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The Week Ahead: Should You Trust Thus Rally?

|Includes: IWM, QQQ, SPDR S&P 500 Trust ETF (SPY)

The stock market finished the week on a positive note after a very wild week as the S&P futures had around a 35 point range every day of the week. They did manage to close the week just barely higher and the Dow Industrials closed the week up just 30 points . The Dow Transports beat out the S&P 500 on Friday as it was up 1.85% and gained 0.97% for the week.

Friday's rally was spurred by the new proposal from Greece that encouraged traders that a deal was possible and as of Saturday morning the Greek parliament appears to have accepted a new debt plan. But of course until it is signed and delivered things could always change. The stock market was also quite encouraged by the 5.23% gain in the Shanghai Composite after three weeks of losses and several large daily swings.

Volatility was the key as the Market Volatility Index ($VIX) closed just below 20 last Thursday. this broke the downtrend, line a, from last October's high. It reversed 16% on Friday and could now correct back to the breakout level. Such a sharp drop from this high a level is typically a short term positive but is this a rally you can trust?

The Markets

To determine the market's short and intermediate trend my favorite technical measure of the market's health is the NYSE Advance/Decline line. For those who are not familiar with it is the cumulative total of the advancing stocks minus the declining stocks. On Friday 2507 stocks rose with just 658 declining which is a ratio of 3.8 to 1. For the week the A/D ratio was negative as 1526 stocks declined and just 1717 rose.

The NYSE weekly A/D line dropped below its WMA on Friday June 5th and it has continued to make lower lows. The five week divergence in the A/D line is consistent with a correction as at bull market tops the divergences form over many months. The A/D line is still well below its declining weekly WMA.

The daily chart of the NYSE Composite shows the drop below the support, line b, that goes back to the December low. This support now becomes resistance in the 11,000 area which is just above the quarterly pivot at 10,942. The downtrend from the May-June highs, line a, is at 11,100 or about 2% above Friday's close. The NYSE hit monthly pivot support last Wednesday with it's low of 10,622 and it is now the key level to watch.

The daily A/D line dropped below support from March, line d, last week before turning higher on Friday. The A/D line has reached its declining WMA with further resistance at the June high. The A/D line needs to move through the negative divergence resistance, line c, that formed at the May highs in order to signal that the corrections is over.

Key resistance Levels To Watch

  • Spyder Trust (NYSEARCA:SPY) -$209.50-$211
  • PowerShares QQQ Trust (NASDAQ:QQQ) - $109.50-$110.25
  • iShares Russell 2000 (NYSEARCA:IWM) - $125.50-$127.00

The 30% plunge in the Shanghai Composite added to the global equity fears as it tested the January highs, line a, early last week. The decline also took prices below the 50% retracement support level at 3576 but so far the 61.8% Fibonacci support at 3197 has held. The rally late in the week was strong but there is major resistance at 4100-4300 which is likely to stall the rally.

The Shanghai Composite topped just over a week before the S&P 500 while the DAX Index topped out on April 10th. It is fairly common for one global market to top or bottom ahead of others. For example, many of the emerging markets bottomed in late 2008 ahead of the US market's bottom in March 2009

The DAX index dropped to the important support zone last week between the 38.2% and 50% retracement levels. This is normally where a correction in an uptrend will find support. It is therefore possible that the Dax has seen the worst of its correction but it needs to overcome the 11,650 level to stabilize the chart. The former uptrend, line b, is now in the 11,750 area.

Interest Rates & Commodities

The yield on the 10-Year T-Note dropped down to test the support at 2.20% area but then rebounded late in the week to close higher. Yields are now in a clear uptrend from the early 2015 lows (line b) suggesting that we may indeed see a rate hike by the Fed in September. A weekly close in yields above 2.50% would support this view with further resistance at 2.55%, line a.

Crude oil dropped 7.3% last week but it was the break of the key support level at $57 the previous week that turned the outlook negative as I mentioned in the June 26 market commentary. The volume was heavy on the decline suggesting that crude can continue even lower with next major support in the $48-$50 area. The HPI has dropped below the zero line indicating negative money flow. The daily HPI (not shown) is also negative and shows no signs yet of bottoming.

The outlook for gold is also still negative as it tested the key support in the $1144 area. The weekly technical studies like the on-balance-volume have already dropped to new lows so a more severe decline looks likely in spite of the positive seasonal tendencies.

The Economy

It was generally a quiet week for economic data but the ISM Non-Manufacturing Composite index did improve but it is still in a downtrend. It will take much stronger numbers in the coming months to break the downtrend. Of the eighteen industries in the survey fifteen were reported as positive.

This week we have the Retail Sales and Business Inventories on Tuesday that are followed Wednesday with the Producer Price index, Empire State Manufacturing Survey and Industrial Production. Then on Thursday we have the jobless claims, the Philadelphia Fed Business Outlook Survey and a speech by Fed Chair Janet Yellen.

On Friday the Consumer Price Index, Housing Starts and Consumer Sentiment will be released. Of course the main focus this week will be on earnings as the energy stocks are expected to drop by 57%. For the second straight quarter the earnings outlook is quite negative as FactSet is looking for a 4.4% drop in earnings and revenues. Going into the 1st quarter their earnings projections turned out to be too negative.

Market Wrap

One eminent market technician, Stan Weinstein, who was the long term editor of the Professional Tape Readers, often referred to what he called the "weight of the evidence" in explaining his view of the market's trend.

In my review the bearish formations in the weekly and daily A/D indicators along with the weekly topping formations on many of the key indices indicates to me that a further rally over the next week or so will be followed by another decline.

The completion of the weekly rising wedge formation in the iShares Russell 2000 is another piece of negative technical evidence. Therefore the weight of the evidence indicates this is a rally that you cannot trust.

The correction is likely to be over in the next month or so and will present a good buying opportunity for what I expect to be a strong 4th quarter rally. There are of course some industry groups that are already acting stronger than the overall market and may have already completed their corrections. This includes the utilities, REITs and many of the home constructions stocks.

I post regular charts and commentary on both Twitter and StockTwits and discuss ETFS as well as stocks on Trade Your Own Money.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.