In The Week Ahead: The Number Every Investor Should Be Watching

John Kosar's picture

Monday, January 25, 2016 - 4:00pm

by John Kosar

The major U.S. indices overcame early weakness last week to post across-the-board gains. The advance was led by the tech-heavy Nasdaq 100, which gained 2.9%, although the market-leading index is still down 7.3% for 2016.

The rebound followed a successful test of underlying support at 1,821 in the benchmark S&P 500, which I discussed in last week's Market Outlook. This is an important intermediate-term decision point for the broader market. From here a new one- or two-quarter advance should begin if the current decline is just a correction within a larger bull market. But I am not yet convinced this is the case.

From a sector standpoint, last week's rally was led by technology, which gained 2.6%. However, a look under the hood via Asbury Research's investor asset flows-based metric shows the percentage of sector bet-related assets being invested in technology has actually been contracting since December. So, unless this quickly changes to a trend of expansion, the recent sector outperformance is likely to be short lived.

Keep Support Must Hold Or Watch Out Below

The chart below shows the S&P 500 testing and holding underlying support at 1,821 on Wednesday. It then rebounded by 5.2% to finish the week at 1,907. As you can see, 1,821 is the October 2014 low. It is also the place from which the 2009 uptrend should resume if it is still healthy and intact.

SPX Chart

But on the other hand, a sustained breakdown below 1,821 would clear the way for a deeper decline to 1,738, which represents the February 2014 low and the March 2009 uptrend line. A fall to that level would represent a 19% correction from the index's all-time high, made in May.

Key A Close Eye On Investor Fear Gauges

One sign that a sustainable bottom may be in place at last week's lows is the CBOE Put/Call Ratio. As the name implies, this metric measures put volume relative to call volume and is an indicator of the level of investor fear.  

The ratio is currently hovering at a historic bearish extreme. Similar readings have coincided with every near-term bottom in the S&P 500 during the past year.

SPX Chart

Unless we have entered a bear market, this metric suggests that 1,821 should continue to hold as underlying support and become the starting point for the next meaningful advance.

The Volatility S&P 500 (VIX), shown on the chart below, is another way to gauge investor fear. It measures the market's expectation of 30-day volatility. 

Over the past several years, moves in the VIX above its 50-day moving average, indicating a significant level of investor fear, have coincided with declines in the S&P 500. 

VIX Chart

I am watching for a sustained decline in the VIX below its 50-day moving average, now at 19.38, to help confirm last week's rebound from 1,821 support is sustainable. Until then, the broader market remains vulnerable to a deeper decline.

Gold Still Has Upside Potential

In the Dec. 28 Market Outlook, I said it was time to start paying attention to gold because I saw the first signs of positive investor asset inflows into the SPDR Gold Shares (NYSE: GLD). Since then, GLD is up nearly 2% while asset flows have continued to expand.

Total net assets invested in GLD have been above their 21-day moving average since mid-December, indicating a monthly trend of expansion like the one that fueled the September-to-October advance.

GLD Stock Chart

As long as this monthly trend of asset expansion continues, I expect this rally to eventually result in another test of GLD's 200-day moving average at $108.79. The 200-day is a widely watched major trend proxy that has closely defined the bear market in the ETF since February 2013. A sustained rise above the moving average would be necessary to indicate a bullish trend change rather than just another bullish correction in a three-year bear market.

Putting It All Together 

Underlying support in the S&P 500 at 1,821, which was tested and held last week, is an important decision point for the broader market. This is likely where an intermediate-term advance should begin if the current decline from the November highs is just a correction in a bull market. 

A sustained move below 19.38 in the VIX this week would be seen as supporting evidence that this is the case. However, a move above that level and a sustained decline below 1,821 in the S&P 500 would warn that stocks are in the midst of a bear market. 

Editor's note: When traders panicked in early July, one expert closed bearish trades for annualized returns of 1,205% and 2,111%. As the market plunged in late August, he closed two more bearish trades for 771% and 3,080% annualized profits. He's agreed to share how he uncovers his picks in a short presentation. If we are in fact entering a bear market, you can't afford to not watch this.

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This article was originally published on ProfitableTrading.com: The Number Every Investor Should be Watching

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.