In The Week Ahead: The Market Throws Double Red Flags

John Kosar's picture

Monday, July 27, 2015 - 4:00pm

by John Kosar

The title of last week's Market Outlook posed the question: "Could Complacency Reverse Last Week's Gains?" The answer was a resounding, "Yes."

One week after aggressively rebounding from the major support levels I identified earlier in July, all major U.S. stock indices collapsed. The S&P 500 fell 2.2%, the Dow lost 2.9%, the Nasdaq 100 declined 2.3% and the Russell 2000 dropped 3.2%.

All sectors of the S&P 500 closed down for the week, led lower by economically sensitive materials, energy and industrials, which warns of a global slowdown that could put even more downside pressure on world stock markets in the weeks ahead.

Nasdaq Fails at Tech Bubble Highs

In last week's Market Outlook, I pointed out that my 4,600 upside target in the tech-heavy Nasdaq 100 (NDX) was met on July 17. I also warned that corrective declines often begin once initial price targets have been met as investors take profits. 

The big question, I said, was how much upside was left. I noted that one key to answering that question was whether the Nasdaq Composite, the Nasdaq 100's broader cousin, could remain above secular overhead resistance at 5,133, which was the tech bubble high from March 2000.

This week's first chart shows that, following three failed attempts to rise above 5,133 -- in April, May and June -- the Nasdaq Composite finally rallied above that level last week before collapsing back below it on Friday.  

Nasdaq Composite

Right now this looks like a failed bullish breakout, and the more time the index spends below 5,133, the more likely it will coincide with a continuation of last week's broader market decline.

Small Caps Also Failing

The next chart plots the small-cap Russell 2000 and shows that three failed attempts to move higher from the 1,280 to 1,300 area have evolved into a bearish head-and-shoulders pattern, which was confirmed on the close Friday. 

The pattern suggests that a sustainable peak is in place at the late-June highs. It targets a decline to 1,175, 4.2% below Friday's close, that will remain valid below the 1,231 area, which represents the trendline drawn between the early May and early July lows.

Russell 2000

As I pointed out repeatedly, technology and small-cap issues typically lead the broader market both higher and lower. Accordingly, last week's bearish reversal from 5,133 in the Nasdaq Composite combined with the emerging bearish chart pattern in the small-cap Russell 2000 are double red flags for the broader market this week.

Housing Losing Steam

Since late November, I have been pointing out a bullish chart pattern in the PHLX Housing Sector (HGX) that targets an eventual rise to $250. However, after gaining roughly 11% from my initial call into its early April high, this housing index has been stalling. This is particularly important to me right now because of HGX's positive correlation to the S&P 500. 

Since the April 6 high, the index has drifted into sideways investor indecision. Continued weakness resulting in a decline below the apex of this indecision area at $229.40 would clear the way for a deeper decline, potentially back to the 200-day moving average at $220.90.

PHLX Housing

On July 13, I recommended considering going long housing sector bellwether Toll Brothers (NYSE: TOL). Traders should exit this stock on a decline below $36.84.

Putting It All Together

The tech-heavy Nasdaq Composite's inability to remain above 5,133 last week, combined with the fact that the small-cap Russell 2000, another market leader, appears to be establishing an important top at the June highs, warns that last week's broader market decline isn't over and could extend into August.

Moreover, Friday's sharp decline in the housing sector, driven by a horrible June new home sales number, which fell to its lowest level in seven months, is yet another negative for U.S. equities heading into this week.

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This article was originally published on ProfitableTrading.com: Warning: Market Throws Double Red Flags

John Kosar does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.