SPRING RALLY ENDS AS S&P 500 FULFILLS INITIAL UPSIDE OBJECTIVES -- A SHORT-TERM HEAD AND SHOULDERS TOP COULD HELP COMPLETE A MAJOR HEAD AND SHOULDERS BOTTOM -- SECTOR ROTATION TURNS MORE DEFENSIVE
S&P 500 HAS FULFILLED UPSIDE OBJECTIVES FOR NOW ... If you've been reading our market messages over the past couple of weeks, you know that we've called for an end to the spring rally and the start of a normal corrective process. There are several reasons for that. One is simply that the S&P 500 (which is the main market benchmark) has fullfilled upside objectives that we wrote about in March. At the time, we wrote that an important bottom had been reached and expected a rally to the January high. Chart 1 shows that S&P 500 having reached that upside target (and even exceeding it by a small amount). The falling resistance line drawn over the highs of the last year is also acting as a resistance barrier. In addition, the S&P has retraced 38% of the price drop from last spring which was another upside objective mentioned in March. With all of those initial upside objectives having been met, and the presence of a number of short-term negative divergences that we've written about, a downside correction seemed likely. This week's selling served to confirm that negative "short-term " view.
Chart 1
A PATTERN WITHIN A PATTERN... Earlier in the spring, I wrote about the possibility of a major "head and shoulders" bottom forming in the S&P 500. I drew a potential "neckline" over the January high which appears to have stopped the spring rally. That sets the stage for the formation of a possible "right shoulder" as part of a bottoming process. I wrote last weekend that a retracement of 38% to 50% of the spring rally was a likely downside target for that correction. The green Fibonacci retracment lines in Chart 2 shows those potential support levels. (The 62% retracement line is just above the level of the "left shoulder" formed in November and can't be ruled out either). The smaller (pink) neckline drawn under the May/June lows highlights the smaller head and shoulders top that I've identified recently. A close below that smaller neckline (which appears likely) would turn the short-term trend lower. [The actual downside target from that smaller top measures to 820]. Since the spring rally lasted three months, a downside correction shouldn't exceed that amount. That puts the outer limit for another bottom sometime in September (which fits with a usual seasonal autumn bottom). So while the short-term picture has worsened, the longer-term view remains more positive. I suggested a couple of weeks ago that "short-term" traders take some profits. Longer-range investors should view a downside correction over the summer months as an opportunity to do some buying at lower levels.
Chart 2
DEFENSIVE ROTATIONS DURING JUNE... Another sign that investors have turned more negative over the last month is the rotation out of economically-sensitive groups (like consumer discretionary and energy stocks) and into defensive groups (like utilities, consumer staples, and healthcare). Chart 3 shows relative strength lines for those five groups (versus a flat S&P 500) since the start of June. The downturn in the Discretionary SPDR (XLY) performance in early June is consistent with views that retail spending is being held hostage by rising unemployment numbers (which were borne out yesterday). The downturn in energy (XLE) is consistent with weaker commodity prices owing to a strong U.S. Dollar. Three of June's best performers are defensive staples (XLP), healthcare (XLV), and utililities (XLU). All of those rotation shifts are consistent with a much-needed correction in a market that's risen too far too fast. While stocks and commodities fell together during June, money has moved back into Treasury bonds and the U.S. Dollar.
Chart 3
HAPPY A HAPPY AND SAFE FOURTH OF JULY ...
