THE S&P 500 AND THE CRB INDEX APPEAR TO BE FORMING HEAD AND SHOULDERS BOTTOMS -- A PULLBACK INTO A RIGHT SHOULDER COULD START DURING MAY -- THE NASDAQ COMPOSITE INDEX TESTS ITS 200-DAY LINE
FIRST THE S&P 500... On Friday April 17, I wrote about the possibility that the S&P 500 could be forming a "head and shoulders" bottom. I based that bullish view on the shape of its pattern since last November. Chart 1 shows the potential bottoming pattern since then. A "head and shoulders" bottom has three major troughs -- a head surrounded by two shoulders with the head the lowest one. Chart 1 shows the March low falling below the November low. That was accompanied by numerous positive divergences that we've written about in previous messages. That raises the likelihood that the November low is a "left shoulder" and the March low a "head". The ensuing rally from the March low (head) should approach the January (but shouldn't exceed it). The flat line over that peak is a potential "neckine". [The exact neckline should be drawn over the January peak and the highest level of the current rebound]. Once the current rebound runs its course, a "right shoulder" should ensue which could take form of a correction of the March/May advance or a period of sideways consolidation. Once the right shoulder is complete, an eventual upside breakout through the neckline would signal a major bottom. Although the current upturn is somewhat over-extended, there's so convincing sign of a top yet. The fact that we've entered the month of May, however, is of some concern.
Chart 1
A MAY PEAK?... On April 3, I mentioned the possibility of a May peak (near the January high) in the S&P 500 as part of a bottoming process. That time target was based on two factors. One is seasonal. After a traditionally strong April, the market has a history of forming peaks during May (hence the expression "sell in May and go away"). Another reason for some caution entering May is the tendency toward symmetry in head and shoulders bottoms. As I pointed out at the start of April, the length of a rally often corresponds to the length of the previous downturn. The decline from early January to early March lasted eight weeks (two months). That would put a potential time target for a peak to form in early May. Two other lines worth watching on Chart 1 are the moving averages. Here's a possible scencario worth keeping in mind. The falling 200-day average (red line) represents a major resistance barrier. It's doubtful that the S&P will exceed that line during the current rally. Any subsequent correction (right shoulder) could pull back to a rising 50-day average (blue line). That could represent a major buying opportunity -- as right shoulders usually do.
Chart 2
20-DAY TREND IS STILL UP... As Arthur Hill has pointed out many times, a market can continue to rally in the face of a short-term overbought condition. In fact, that's usually a sign of strength. At such times, it's nice to have some trigger to signal when a rally has ended. One simple trigger is a break of the 20-day moving average shown in Chart 2 (which is part of the Bollinger bands that I wrote about recently). A close below that line (currently at 852) is needed to signal that the current rally is turning lower. As long as the S&P price remains above that support line, however, the current uptrend remains intact. That is the case at present.
HEAD AND SHOULDERS COMMODITY BOTTOM? ... The possibility that the S&P 500 is forming a head and shoulders bottom is supported by a similar pattern in commodities. Chart 3 shows the CRB Index having formed a possible "left shoulder" in December and a "head" in late March (not unlike the S&P 500 below the CRB chart). The 50-day average for the CRB Index has gone from being resistance over the market to support below it. Since commodity markets have been highly correlated to stocks since last summer, and since both are rallying on hopes for an economic rebound, it makes sense that both should have similar basing patterns. The bottom line in Chart 3 shows a close correlation between troughs in the Euro and the other two markets. That's potentially bad news for the dollar.
Chart 3
DOLLAR PEAK?... Another good sign for the S&P 500 and commodity markets is continued signs of topping in the U.S. dollar. In fact, the chart of the Dollar Index since last autumn is nearly a mirror image of the CRB and S&P 500 indexes (see chart 4). The November and March peaks in the Dollar Index (down arrows) correspond roughly with similar troughs in the other two markets. The UUP failed a recent test of its 50-day average (blue line) and is nearing a test of its 200-day average (red line). If recent correlations continue, further weakness in the dollar should be good news for stocks and commodities. That would also be good news for most foreign currencies and foreign stocks tied to commodities.
Chart 4
NASDAQ TESTS 200-DAY LINE... One of the problems with doing an analysis of the "stock market" is choosing which market index to represent it. Like most analysts, I rely on the S&P 500 which is generally viewed as the market benchmark. As we've pointed out several times, however, some parts of the market have been rallying much stronger than others. One of those groups is technology which is heavily represented in the Nasdaq market. Generally speaking, relative strength by technology and the Nasdaq are good signs for the rest of market. And the fact that the Nasdaq Composite has already exceeded its January high is a definite sign of leadership. However, the Nasdaq is undergoing another test of its uptrend. Chart 5 shows the Nasdaq Composite Index testing its 200-day moving average near 1750. It's a good idea to keep an eye on that test. It's also a good idea to watch the rising 20-day average (green line). The Nasdaq needs to stay above that rising support line to keep its uptrend intact.
Chart 5
