In The Week Ahead: Chart Warns Blue Chips May Be Peaking

John Kosar's picture

Monday, May 16, 2016 - 4:30pm

by John Kosar

The major U.S. stock indices posted their third negative weekly close on Friday. The benchmark S&P 500 ended the week 3.1% off its April 20 high, which came two days after I warned readers going long was a dangerous prospect.

Last week's decline was led by the blue-chip Dow industrials, which lost 1.2%. However, the index is actually in the lead for the year with a modest 0.6% gain. Meanwhile, the tech-heavy Nasdaq 100 and small-cap Russell 2000 -- which typically lead the broader market both higher and lower -- are down 5.8% and 2.9% year to date.

From a sector standpoint, last week's decline was led by real estate (-1.6%) and consumer discretionary (-1.5%). Utilities were the only sector of the S&P 500 to finish in positive territory, gaining 1.2%.  

The table below shows that, for the second week in a row, the biggest positive percentage change in sector bet-related assets invested over the past one-month and three-month periods went to energy. Continued expansion would bode well for energy stocks and oil prices in the weeks and months ahead. 

Follow The Bouncing Apple

Two weeks ago, I pointed out that influential and often market-leading Apple (Nasdaq: AAPL) was testing major underlying support at $92. I said a break of this level would clear the way for an even deeper decline in the stock, as well as in the positively correlated Nasdaq 100 and S&P 500.

After hovering just above this support for two weeks, AAPL collapsed below it on Thursday and Friday.

The next formidable support level is at $84.77, which represents the stock's 2009 uptrend line and is 6.4% below Friday's close. 

The stock bounced Monday following news that Warren Buffett's Berkshire Hathaway (NYSE: BRK-B) bought over $1 billion worth of shares, but further selling would carry a negative implication for the overall market.

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Is The Dow Peaking?

In last week's Market Outlook, I said the Dow Jones Industrial Average was just a weak session or two away from a negative shift in its one-month rate of change -- a near term-trend gauge. Not only did this negative shift occur last week, but the blue-chip index also completed a bearish head-and-shoulders pattern on the close Friday.

 

While I want to see another day or two of weakness to confirm the pattern, it targets a decline to 17,000, which is 3.1% below Friday's close and would essentially result in a test of the 200-day moving average, a widely watched major trend proxy. If broken, it would clear the way for an even deeper decline.

Even The Bond Market Is Getting Nervous

Last week, I also noted that the sideways movement in the yield of the U.S. 10-year Treasury note since February has traced out a triangular pattern, indicating temporary investor indecision. I said several closes below the lower boundary of the pattern at 1.75% would target a decline to 1.44%.  

The next chart shows that these benchmark yields logged their first meaningful close below 1.75% on Friday, finishing the week at 1.71%.

 

As long as the 1.75% area loosely contains yields on the upside, the negative bias in long-term interest rates remains valid. A further decline from these already historically low levels would likely coincide with a stock market pullback, since both are characteristic of apprehensive investors moving into safer assets.

Emerging Trend Change In Oil Prices?

In the May 2 Market Outlook, I pointed out that West Texas Intermediate (WTI) crude oil prices had risen above major overhead resistance near $44 per barrel, suggesting a meaningful bottom was emerging. Prices have continued to climb since then, closing as high as $46.65 on Thursday.

The more time that oil prices spend above $44.53, the more likely that a meaningful bottom is indeed in place at the $26.14 February lows.

However, oil prices are no longer positively correlated to the S&P 500, as had previously been the case since late 2015. So, although a sustained rise in oil prices should generally bode well for the global economy heading into the second half of the year, it should no longer be viewed as indirectly bullish for the U.S. stock market.

Putting It All Together 

In last week's report, I said the U.S. stock market was at an important near-term decision point from which its February advance must soon resume or risk a more damaging correction.  

Last week's collapse below $92 in market-leading Apple, the bearish chart pattern in the Dow, and what appears to be a move toward significantly lower long-term U.S. interest rates in the weeks ahead, point to a deeper decline.

The potential silver lining is the recent strength in oil prices, which could eventually help allay investor fears of global deflation.

This article originally appeared on Profitable Trading: Chart Warns Blue Chips May Be Peaking

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.