In The Week Ahead: A Look Under the Market’s Hood Reveals Problems
Just a week after successfully rebounding from its 200-day moving average, the S&P 500 collapsed right back into this widely watched major trend proxy at the end of last week for the third time since late June.
The index’s inability to sustain a rally from a major support level like this is problematic. It suggests a lack of bullish conviction by investors and may be the precursor to the first real corrective decline in years.
All major U.S. indices closed in the red last week, led lower by the small-cap Russell 2000, which lost 2.6%. Two weeks ago, I pointed out an emerging bearish chart pattern in this market-leading index that continues to target a decline to 1,175, which is 2.6% below Friday’s close.
Defensive Utilities Stand Out
In last week’s report, I said utilities were on my radar screen as a potential sector to overweight this quarter. It was actually the only sector of the S&P 500 to post a positive close last week, gaining 0.9%. Utilities now appear poised for more strength and relative outperformance.
The chart of the Utilities Select Sector SPDR ETF (NYSE: XLU) displays a bullish inverse head-and-shoulders pattern that emerged as a result of the successful June-to-July test of major support at the August 2011 uptrend line.
This pattern targets a move to $46.50, a 4.8% rise, which will remain valid above the July 23 low at $42.08. The utilities sector is generally seen as defensive and tends to do well when U.S. interest rates are declining.
Blue Chips Testing Major Support
In last week’s Market Outlook, I pointed out that the PHLX Semiconductor (SOX) index, another market leader, was testing major support at its November 2012 uptrend line. That support, currently situated at 628, continues to hold heading into this week, but just barely as the index closed at 637 on Friday.
The blue-chip Dow Jones Industrial Average also began this week situated on top of its November 2012 uptrend line at 17,303. The index finished last week at 17,373.
So three key indices — the S&P 500, SOX and Dow — began this week right on top of major support levels. This is where new and aggressive investor buying should come in if the larger bullish trends are still healthy and valid.
Things Look Dicey ‘Under the Hood’
A look “under the hood” of these indices, however, continues to reveal some potential problems. I already mentioned the bearish chart pattern in the Russell 2000 and its 1,175 downside target. In addition, as I discussed on June 29, the chart of technology bellwether Cisco Systems (NASDAQ: CSCO) warns of a decline to $25, 11.2% below Friday’s close.
The next chart points out what has become the most recent red flag for the market: last week’s breakdown in Apple Inc. (Nasdaq: AAPL). Apple, which is the largest U.S. stock according to market capitalization, is positively correlated to both the S&P 500 and Nasdaq 100.
I noted AAPL was testing major support at its 200-day moving average, now at $121.18, and the November high at $119.75. These levels were clearly broken last week. This suggests a bearish change is emerging. Moreover, last week’s breakdown from more than five months of sideways investor indecision now targets a decline to $109.75, 5% below Friday’s close. Note that Monday’s rebound in AAPL did not undo last week’s technical damage.
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Finally, last week, I also mentioned that Volatility S&P 500 (VIX) was hovering near a multiyear complacent extreme of 12. I cautioned that adding new long positions with the VIX near 12 had not been a good near-term strategy.
The VIX finished last week at 13.39, still close enough to 12 to discourage aggressive buying of U.S. stocks just yet.
Putting It All Together
A number of key U.S. stock indices began this week situated right on top of major support levels and, as I have stated in this space a number of times, it is never a bad idea for intermediate-to-long-term investors to put some money to work at these levels because this is where the best risk/reward ratio exists.
However, recent weakness in market-leading indices like the Russell 2000 and technology bellwethers like Cisco and Apple, amid an extreme in investor complacency, warn of the market’s vulnerability to a deeper correction.
Market Outlook readers should consider keeping a little powder dry in the event that a long overdue stock market correction provides us with a better buying opportunity later this quarter.
This article was originally published on ProfitableTrading.com: A Look Under the Market’s Hood Reveals Problems.