STOCKS MOVE SHARPLY LOWER TO AFFIRM RESISTANCE ZONES -- BREADTH INDICATORS REMAIN BEARISH OVERALL -- RISING EURO WEIGHS ON GOLD -- GOLD BREAKS WEDGE SUPPORT -- VOLATILITY INDICES TEST IMPORTANT SUPPORT ZONES
STOCKS MOVE SHARPLY LOWER TO AFFIRM RESISTANCE ZONES... Link for todays video. After an eight week advance that pushed the S&P 500 up over 7%, stocks moved sharply lower in early trading on Friday. The day is still young, but the S&P 500 is down almost 2% and the Russell 2000 down over 2%. Gold and oil are following the stock market higher. Bonds are higher and the Dollar bounced after a weak open. Chart 1 shows the S&P 500 ETF (SPY) stalling around 110 the prior three days and then forming a long red candlestick early Friday. The resistance zone around 110-113 stems from the June-July highs and the trendline extending down from the April high. The indicator window shows RSI moving back below 50 in early trading. As noted before, the 40-50 zone acts as resistance in a downtrend. Notice how this zone held in early May and mid June.
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Chart 1
Chart 2 shows the Russell 2000 ETF (IWM) stalling just below the upper trendline of a falling wedge. The advance back to 64 retraced 62% of the prior decline and fell well short of the 67-68 resistance zone. With SPY hitting the lower edge of its corresponding resistance zone, we can assume that small-caps show relative weakness by falling short. Relative weakness is also confirmed with the price relative in the indicator window. The IWM:SPY ratio peaked in mid May and has been trending lower the last two months. Turning back to the IWM price chart, a resistance area has not been established around 64-65 with this weeks high and the wedge trendline. A recovery and break above 65 would call for a reassessment of the current downtrend.
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Chart 2
BREADTH INDICATORS REMAIN BEARISH OVERALL... The next two charts show the AD Line, AD Volume Line and Net New Highs for the Nasdaq and NYSE. These breadth indicators gauge underlying strength or weakness in the broader market. Chart 3 shows the NYSE AD Line holding up quite well over the last six weeks. Notice how the AD Line held the May-June lows and bounced towards resistance. A break above the June high would turn this indicator from bearish to bullish. The AD Line favors small-caps and mid-caps because an advance counts at +1 and a decline counts as -1, regardless of market capitalization or volume. There are many more small and mid-caps than large-caps. Net New Highs for the NYSE were positive the entire week, but did not break above the red resistance line (May-June highs). Again, watch for a surge above 100 in NYSE Net New Highs to forge a breakout. Overall, these breadth indicators are still bearish.
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Chart 3
Chart 4 shows the same indicators for the Nasdaq. The AD Line and AD Volume Line are both trending lower. Both forged lower lows in early July and remain below their June highs. Net New Highs edged into positive territory earlier this week, but just barely. Net New Highs did not exceed their June high and did not even come close to the May high. Nasdaq breadth also remains bearish overall.
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Chart 4
RISING EURO WEIGHS ON GOLD... Gold and the Euro were negatively correlated from mid March until early June. Chart 5 shows the Euro ETF (FXE) in red and the Gold ETF (GLD) in black. Notice how gold surged as the Euro fell from mid March until early June. Gold ignored initial strength in the Euro the first part of June, but continued strength in the Euro may be taking its toll on gold, which is the only alternative to paper currencies. Fears surrounding the Euro pushed money into the Dollar and gold. Money moved out of the Dollar as fear subsided, but the exit from gold was delayed. Gold is now underperforming the Euro. The indicator window shows the GLD:FXE ratio peaking in early June and moving lower in July. This means gold priced in Euros is declining.
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Chart 5
GOLD BREAKS WEDGE SUPPORT... Chart 6 shows the Gold ETF moving sharply lower in early July and then bouncing with a rising wedge the last seven days. This small rising wedge or possible flag looks like a short-term bearish consolidation. Todays break below wedge/flag support signals a continuation lower and targets a move towards the next support zone around 114. Notice that broken support around 119.5 turns into the first resistance level to watch. Further weakness in stocks AND a decline in the Euro would be positive for gold and we might then see GLD hold above support. Chart 7 shows the Gold Miners ETF (GDX) hitting resistance just above 51 with a large black candlestick this week. A break below the trendline extending up from late February would target a move towards the next support zone around 46-47.
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Chart 6
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Chart 7
VOLATILITY INDICES TEST IMPORTANT SUPPORT ZONES... The S&P 500 Volatility Index ($VIX) and the Nasdaq 100 Volatility Index ($VXN) are also at their moments-of-truth. With the stock market surge the last eight days, both volatility indices fell sharply to test support from the June lows. These indices are getting a bounce as stocks move lower on Friday. Even though volatility is largely a coincident indicator, the overall direction can confirm or refute a market view. An uptrend in volatility is negative for stocks because it shows increasing fear. A downtrend is positive for stocks because it shows increasing confidence. As the charts stand, it looks like we still have an uptrend in volatility. To filter out some of the noise, these charts focus on the 5-day EMA (red line). Chart 8 shows the 5-day EMA of the VIX breaking resistance with a surge in May and then establishing support around 25 with a bounce in late June. Notice that broken resistance turns into support. After a lower high in early July, the indicator is once again testing support around 25. The breakout is holding so far. A 5-day EMA break below this support zone would call for a reassessment of the uptrend. Chart 9 shows the Nasdaq 100 Volatility Index ($VXN) with similar characteristics.
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Chart 8
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Chart 9
ELLIOTT WAVE COUNT SHOWS THE S&P 500 IN WAVE 4 ... And now some food for analytical thought... Elliott Wave is not concerned with support breaks, head-and-shoulders patterns or many other aspects of traditional technical analysis. Instead, Elliott Wave analysis counts current waves and then extrapolates into the future with the remaining wave count. Bob Prechter of Elliott Wave international is quite bearish, but I am sure there are some bullish Elliotticians out there. Just like economist, we all look at the same data and arrive at different conclusions. No wonder the market is so fickle.
Chart 10 shows the S&P 500 with a potentially bullish wave count, but the trend since late April remains down. First, the wave count suggests that we are currently in Wave 4 of a five wave advance. Second, Wave 4 is still a work in progress because the trend since late April remains down. This current downtrend is the most important point to keep in mind. Third, Wave 4 retraced 50-62% of Wave 3 with a falling wedge. Both the size of the retracement and the pattern are typical for pullbacks. The only thing missing is a break above the June high. This chart shows the S&P 500 as a 5-day EMA, which smooths the volatility of the last two months. Should the 5-day EMA move above its June high, we should entertain the possibility of an advance to new highs. Barring such an advance, the trend since late April remains down and I would expect further weakness until proven otherwise with a reversal/breakout.
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Chart 10
The indicator window shows the Percentage Price Oscillator (5,63,1). The first exponential moving average is 5 days (one week) and the second is 63 days (one quarter). The signal line is set at 1 to hide it. The last two dips ended when this oscillator moved back into positive territory (July 2009 and February 2010). Another move into positive territory would be, well, positive for stock market momentum. This would require follow through to the advance over the last two weeks.
AN ALTERNATIVE ABC CORRECTION AND SUMMER RALLY... There is, of course, an alternative count to consider. The ability to consider alternatives is critical to analysis and trading. Once an opinion is formed, focus turns on what might prove this opinion wrong. Looking at alternatives prepares us for the unexpected. The surge over the last eight days was quite impressive, even if volume was relatively low. However, keep in mind that volume should be low during the summer and Wall Street is known for its summer rallies. Must be the cool aid. Chart 11 shows an alternative count that forecast a summer rally as ABC correction. First, the S&P 500 completed a 5-wave sequence with the advance from March 2009 to April 2010. Second, the decline from April to July formed Wave A, which is the start of an ABC correction. Third, a Wave B rally would be forecast to retrace 50-62% of Wave A and exceed the June high. Third, Wave C would then decline below the low of Wave A. The Wave B breakout would be a bull trap that precedes the Wave C decline. Talk about brutal. Overall, the ABC correction is forecast to retrace 50-62% of the entire March-April advance and end in October.
