The week ahead: Time to buckle up

Every high-flying market is bound to find patches of rough air, and the charts show a potential decline is in store. However, several plays should defy these trends.

By MoneyShow.com Jan 15, 2012 11:30PM

By Tom Aspray, MoneyShow.com


Even disappointing retail sales numbers and a pickup in unemployment claims couldn't stop the market from closing higher last Thursday.


However, market internals indicated that the market was struggling to move higher. Each day it seemed a bit weaker, until the sellers stepped in on Friday -- the potential of an S&P downgrade of France’s debt rating was the good reason to sell they were waiting for.

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Though the losses were not severe enough on Friday to confirm a top, the action does suggest that stocks are likely to be under pressure this week. This view is supported by the interest-rate markets, as yields dropped on Friday.


The chart of the 10-year T-Note Yield has completed the flag formation that I discussed in December.


The euro also came under additional pressure on Friday. The weekly uptrend was broken in September, and the close this week was well below the early 2011 lows. This is not a positive sign unless you are planning a European trip. A drop below $1.25 looks likely, with the next major support in the $1.20 area.


This decline comes despite the fact that the European Central Bank seemed encouraged by how well the Spanish and Italian bond auctions were received. Of course, there are quite a few more auctions in the coming months... and there are signs that investors are moving out of euro fixed-income markets, which helps to explain the declining yields of U.S. Treasuries.


Many of the emerging stock markets have rebounded nicely early this year, but the majority have still not completed their bottom formation. It will be important that some of these markets are able to break out to the upside in the next month or so.


Copper prices have moved higher, and are now in a strong seasonal period. Significantly higher prices would be a positive sign for the economy.
 
Last week’s economic reports were mixed, though the week ended with better-than-expected preliminary numbers on consumer sentiment. There is a heavy slate of earnings reports this week, including many of the large Dow stocks, most of the big banks, and tech giants like Google (GOOG), Microsoft (MSFT), and EBay (EBAY). This is likely to provide quite a test for the stock market.


With the U.S. markets closed Monday but overseas markets open, we could see some wild action in the stock index futures. The first report Tuesday is the Empire State Manufacturing Survey, followed Wednesday by the Producer Price Index, Industrial Production, and the Housing Market Index.


On Thursday the pace picks up, with consumer prices, housing starts, jobless claims, and the Philadelphia Fed Survey. There is more data on housing Friday, as we get the report on existing home sales.


WHAT TO WATCH 
As I noted earlier and discussed in more detail last Friday morning, the failure of the Advance/Decline lines to make new highs with prices last week was a concern.


The A/D lines have turned down, with last Friday’s action consistent with a further decline. The A/D lines now need to move above last week’s highs to signal a further rally.


How much of a drop could we expect? Probably 2% to 4% in the major averages, as there are many stocks that have charts that look much stronger than the indices. The major A/D lines that I follow have well identified levels of support, which if broken would signal a deeper decline.


The sentiment numbers edged up a bit last week, but are still well below extreme levels. Data suggests there is still plenty of money on the sidelines; hedge funds in particular have not participated.


From the seasonal analysis, a late January decline is generally a good buying opportunity.


S&P 500
The Spyder Trust (SPY) pushed 28 cents above the Oct. 27 high at $129.42 last Thursday. It then closed lower Friday, but was higher for the week.


There is next good support now at $127.20, with the rising 20-period exponential moving average (EMA) at $126.80. The more important support is at $124.73 to $125.


There is initial resistance now in the $129 area, and then at $129.70. The 127.2% Fibonacci retracement target is at $133.26.

Click to enlarge


Dow Industrials
The daily chart of the Spyder Diamonds Trust (DIA) shows the breakout above the downtrend from last summer’s highs (line a) and then Friday’s close back below it. DIA came fairly close to the 127.2% Fibonacci retracement target at $125.61.


Next support is just a bit lower at $122.40 to $122.60, with the daily uptrend (line b) and the lower Starc- band now in the $120 to $121 area. The key support is now at the Dec. 19 low of $117.05.


The daily relative performance, or RS analysis, has been declining since early December, while the weekly (not shown) shows no signs yet of a top.


The daily on-balance volume (OBV) is more of a concern, as it formed significantly lower highs (line d) last week. A drop through support (line e) would confirm the bearish divergence.


Russell 2000
The iShares Russell 2000 Index Fund (IWM) again tested the major 61.8% Fibonacci retracement resistance in the $77 area (line f) last week before turning lower.


The support at $73.20 to $73.30 needs to hold on a pullback, or the chart will look more negative and may suggest a test of the uptrend (line g) in the $71.70 area.


The daily RS line broke its uptrend (line h) in early January, then formed a lower high last week. It has now diverged from the price action.


The daily OBV needs to move through resistance (line i) to signal a breakout above the $77 level. There is important daily OBV support at line j.


Nasdaq-100
The PowerShares QQQ Trust (QQQ) lost some of its upside momentum last week, as it failed to move though strong resistance connecting the July and October highs at $58.90. This is still the key level of resistance to overcome.


The daily RS line is still in a short-term uptrend, suggesting it is acting stronger than the S&P 500.
The daily OBV is well above its rising WMA, which is a positive sign. 
 
QQQ has initial support now at $57.50 to $57.20, with much stronger levels at $55.60 to $56.40.


Sector Focus 
The iShares Dow Jones Transportation ETF (IYT) moved well above the October highs last week, but still has strong resistance in the $94.70 area. Initial support now sits at $88, with much stronger levels at $85.50 to $86.50.

Click to enlarge


This chart shows the striking percentage gains of three ETFs since the October lows with the SPDR S&P Homebuilders ETF (XHB) leading the way up over 47%. It was recommended in October.


This analysis was updated last week, and I also took a look at the second-best performer, which was the SPDR S&P Bank ETF (KBE), up over 28%. The Spyder Trust (SPY) has gained almost 17%.


I continue to think that sector selection will make the difference in 2012. If we get a deeper correction, I will be looking at some of the industrial stocks, as well as the regional banks.

Click to enlarge


Oil
The April crude oil contract failed to move above the prior week's highs of $104.10, hitting $103.80 before turning lower. Crude again may be leading the S&P 500; it closed the week lower and back below line a.


With Friday’s decline, prices are getting closer to the daily Starc- band. The major support (line b) is still in the $93.15 area.


The selling on the decline took the daily OBV below its WMA and the uptrend (line c). The weekly OBV (not shown) is also below its WMA, and did form a negative divergence at the recent highs.


This suggests that crude oil can decline further. The seasonal pattern is for crude to bottom in February, so a deeper drop could be a good buying opportunity in the oil stocks.


Precious Metals
SPDR Gold Trust (GLD) was lower on Friday, but still closed the week higher. The next support sits in the $157 area, and then at $152 to $154. The prior low follows at $148.27, with the lower trend line support at $147 (line e).


The daily flag formation (lines d and e) is still intact, and a decisive close above $166 will complete the formation. The upside Fibonacci targets are at $193.


The daily OBV is still above its WMA, but has not moved through resistance (line f). A break in this downtrend would be very positive and indicate that the correction is over. However, I still can not rule out one more drop below the recent lows before a bottom is completed.


The iShares Silver Trust (SLV) is still in its short-term downtrend, and shows no evidence yet of a bottom. While GLD was rallying, the action in SLV was not all that impressive.


The Week Ahead 
Given the short holiday week, the unknown impact of the downgrade of France’s credit rating and the massive number of earnings reports should make this week interesting.


The tone of the overseas markets on Monday is likely to set the tone for Tuesday’s US trading. A close in the German Dax below the 6,000 level would clearly be a short-term negative.


If the correction proceeds as expected, it should be a good opportunity for those underinvested in the stock market to look at some of the high-yielding Dow stocks that I have previously mentioned.
 
A further stock correction should also create a good buying opportunity in the SPDR Gold Trust (GLD), and I will be updating my analysis on the in my regular Charts in Play column.


If you have some nice profits on your stocks or ETFs, be sure to adjust your stops to lock in a profit in case the decline is worse than I expect.


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