STOCKS SURGE AROUND THE WORLD -- A POSSIBLE SMALL HEAD AND SHOULDERS IN THE S&P 500 -- EURO AND EURO STOXX BOUNCE -- GOLD AND BONDS FALL AS STOCKS RISE -- VOLATILITY INDICES HOLD THEIR MAY BREAKOUTS

STOCKS SURGE AROUND THE WORLD... John Murphy is off today and will return next week. Stock markets around the world moved higher on Thursday. Indices in Japan, Taiwan and Australia got it started with 1+ percent gains. This carried over to Europe where French, German, and Dutch indices also gained over 1 percent on the day. Strength carried to the US with the major US indices surging over 1% in early trading. Chart 1 shows the S&P 500 ETF (SPY) getting yet another bounce of the May-June lows. A gap off support is impressive. However, it only becomes really impressive if/when we see a strong close on good volume and breadth. At the very least, SPY needs to close above 109 and near the high of the day. As noted before, a complete trend reversal is dependent on a break above resistance at 111. RSI remains with its small bullish divergence. A break above 50 is needed to turn this momentum indicator bullish again.

(click to view a live version of this chart)
Chart 1

A POSSIBLE HEAD-AND-SHOULDERS IN THE S&P 500 ... A failure to hold todays gains and another downturn from current levels would open the door to a head-and-shoulders pattern on the 5-min chart. I do not normally use such short-term timeframes, but it is necessary to show the pattern working over the last three weeks. First, chart 2 shows the S&P 500 declining sharply in May and establishing support in the 1045-1055 area with bounces in late May. With the prior move down, this makes the head-and-shoulders a continuation pattern. Yes, it is possible to have a continuation head-and-shoulders pattern. The highs above 1100 formed a double head and then there was another bounce off support in the 1045-1055 area. This is the bounce that needs to hold. Failure to hold this weeks bounce and a move below the neckline support zone would signal a continuation lower. Based on traditional technical analysis, the downside target would be to around 985. The height of the pattern (~60 points) is subtracted from the neckline break (1045) for a target. Also notice that the right half of the pattern looks like a rising wedge. No worries for the bulls as long as this wedge rises. A move below Wednesdays low would break wedge support.

(click to view a live version of this chart)
Chart 2

EURO AND EURO STOXX BOUNCE... Strength in global markets was helped with a bouncing Euro. Chart 3 shows the Euro ETF (FXE) advancing three days in a row (so far). The Euro was clearly oversold throughout May-June and due for a bounce. Due for a bounce and getting a bounce are clearly two different things. This is a case of becoming oversold and remaining oversold. At this point, the three day bounce does not look like the start of a trend change, just an oversold bounce. First resistance is around 125. Second resistance is in the low 30s.

(click to view a live version of this chart)
Chart 3

Strength in Asia and the Euro provided a lift for European stocks. Chart 4 shows the Euro Stoxx 50 SPDR (FEZ) surging over 4% today. Astute readers may notice that this chart differs from the Euro Stoxx 50 index ($STOX50), which was shown on Wednesday and which is shown in the first indicator window. FEZ broke down in January, along with the Euro. $STOX50 held up much longer and even hit a higher high in April. This is another good example of an ETF not exactly tracking the underlying index. First, an ETF is not an exact copy of the index. Second, ETFs have associated fees. Third, ETFs require regular rebalancing. Fourth, Dollar ETFs based on foreign indices have exchange rate risk. The bottom indicator window shows the Euro Stoxx 50 index divided by the US Dollar Index. This chart looks much closer to the Euro Stoxx 50 SPDR (FEZ) chart. FEZ advances more than the Euro Stoxx 50 Index when the US Dollar falls. FEZ falls more than the Euro Stoxx 50 Index when the US Dollar rises.

(click to view a live version of this chart)
Chart 4

GOLD AND BONDS FALL AS STOCKS RISE... Strength in stocks and the Euro is weighing on bonds and gold. However, weakness in bonds and gold is not as prevalent as strength in stocks today. Chart 5 shows the Gold ETF (GLD) falling modestly in early trading on Thursday. The ETF is meeting resistance around 122 from the May high, but the overall trend remains up. Perhaps GLD is just correcting some after the big two day surge (Friday-Monday). Chart 6 shows the 20+ Year Treasury ETF (TLT) with a modest decline early Thursday. As noted earlier this week, TLT has resistance around 99, but the overall trend remains up. Bonds are benefitting from a flight to safety and weakness in commodities. The indicator window shows TLT with the DB Commodity Index Tracking ETF (DBC). Notice how these two move opposite one another.

(click to view a live version of this chart)
Chart 5

(click to view a live version of this chart)
Chart 6

VOLATILITY INDICES HOLD THEIR BREAKOUTS... The S&P 500 Volatility Index ($VIX) and Nasdaq 100 Volatility Index ($VXN) broke resistance with big surges in early May. These breakouts came after extended downtrends from October 2008 to April 2010. There are two ways (at least) to use these volatility indices. First, the overall trend acts as a coincident indicator for the stock market. Second, extremes can foreshadow medium-term turning points. Lets look at the overall trend first. Chart 7 shows VIX over the last two years. The indicator peaked in October 2008 and broke support with a sharp decline in December 2008. After a consolidation in early 2009, the indicator broke triangle support to continue its downtrend. Even though the VIX peaked in October 2010 and the S&P 500 bottomed in March 2009 (5-6 months later), the triangle break in the VIX in late March coincided with a surge and new uptrend in stocks. The S&P 500 trended higher as volatility trended lower the next 11 months. In regards to the big trend, the VIX can be considered a coincident indicator. An uptrend in volatility is generally bearish for stocks. A downtrend in volatility is generally bullish. Volatility is important for many fund managers because it helps define risk. Some fund managers have volatility thresholds that prevent them from investing in securities that are deemed too volatile (risky). Some managers may be priced out of the stock market should it become too volatile, as was the case in September 2008.

(click to view a live version of this chart)
Chart 7

(click to view a live version of this chart)
Chart 8

Chart 8 shows the Nasdaq 100 Volatility Index with a pattern similar to the VIX. Nasdaq 100 volatility used to be higher than S&P 500 volatility (pre 2008). That changed with the meltdown in financial stocks. Now, VIX and VXN are just about equal. VXN also peaked ahead of the Nasdaq 100, but the triangle break in March 2009 coincided with a breakout and new uptrend in the Nasdaq 100. As with the VIX, VXN surged in May to reverse this downtrend and start a new uptrend in volatility. Notice that 30% turned from resistance to support for both volatility indices. Also notice that the breakout at 30% is holding. This is an important level. The bears maintain their edge as long as both hold above these support zones (call it 29%). A move back below 29% would show falling volatility and this would be positive for stocks. Remember that the volatility indices are mostly coincident indicators when used in this manner. As such a support break in volatility would likely translate into a resistance break in the major stock indices. Tomorrow I will show how to normalize the volatility indices to measure bullish and bearish extremes.