerated in early June. For the past two weeks funds have been flowing into bonds and out of stocks. Any pullback in yields should be watched closely with yield support for the 10 Tear T-Note at 2.26% with more important now at 2.09%.

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Crude oil and gold have continued to be weak and their technical outlook remains negative suggesting even lower prices. Gold dropped to a new five year low as the Comex futures closed below important support at line b. The recent trading range on the daily chart has downside targets in the $1080-$1100 area. The volume has been heavy on the decline as the OBV broke support three weeks ago when gold was over $30 higher.

Crude oil prices are trying to hold the quarterly pivot support in the $50 area. If this level is broken the next good support is in the $47-$48 area. The oil & gas stocks were one of the few losing sectors last week as they were down 1.4%.

In last week’s “Two Sectors Breaking Out” I recommended sticking with the strong health care and consumer discretionary sectors which were both up over 2% for the week.

Market Wrap

In last week’s column I was looking for a rebound that would fail below the recent highs. The iShares Russell 2000 (IWM) was acting the weakest as it only gained about half as much as the S&P 500 did last week. This makes the close this week very important as a sharply lower close would negate last week’s positives.

The NYSE weekly A/D ratios were slightly positive but the A/D line is still below its WMA which supports a cautious outlook for now. Clearly the new highs in the Nasdaq and the improvement in the daily technical studies does suggest a pullback this week will be supported.

Nevertheless a patient approach is the best as one should not buy ETFs or stocks close to resistance where stops need to be more than 5% below your planned entry level. If a major new uptrend has begun there will be corrections or periods of consolidation where the risk on new positions can be better controlled. Look for updates during the week on both Twitter and StockTwits