It was a volatile week that ended up serving as a consolidation for the general markets. While the indexes generally closed near unchanged, there was plenty of movement mid-week following the State of the Union and Fed Statement. It was interesting to note, that despite the general indexes ending near flat, there were several individual stocks that traded very well helping to propel several sectors. Investors also revealed an appetite for risk, as the Nasdaq and small caps fared significantly better than the S&P 500 and Dow.
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The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, ended the week near unchanged, although it did trade in a wide range. After a strong close on Wednesday, SPY gapped higher and reversed on Thursday. This action may be revealing that the market is in need of some consolidation or rest, as traders backed away from higher prices. While Friday was a strong day, as SPY shed earlier weakness and trended higher most of the day, this week's highs may now act as a line in the sand for the index. Traders need to remain cautious, despite the multitude of stocks moving higher. This week's highs occurred at a significant level, so it is likely that sellers may still remain above $132.50. (For related reading, see Is It Possible To Invest In An Index?)
The DJ Industrial Average, as represented by the Diamonds Trust, Series 1 (NYSE:DIA) ETF, traded in a very similar fashion to SPY this week. After some mid-week volatility, DIA ended slightly in the positive column. The more significant pattern to note is that DIA has been resting just under the key $128 level. This is right under last year's highs, and may continue to act as a barrier in the near future. However, it is a positive that after failing to crack this level, DIA has traded sideways rather than fall apart. If DIA continues to consolidate quietly, it could set the stage for a successful breakout. (For related reading, see 3 Reasons Not To Trade Range Breakouts.)
While SPY and DIA took a break this week, the Nasdaq 100 as represented the Powershares QQQ ETF (Nasdaq:QQQ) ETF ended the week at multi year highs. Despite closing off its Thursday highs, QQQ ended the week solidly in the green aided by an earnings surprise from Apple, Inc. (Nasdaq:AAPL) that sent the stock soaring higher. We've mentioned on several occasions that it is always a positive when leadership comes from the Nasdaq or small caps, so it is definitely worth noting that QQQ is leading the charge again. While QQQ could stand for some consolidation, this week's price action was very positive for the markets. (For related reading, see An Introduction To Small Cap Stocks.)
The other standout this week was the as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF. The index ETF was actually able to close near its highs for the week, and well above last week's close. After months of lagging its larger cap peers, it was good to see this group take charge. IWM has now put some distance between itself and last October's highs increasing the odds that the markets have more upside ahead. The most basic definition of an uptrend is a market setting higher highs and higher lows, and this is the pattern that has started to unfold for IWM. Of course, last year's highs still loom above, but important progress has been made so far in 2012. (For related reading, see An Inside Look Into ETF Construction.)
The Bottom Line
While the general markets are still overbought, there have been some subtle changes that imply an increase in underlying strength and a possible change in character. As mentioned above, it is good for the markets when leadership comes from riskier assets. A market can only go higher when market participants are chasing returns rather than focusing on safety. Beyond the action in the indexes, many individual stocks are performing well, and a healthy market depends on broad participation. Currently, over 85% of stocks are trading above their 50-day moving average, which reveals a broad based rally. However, it also reveals an overbought market, so traders can't simply throw caution to the wind. It would be very difficult for the markets to stage an extended rally from this point, so some consolidation or pullback remains likely. If the pullback is tame, it could set the stage for a healthy rally moving forward. (For related reading, see Simple Moving Averages Make Trends Stand Out.)
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At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.