The Week Ahead: Can Stocks Climb the Wall of Worry?
Seeking Alpha Analyst Since 2010
Last week’s financial headlines may have caused many stock investors to run for the exits, as there was very little to make one think that stocks could move higher. Here is a sampling:
- Demand For Durable Goods Falls the Most in 6 Months
- Countries Urged To Raise Rates
- Goldman Says Brent Will Hit $130
- Revenue Slide Dents Banks’ Recovery
- Draghi Warns on Global Recovery
- Fears of Debt Contagion Return to Eurozone
- UK Lenders Face Rating Downgrade
- Steep Quarterly Drop For Home Prices
Despite the concerns over debt contagion, a double dip in the economy, and slower growth in China, the US stock market was surprisingly strong. The early-morning declines on Wednesday and Thursday were met with good demand.
Therefore, even though the major averages made new correction lows, the market had plenty of reasons to drop more sharply. For most of the week, Tuesday’s headline from the Financial Times, “Investors swept up in wave of bearishness,” said it all.
So even though the stock market was not as strong as I had forecast last week, I am sure most were surprised that it closed higher. Sentiment measures continue to get more negative, with only 25% bullish in a recent AAII survey. This is the lowest reading since last summer.
Last week’s pending home sales dropped 11%—but new home sales were stronger than expected, giving some home builders a boost. On Tuesday, we get more housing data, as the S&P Case-Shiller price index will be released along with consumer-confidence numbers.
Of course, this is another jobs week, with a preliminary reading Wednesday from the ADP Employment Report, followed by jobless claims Thursday and the monthly employment report on Friday. Also out Wednesday is the ISM Manufacturing Index, with the ISM Non-Manufacturing following on Friday.
As the headlines show, there are still plenty of problems facing the Eurozone, and the Strauss-Kahn scandal has not helped—the BRIC countries, among others, are not in favor of a new IMF head from the Eurozone. Also, as my colleague Jim Jubak suggests, “Another Quick Fix For Greece” is likely.
Euro investors have also been moving away from risk, as the yields on German debt have dropped 3%, matching similar yield declines in both the UK and the US. Nevertheless, the DJ STOXX Europe 600 was able to close the week well above the lows, as it tested strong support in the 272 to 274 area early in the week.
Commodity prices have bounced nicely from the mid-month lows, and the strength in copper may be a sign that the economy is really stronger than most expect. Crude oil has bounced from the recent lows, but is now hitting first strong resistance. Technically, this rally looks as though it will be followed by a further decline.
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WHAT TO WATCH
As I noted in more detail before Friday’s opening, the technical and sentiment picture for the stock market had improved. The positive action Friday supports this view, even though the major averages closed below their best levels.
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S&P 500
The Spyder Trust (SPY) tested its downtrend (line a) on Friday, and still has strong resistance at $135.36. A daily close above this level should confirm that the correction is over. A test of the May 2 highs at $137.18, if not a move to the $138.50 area, is still a distinct possibility.
The low for SPY at $131.38 is now the critical level, with the daily uptrend (line c) now at $130.50. If this level is violated, the April lows are at $129.51 (line b).
The S&P 500 A/D line has turned up, and is very close to breaking its downtrend. It did make new highs in May, and is still well above long term support (line d).
Dow Industrials
The Diamonds Trust (DIA) also appears to have completed a short-term bottom, but is slightly lagging the SPY. DIA has just filled the gap from last Monday’s opening. There is still a strong band of resistance in the $126.50 to $127.50 area.
The support level to watch now for DIA is $122.80, while the April low and major support follows at $120.65.
Dow Transportations
The Dow Transportation Index held above the prior week’s low at 5,311, and did close last week higher.
A close above 5,500 is needed to complete the correction and signal a rally to new highs in the 5,650 to 5,700 area.
If one of the other major averages is able to exceed the May highs, and the Transports fail to make a new high, it would be a warning sign.
Nasdaq-100
I have been looking for the PowerShares QQQ Trust (QQQ) to lead the market on the next rally, but it has continued to lag. It will now take a much stronger rally for QQQ to take over leadership.
The first hurdle is the resistance in the $58.50 area with major at $59.34 area.
The down gap last Monday violated the support in the $57 area as QQQ hit a low of $56.47 which weakened the short term outlook. There is now important support below $56.
Russell 2000
The iShares Russell 2000 Trust (IWM) has concerned me for several months, and last week it dropped below the April lows. This is a further sign of weakness, and as I noted several weeks ago the A/D line on the Russell 2000 failed to make a new high with prices in April.
The rebound in IWM is likely to fail in the $85 to $85.50 area, even if the SPY makes new highs. Therefore, the current rally should be used as an opportunity to move out of both small and mid-cap stocks.
Once below the recent lows at $80.76, the next major support is in the $77.50 to $78 area.
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