Despite recent gains, critical market internals suggest the correction is not yet over, but more upside earnings surprises could be just what is needed to turn momentum decisively positive.
The stock market put in a positive performance this past week, as Friday's gains pushed stocks into positive territory. This was a pleasant surprise after the prior week's decline, which was the S&P 500's largest drop of the year so far.
There were quite a few wide swings during the week, as Monday's large-cap gains were not matched by the Nasdaq, which was down 0.76% on the day due to the losses sustained by Apple Inc. (AAPL) shares. All the major averages were strong on Tuesday with the Dow Industrials closing back above 13,000.
However, the story changed on Wednesday and Thursday, when the market gave up the gains of the prior two days and the S&P 500 came very close to key support before late buying pushed the market higher.
It certainly has been a battle between the buyers and sellers, but stronger-than-expected earnings have made all the difference. According to Bloomberg, well over 80% of the reporting companies have beaten analyst estimates. This has clearly encouraged new buying, and earnings from Microsoft Corp. (MSFT) announced after the close on Thursday gave the market a boost on Friday, a day on which MSFT was up almost 6%.
See also: 3 Ways to Predict Post-Earnings Shocks
Despite the stock market gains, market internals like the Advance/Decline (A/D) line (see below) have not yet signaled that the correction is over. A sharply lower close early this week could reverse the positive momentum carried in from the prior week, but if earnings continue to be strong, that could be enough to reverse the recent deterioration.
Over the years, I have found that the technical readings do a better job of forecasting stock prices than counting on the earning reports.
Strong earnings were helped by some encouraging data, as the Conference Board's Leading Economic Indicators (LEI) put in a strong performance. The chart shows that both the LEI and the Coincident Economic Indicators (NYSEMKT:CEI) are sharply rising and have been since the 2009 low.
It is interesting to note that the LEI peaked in 2006 and had started to roll over in 2007 even though the CEI was still rising. The strong uptrend in both the LEI and CEI suggests that there are no signs of a recession on the horizon.
Not all of the news last week was positive despite better-than-expected retail sales numbers. Other economic news concerned investors, as this excellent graphic from the Wall Street Journal indicates. The jobless claims data has deteriorated over the past few weeks, which, after March's disappointing monthly job report, is not a good sign.
The existing home sales data also discouraged investors, as did the unchanged report on March Industrial Production. Most were expecting a slight gain.
More news on housing will come on Tuesday when the S&P/Case-Shiller Housing Price Index and new home sales data is due out. This will be followed on Thursday by the pending home sales index.
This is quite a busy week for economic data, as the FOMC meeting starts on Tuesday, the same day the April Consumer Confidence report will be released. Durable goods are out on Wednesday, as is the FOMC meeting announcement, which will be followed by Fed Chairman Ben Bernanke's press conference.
Thursday brings weekly jobless claims, which may get more attention than normal this week. That will be followed Friday by the advance reading on first-quarter GDP, the employment cost index, and the latest reading on consumer sentiment from the University of Michigan.
The market was relieved this past week when the Spanish bond auctions went better than expected, although the European debt crisis remains a wild card in the markets. The number of delinquent loans at Spanish banks hit a 17-year high last week, and it is being reported that Eurozone banks have already used most of the cash that was provided by the European Central Bank (ECB).
To make matters worse, the ECB seems reluctant to provide additional cash at the moment, and the Bank's role is being hotly contested in the first round of French Presidential elections being held over the weekend. Also, despite the auction results, yields on Spanish bonds started to rise again on Friday.
WHAT TO WATCH
Though the major averages closed higher on Friday and positive for the week, they remained well below the day's highs. Some important stocks were bucking the trend, however, and two of the big banks, Bank of America (BAC) and Citigroup Inc. (C), both closed lower for the day.
The daily charts for both bank stocks look negative, and BAC appears ready to drop to the 38.2% support at $8.13, if not the 50% support at $7.52. Volume was not heavy in BAC on Friday, but the on-balance volume (OBV) has broken its uptrend.
Citigroup Inc. (C) could easily drop back to the 38.2% support at $31.94, which is about 6% below Friday's close. The OBV for Citigroup looks even more negative and could start to lead prices lower.
The A/D numbers oscillated back and forth last week, but overall, they had a slightly positive bias. As I mentioned here on Thursday, the patterns do suggest another market decline. The confirmation will come if the A/D line breaks below last week's lows. If that occurs, the selling could clearly pick up.
The sentiment numbers are still too bullish for my liking, and the equity put-call ratios are in the sell mode, according to option expert Larry McMillan. The failure of the major averages to move through key resistance last week clearly suggests that the market is still vulnerable.
The Spyder Trust (SPY), which follows the S&P 500, managed minor gains by the close on Friday, and the trading over the past two weeks (highlighted in yellow) still could be a continuation pattern or a pause in the decline from the early-April highs.
A drop below the support at $136.58 would turn the focus again to the downside, and a break of the April 10 lows at $135.76 would signal a drop to the May lows at $134.36, line a.
If the next decline is equal to the initial drop from the April highs, then the Fibonacci price projection, or equality target, for SPY is at $132.91. There is major support in the $128.90-$130 area.
The A/D line did form a negative divergence at the recent highs (line b) and needs to move back above its former uptrend, line c, and its weighted moving average (WMA) to improve. A move through the downtrend, line b, will signal a resumption of the intermediate term uptrend.
The S&P 500 A/D line is still in an uptrend, but one day of sharply negative A/D numbers could turn it negative. A drop below the April lows in the A/D line would signal a deeper correction.
There is first resistance for SPY at $139.36, and move above $140 would improve the outlook.
On Thursday, I recommended the ProShares Short S&P 500 ETF (SH). Despite Friday's rally, it still looks positive, and the initial buying zone was hit. The rally from the April lows in SH was accompanied by strong volume, as the OBV is in a clear uptrend, line e. A close above the downtrend at $36.80, line d, would signal a further rally.
The SPDR Diamonds Trust (DIA), which tracks the Dow Industrials, did manage to move back above its 20-day exponential moving average (NYSEMKT:EMA) and the resistance at $130 last week. DIA is acting somewhat better than the S&P, as nervous investors have been favoring the large-cap stocks.
The Dow Industrials' A/D line is also in a short-term uptrend but is below its weighted moving average and its former uptrend.
There is minor support now at $128.80 with more important support in the $128 area. On a break below the April 10 lows at $126.92, the 38.2% Fibonacci retracement support from the October 2011 lows is next at $121.57.
The iShares Russell 2000 Index Fund (IWM) is still acting weak, as it failed on Friday to move above Thursday's highs. A drop below short-term support at $79.26 would weaken the outlook, and more important support is now at $78.
The Russell 2000 A/D line is still below its declining weighted moving average and well below the bearish divergence resistance from the February and March highs. IWM now has resistance in the $81.50-$82 area, and then at $83.50.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.