In The Week Ahead: Don't Bet On A Bottom In Stocks Just Yet

John Kosar's picture

Monday, August 31, 2015 - 4:00pm

by John Kosar

One week after a nasty 5.8% collapse in the S&P 500, driven primarily by continued weakness in China, the broader market index turned an early week continuation of that decline into a modest 0.9% gain by Friday.

The stabilization in U.S. equities was led by the market-leading technology-heavy Nasdaq 100 and small-cap Russell 2000, which posted weekly gains of 3.1% and 0.5%, respectively.

While this is certainly a good near-term sign heading into this week, the jury is still out on the market's prognosis for the rest of the year. The August decline has pushed all major U.S. indices except for the Nasdaq into negative territory for 2015.

In this week's Market Outlook, I will define some key levels in a U.S. market bellwether that should help us determine whether the worst is over or there is more pain to come.

Most sectors of the S&P 500 posted gains last week, led by the beleaguered energy sector, which rose by 3.5%. Moreover, the table below shows that, according to Asbury Research's own metric, the biggest percentage increase of investor assets over the past one-week and one-month periods went into energy. 

These inflows are basically "trend fuel" for the sector. As long as they continue, they should produce more outright strength and relative outperformance during September.

Market Sectors

On the other side of the spectrum, the biggest outflow of investor assets during the same one-week and one-month periods came from financials. This is why the sector has underperformed the market recently despite strong performance between June and early August. 

The recent exodus of investor assets from financials has been driven by the sharp decline in long-term U.S. interest rates since late July amid a flattening yield curve, both of which have adversely affected profitability in lending.

Investor Fear May Lead To Opportunity

Considering market conditions during the past two weeks, I can't think of a better chart to kick off this week's report than this one of the Volatility S&P 500 (VIX) going back almost six years. 

VIX

The highlights in the chart show that the VIX has only spiked up through the 48 level three times during this period: May 2010, August 2011 and last week. The first two instances closely coincided with what were arguably the two most important bottoms in the S&P 500 in the past half decade.

However, in 2010, the bottom came five weeks later and 4.3% lower than the initial index lows while the VIX was breaching 48. In 2011, it came eight weeks later and 4% lower.

In short, this metric suggests the broader market is probably within a month or so of another similarly important bottom and warns we could still see lower lows first.

Watch Dow Industrials For Clues

The next chart of the bellwether Dow Jones Industrial Average will help us determine exactly if and when this emerging stock market bottom is in place. There is a lot of information on this chart, so we'll go through the key index levels one by one.

The support at the Dow's 2009 major uptrend line was temporarily broken last week before the average stopped on a dime at 15,370, 16% off the May highs and just above the February 2014 low at 15,341. It then rebounded back above the 2009 trendline by the close on Friday.

Dow Jones

It was a nice recovery, but the breaking of a six-year trend is still a negative and warns of more upcoming weakness, as does the death cross that occurred over the past week when the Dow's 50-day moving average declined below the 200-day.

The key level to watch is 17,215 to 17,786, which represent the 61.8% Fibonacci retracement of the May-to-August decline and the 200-day moving average, respectively. It would take a sustained rise in the Dow above these levels to help confirm that the worst is over and suggest that a retest of the May highs is imminent. Until then, the Dow looks vulnerable to more near-term weakness, which could be triggered by it slipping back below its 2009 trendline at 16,475.

Putting It All Together 

Unless stocks are entering into a bear market -- which frankly I cannot see right now due to a number of economic factors including solid jobs data and a significant improvement in the housing sector this year -- the market appears to be within a month or so of an intermediate-term bottom that should precede a rally into year end. 

Meanwhile, the latest data shows investor assets are moving back into the energy sector, which is at least near-term positive for both energy-related assets and crude oil prices. A recovery in this economically sensitive sector would also support an emerging stock market recovery.

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This article was originally published on ProfitableTrading.com: Don't Bet on a Bottom in Stocks Just Yet

 

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.