There’s lots of cash on the sidelines of this aging rally, but investors should not get caught up in the hype. Instead, stay defensive and only look to buy into select low-risk plays, as outlined by MoneyShow senior editor Tom Aspray.
The Dow Industrials, S&P 500, and Nasdaq Composite all made further new highs last week, and Tuesday’s close in the Dow’s above 13,000 was widely touted.
The majority of financial experts who appear on the cable networks seem to be getting more bullish, as some seem to be less certain we will see a correction. The forecasts for the major averages keep getting raised, and you hear comments like “US stocks are ridiculously undervalued.”
I have never placed much faith in fundamental valuations. I feel technical analysis—which studies the price and volume of a stock—is a better gauge of whether a stock or a market is over- or undervalued.
The intraday reversal on October 4, 2011 is a perfect example of prices reaching an undervalued extreme. Now, the majority of stocks look positive technically, but investors are faced with the choice of buying with a very wide or a very tight stop. Either choice, in my opinion, increases the chances of failure.
It also appears that the majority of individual investors are also not convinced about the stock market. This Wall Street Journal chart shows that they have continued to move money out of stocks as the market has moved higher. Even at the end of 2010, when the market was rising sharply and was technically strong, investors were still moving out of stocks.
The most recent AAII survey of individual investors shows that now just over 45% think the market will be higher over the next six months. Once the market corrects, this number should drop well below 40%. The financial newsletter writers are more bullish, although unchanged last week at 51.1%.
The lack of buying by individual investors means that there is lots of cash on the sidelines…but it will probably take a significant rise in interest rates to coax them back into stocks. I am frankly surprised that this year’s gain of over 10% in the Spyder Trust (SPY) has not brought more money into stocks.
The lack of interest can’t be blamed on the economic news, as it was generally positive—and had been for most of February.
Consumer sentiment hit its highest level in over a year, and on the retail side, many stores showed surprisingly strong growth in February, with high-end retailer Nordstrom (JWN) reporting same-store sales were up over 10%. Also last Wednesday, the preliminary report on fourth-quarter GDP beat analysts’ expectations
The worst news came from the manufacturing sector, as the ISM factory index dropped sharply last month, and was worse than anyone expected. Also, consumer spending was down, but his data was balanced out last Thursday by better-than-expected jobless claims.
This week, we have the latest report on Factory Orders and the ISM Non-Manufacturing Index on Monday, followed by the ADP Employment Report on Wednesday. Also out Wednesday is the Productivity and Costs report, which can help gauge future inflationary trends.
Thursday, of course, we get the weekly jobless claims, and then on Friday the monthly employment report. Most are expecting this to be quite good, so a miss could dampen some of the enthusiasm in the stock market.
Overseas, the second phase of the ECB’s refinancing was very popular, as they provided $720 billon to more than 800 banks. Apparently, Italian and Spanish banks received about half of the money.
Late last week, Spain jolted the markets by raising their deficit target. Also, unemployment in Spain is close to 23%. (In the Eurozone as a whole, unemployment was at 10.7%, which is a 15-year high.) Though Greece’s debt deal looks like it will go through, one can never be sure.
WHAT TO WATCH
While the S&P 500 was making new highs last week, the mid-cap S&P 400 and the small-cap S&P 600 did not.
As I discuss below, the deterioration in the Advance/Decline line for the small-cap Russell 2000 has deteriorated further. This is a strong indication that we will eventually see a correction there, though the S&P 500 and/or Dow Industrials could make another new high first.
This comparative performance chart since the November 25 lows shows the performance of four ETFs that track the five key market indices: The Spyder Trust (SPY), iShares Russell 2000 (IWM), PowerShares QQQ Trust (QQQ), the SPDR Diamond Trust (DIA) and the iShares Dow Jones Transports (IYT).
The transports, as represented by IYT, was one of the top sectors until early February, up close to 18%. It is now the weakest. It was outperforming the QQQ until February 7, and since then IYT has fallen 3% and the QQQ has gained over 5%.
It also reveals that while IWM was the strongest into early February, it has already dropped 4% from its highs. Its performance dropped below the QQQ last week. (The QQQ is still outperforming the SPY by a healthy margin.)
The Dow Industrials is still lagging, but as I discussed in “The Dow’s Most Overbought Stocks,” there are a few Dow stocks that look very positive based on the monthly analysis, and could emerge as new leaders after a correction.
The ranges in the Spyder Trust (SPY) narrowed at the end of last week, though it came very close to the converging resistance at $138.26, which is the 78.6% Fibonacci retracement resistance, as well as the Fibonacci equality target (100%) from the October rally.
The S&P 500 A/D line has broken its uptrend from the late December lows (line b), and is close to its flattening WMA. It would take a decisive close in the A/D line below its WMA to indicate that a short-term top was in place.
In terms of price, a close below $135.80 is likely to signal that a correction is underway. The next chart support and the minor 23.6% Fibonacci support sit in the $133.80 to $134.50 area. There is much more important chart and retracement support now in the $129 to $131 area.
The SPDR Diamonds Trust (DIA) made marginal new highs last week at $130.37, but then closed for the week back below $130.
The first key support is now at $128.50, which if broken should signal a drop to the uptrend (line e), which is now in the $126.70 area. There is further trend line support just below $126 (line d).
The Dow Industrials A/D closed on its uptrend, line f, on Friday but it is still well above its WMA. It just made marginal new highs in February consistent with its lagging performance.
A decisive close above $130.50 is needed to suggest a move to the $131.50 to $132 area.
The PowerShares QQQ Trust (QQQ) spent most of last week bumping into the upper boundary of the parallel trading channel (line a).
Though an upside breakout is certainly possible, it is more likely to come after a pullback. The chart reveals that QQQ has not come very close to its rising 20-day EMA so far in 2012.
There is first support now in the $63 to $63.50 area and the 20-day EMA.. A daily close below $62.63 will suggest a move to the $60.60 to $61.40 area. The 38.2% support is now at $60.30.
The Nasdaq-100 Advance/Decline (A/D) line made marginal new highs last week after overcoming resistance (line c). The WMA of the A/D is now starting to flatten out, which is consistent with a loss of upside momentum. It would take a day or two of very strong A/D numbers to reverse.
There is next resistance from 2001 at $65.61, with a Fibonacci price target of $67.15.
The iShares Russell 2000 Index Fund (IWM) dropped below its trading range (in yellow) last week, closing below the last three weeks’ lows.
There is next support at $79.50 and then more important in the $77 to $77.50 area. The 38.2% retracement support, calculated from the October lows, is at $74.40.
I noted last week that the Russell 2000 A/D line had started to form lower highs and lower lows, and it accelerated to the downside last week. This has confirmed the negative divergence (line f), as the A/D line has dropped below the February 15 lows. There is converging support for the A/D line at line g.
This comparative chart shows that the Select Sector SPDR Technology (XLK) is still performing the best, as it is up over 14% since the start of the year.
The Select Sector SPDR Energy (XLE) was outperforming the Spyder Trust (SPY) until the last day of February. This correction in the energy stocks is likely to set up a good buying opportunity in the coming weeks.
Select Sector SPDR Industrials (XLI) are still outperforming the SPY, but has also declined from the late February highs. Therefore, this sector needs to be watched closely.
The Select Sector SPDR Financial (XLF) surged last week, and while I do not want to chase the big banks at these levels, some of the asset managers do look interesting.
Crude oil got smacked at the end of last week, after concerns over the price of crude oil became more widespread. The May crude oil contract was down more than $2 on Friday and lost over $3 for the week.
The daily chart shows that crude is already getting back to the breakout level (line a) in the $103.80 to $104 area. A drop back to the $102 area is possible before the uptrend resumes.
The SPDR Gold Trust (GLD) was hit hard last week after Fed Chairman Ben Bernanke’s made comments that some thought ruled out any more quantitative easing.
Though the sell was likely overdone, there was some technical damage done. As I discussed last Thursday, the next favorable buying point is likely to come at lower levels.
The iShares Silver Trust (SLV) also reversed to the downside last week, and got as low as $32.90 before stabilizing. There is still key support at $31.80, which if broken would signal a drop to the $30 area.
The Week Ahead
I would expect the action to be even choppier this week, as the battle between investors and those hedge funds that are short continues. The action of the Russell 2000 A/D sends a strong warning that investors should not get caught up in the euphoria at current levels.
Stocks generally drop faster than they rise, and I would expect that heavier selling will be triggered by some news event. It’s tough to tell what that event might be, but the likely candidates are Greece and Iran.
Since it has taken so long for the market to correct, it is possible that we will see more than a 3% to 5% correction once it gets underway. Therefore, raise some cash and be patient—selective buying should only be done where the risk is low.
I will continue to look for sectors and stocks that have not really participated. I will also keep taking profits on those positions I have recommended, as well as raising my stops.
The portfolio of stocks I have recommended since last October was updated as of last Thursday’s close and can be found here.
- Read Tom’s latest Trading Lesson, “Don’t Miss Another Big Rally”