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Tough Headwinds for the Equity Markets

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Watch the action this week for some of the clues that will ultimately determine the health of the market and sustainability of the current advance.

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Minyanville is proud to welcome our newest professor, Cody Tafel, into the community. Cody Tafel is a trader for a Richmond, VA based registered investment advisor. He has also worked for Rapidan Capital LLC as Director of trading and was Head Trader at for a long/short equity hedge fund. Please join us in welcoming Cody to the 'Ville.


First and foremost I would like to thank everyone at Minyanville for giving me the opportunity to contribute to such a wonderful community. It's not every day you get a chance to write about a true passion and share it with others who feel the same way about their work.

The equity markets have continued to defy gravity during this rally off the early March lows.

After the swift correction in late February, the indexes have managed to grind higher over the past month, led by the S&P 500 (1468), now seven points above the recent peak and new 52 week highs. The Dow Industrials (12,720) are 75 points below the February peak and the Nasdaq Composite (2518) is 13 points below its 52 week high. These recent highs will be key levels to watch in the coming weeks as the bulls want to see confirmation and a breakout closing above these levels, while the bears will be looking for the market to roll over here and fail. Many bears will have their stops set near these highs, and the bulls will certainly be gunning to take them out, so it will be important to watch the reaction of the market near these levels.

Closing above new highs for several days would be a significant victory for the bulls. An immediate move lower early this week, or a failed breakout (trading above the levels and then reversing back below quickly) would embolden the bears to press their bets. It will also be important to watch for any signs of negative divergence. This occurs when several indexes make new highs, but are not confirmed by an additional index underperforming and remaining below the key breakout levels. Monday's action has left us with evidence this might be occurring with the S&P 500 at new highs, but unconfirmed as the Dow Industrials and Nasdaq are still below their respective breakout levels. See the below chart of the S&P 500 breakout. Keep a very close eye on these breakout levels this week!



There are two groups I think are telling in the quality of this advance off the March low. First I think it is important to emphasize the underperformance of the financials. Typically it is hard for the market to rally without the financials' support as they are a large percentage of the broader S&P 500 index. A good example of this underperformance can be seen in the below chart of the BKX (KBW Banking Index). Notice how this index is still holding below the 50 day moving average, and is 4.79% below the recent February peak. We need to see the financials start to pick up some slack if the market is going to continue higher.



Secondly, energy has led to the upside during this market rally off the early March lows. This group has become a much larger percentage of the broad market S&P 500 than it used to be three or four years ago. Gasoline, oil, and natural gas have all rallied strongly off their January lows. Of course some of this strength can be attributed to the recent tensions in the Middle East, but if it continues consumers will certainly feel the impact. The below chart of the OSX (Oil Service Index) shows just how strong this group has been recently, and this index is now up almost 14.9% for the year.



Another market that we need to keep our eye on here is gold. Always a good proxy for inflation fears, continued strength in gold is a clear sign that the Fed won't be able to bail out the weakening housing market by lowering rates because they are more concerned about higher inflation. This strength in gold is also a result of central banks attempting to diversify their reserves away from US dollar holdings. Gold is in a clear uptrend, and as you can see in the below chart, gold has broken out to the upside of a bullish pennant formation suggesting continued higher prices.



As gold has continued higher, the dollar index (a basket of currencies measured against the dollar) broke to new two year lows last week, and is not far from all time lows against many currencies. This is another reason the Fed is in a tough position right now. They can't lower rates because that would make the US dollar less attractive to foreign investors, and it is already in distribution as you can see by the below downtrend in the US dollar index.



As you can see there is technical evidence the equity markets have some tough headwinds in the near future. However, unless we move immediately lower due to this short term negative divergence I think the benefit of doubt must be given to the bulls, and we might see the Dow Industrials and Nasdaq follow the S&P 500 to new highs. Watch the action this week for some of the clues I mentioned above that will ultimately determine the health of the market and sustainability of the current advance. I look forward to sharing my thoughts going forward with you soon! Happy Trading!
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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