IWM AND MDY CHALLENGE NECKLINE RESISTANCE -- SPY BOUNCES ON LOW SEASONAL VOLUME -- DEFENSIVE SECTORS ARE TRADING ABOVE OCTOBER HIGHS -- OFFENSIVE SECTORS SHOW RELATIVE WEAKNESS ON CHARTS -- HAPPY NEW YEAR!
IWM AND MDY CHALLENGE NECKLINE RESISTANCE... Link for todays video. Going into 2012, some of the major index ETFs are at important make-or-break levels. These major index ETFs include the Dow Industrials SPDR (DIA), S&P 500 ETF (SPY), Nasdaq 100 ETF (QQQ), the Russell 2000 ETF (IWM) and the S&P MidCap 400 SPDR (MDY). These five represent large-caps, large techs, small-caps and mid-caps. Considered in Dow Theory terms, breakouts and higher highs in three of the five would be most bullish for the stock market as a whole. In other words, a simple majority is needed to confirm a bullish breakout. At one end of the spectrum, DIA has already broken above its October highs and is the strongest of the five. At the other end, QQQ remains well below its October high and is the weakest. The other three ETFs (IWM, MDY, SPY) formed inverse head-and-shoulders patterns over the last two months. Moreover, all three ETFs are poised for a resistance challenge as we head into 2012.
Chart 1 shows IWM advancing back towards its resistance zone with the move above 74. Resistance in the 76 area stems from the October-December highs and the 200-day SMA. After the October surge, IWM moved into a sideways consolidation that looks like a continuation inverse head-and-shoulders pattern. Theres a mouthful. Inverse means the pattern is upside down. Continuation means the pattern formed after an advance. The left shoulder formed in early November, the head in late November and the right shoulder in mid December. A break above the resistance zone would confirm this pattern and signal a continuation of the October surge. Such a breakout would target a move to the summer highs. With the late December bounce, the mid December lows now mark key support in the 70 area. Failure at resistance and a break below this level would be bearish.
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Chart 1
The indicator window shows the Price Relative with a similar pattern. The IWM:SPY ratio surged in October and then traded flat the last two months. Small-caps (IWM) were outperforming large-caps (SPY) in October, but performance flattened in November-December. A break above the November-December highs would signal renewed relative strength from small-caps and this would be bullish for the market overall. Chart 2 shows MDY with a similar pattern. Notice, however, that MDY fell short of its early December high and the Price Relative has been trending lower since early November.
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Chart 2
SPY BOUNCES ON LOW SEASONAL VOLUME... Traditional technical analysis teaches us that volume is an important part of the inverse head-and-shoulders pattern. Ideally, volume should expand with the advances off the head low and the right shoulder low. Chart 3 shows SPY with volume in the first indicator window and the Percentage Volume Oscillator (1,250,1) in the second window. PVO (1,250,1) measures the 1-period EMA of volume as a percentage of the 250-period EMA. A 1-day EMA is the closing value for volume and the 250-day EMA covers the past year. Volume is above average when the PVO is positive and below Average when negative. As the PVO shows, volume was mostly above average until November. There was one spike during the late November surge (green arrow), but volume retreated afterwards and has been inspiring throughout December.
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Chart 3
Volume, however, is supposed to be low in late November and late December. That makes volume analysis tricky at this stage. Volume is also supposed to be low in August and late summer. However, we have seen rallies begin with low volume surges and continue for many months. Chart 4 shows the July 2009 surge occurring with below average volume and SPY continuing higher into March 2010. Chart 5 shows SPY breaking resistance with a low volume surge in September 2010 and continuing higher into 2011. Also notice that volume was low from mid December 2010 until mid February 2011. Even though low volume may have undermined the rally, SPY still advanced from 115 to 130 before forming a top. The moral of the story? Volume may be an important indicator, but price action trumps volume any day of the week. Dont forget that the markets can remain irrational a lot longer than we can remain solvent. A traders P&L is based on price movement, not the volume behind the price movement. With this in mind, I will keep volume in mind and watch key support or resistance levels for action.
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Chart 4
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Chart 5
DEFENSIVE SECTORS ARE TRADING ABOVE OCTOBER HIGHS... The three defensive sectors show relative strength by holding their December breakouts. The nine sector SPDRs can be broken down into three groups: offensive, defensive and raw materials. The offensive sectors are finance, consumer discretionary, technology and industrials. The defensive sectors are consumer staples, healthcare and utilities. The raw materials sectors are energy and materials. Relative strength in the offensive sectors is generally bullish for the stock market. This suggests an appetite for risk and optimistic economic outlook. Relative strength in the defensive sectors is generally bearish because this indicates risk-aversion and a pessimistic economic outlook. At this point in time, the three defensive sectors have stronger charts than the four offensive sectors. In particular, the October highs mark a line in the sand for these charts. Securities trading above their October highs show relative strength, while securities trading below their October highs show relative weakness. Chart 6 shows the Consumer Staples SPDR (XLP) breaking resistance in October and again in late November. Chart 7 shows the Healthcare SPDR (XLV) breaking flag resistance and its October high this month. Chart 8 shows the Utilities SPDR (XLU) breaking resistance and recording another 52-week high in late December.
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Chart 6
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Chart 7
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Chart 8
OFFENSIVE SECTORS SHOW RELATIVE WEAKNESS ON CHARTS... The four offensive sectors bounced along with the rest of the market in late December, but all four remain short of breakouts. This explains why the major index ETFs have yet to break resistance from the inverse head-and-shoulders patterns mentioned above. Chart 9 shows the Consumer Discretionary SPDR (XLY) bouncing towards resistance from the October-December highs. Chart 10 shows the Finance SPDR (XLF) breaking flag resistance with the late December surge, but remaining below the early December high and well below the late October high. Chart 11 shows the Industrials SPDR (XLI) hitting resistance from the October-December highs. XLI is the closest to a breakout. Chart 12 shows the Technology SPDR (XLK) falling well short of its early December high and showing some serious relative weakness the last two months. The major index ETFs could use a little help from these offensive sectors in early 2012. A failure at resistance and break below the mid December lows would be most bearish for these sectors and the market as a whole.
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Chart 9
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Chart 10
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Chart 11
