CHANNEL SURFING WITH THE S&P 500 -- USING CCI TO TRADE THE TREND -- MARKET INTERNALS CONFIRM UNDERLYING STRENGTH -- HIGH-LOW LINE CAPTURES SMOOTH UPTREND -- XLY AND XLI SUPPORT A STRONG STOCK MARKET -- FINANCE AND TECHNOLOGY SPDRS START OUTPERFORMING
CHANNEL SURFING WITH THE S&P 500... Link for today's video. The S&P 500 remains in a strong uptrend and is now nearing the upper trend line of a twenty-six month channel. First and foremost, there is no sign of a major top on this chart, or any other major index chart for that matter. The Dow, Nasdaq 100, S&P 500, S&P MidCap 400 and S&P SmallCap 600 all hit new highs in late December. Tops often take months to form and we have yet to see a lower peak, a double top or a head-and-shoulders top. The only potential negative is the short-term overbought condition. This however, is a relatively benign problem because overbought is actually a sign of strength. After all, it takes strong buying pressure to push indicators into overbought territory.
Chart 1 shows the S&P 500 getting a bit extended within this uptrend. First, the S&P 500 is up 10+ percent since early October (1650 to 1850). Second, the index is nearing the upper trend line of the rising channel, which suggests that the current upswing is getting long in tooth. Third, note that the S&P 500 has not seen a 10% correction since the second quarter of 2012. That does not mean we will get one in 2014, but the odds are certainly high that we will see a decent correction at some point this year. A 10% correction from the current high would take the index down to the 1665 area. Notice that the lower trend line of the rising channel hits this area in early April. Shorter-term, I would mark support in the 1775 area.
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Chart 1
The indicator window shows the Commodity Channel Index (CCI) moving above 100 at the end of December 2012 and remaining positive throughout 2013. This 12-month streak is the longest since the eighteen-month streak from January 1995 to June 1996. In other words, this strong uptrend could continue before we see a correction. At this point, I would simply abide by this long-term uptrend as long as CCI remains positive. A dip into negative territory would suggest that a correction is underway and this might provide a future buying opportunity.
USING CCI TO TRADE THE TREND... Trading in the direction of the bigger trend is a classic strategy. Chartists use a long timeframe to identify the trend. The trend defines the path of least resistance and the trading bias. Chartists can then use shorter timeframes to identify setups in harmony with that trend. As shown above, the rising channel and positive CCI define the long-term uptrend. This means we are only interested in bullish setups on a shorter timeframe. Chart 2 shows daily bars for the S&P 500 and the Commodity Channel Index (CCI). While weekly CCI stayed positive the entire year, daily CCI dipped below -100 at least nine times during the year. A move below -100 means CCI is oversold and some sort of correction is underway. Chartists should then be on guard for a potential resumption of the bigger uptrend. The green dotted lines show when CCI moved back into positive territory after an oversold reading. Eight of the nine signals worked well in 2013. As the chart now stands, CCI is near 100 and it is time to wait for the next pullback.
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Chart 2
MARKET INTERNALS CONFIRM UNDERLYING STRENGTH... The stock market also looks quite healthy because the AD Line, AD Volume Line and High-Low Line hit new highs in late December. Breadth indicators, which are known as market internals, tell us what is happening inside an index. In these examples, we are measuring the vital signs for the S&P 1500, an index that includes the S&P SmallCap 600, the S&P MidCap 400 and the S&P 500. Chart 3 shows the S&P 1500 AD Line ($SUPADP) breaking out just before Christmas and surging to a new high. Chart 4 shows the S&P 1500 AD Volume Line ($SUPUDP) with similar characteristics. At the very least, these new highs confirm the new highs in the S&P 500 and other major indices. I would be concerned if one or both failed to confirm and formed bearish divergences, but this is clearly not the case.
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Chart 3
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Chart 4
ONE BREADTH INDICATOR THAT CAPTURES A SMOOTH UPTREND... Chart 5 shows the High-Low Line moving to a new high as new highs expanded the last few weeks. Notice that this High-Low Line has been above its 10-day EMA since November 2012. It is a smooth indicator that captures the steadiness of the current uptrend. The bottom window shows S&P 1500 High-Low Percent ($SUPHLP) moving back above 20 percent last month. Chartists will now have to wait for a pullback to the zero line for the next opportunity.
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Chart 5
XLY AND XLI SUPPORT A STRONG STOCK MARKET... I am also not concerned with a major top because two key offensive sectors are leading the market and have yet to stumble. The Consumer Discretionary SPDR (XLY) and the Industrials SPDR (XLI) certainly did their part in 2013 as both showed relative strength throughout 2013 and ended the year at new highs. Chart 6 shows XLY within a large rising channel over the last twenty-six months. XLY moved to the upper trend line in early November and has hugged this trend line the last six weeks. The ETF may look frothy and ripe for a correction, but it is by no means weak. The indicator window shows the price relative (XLY:$SPX ratio) hitting a new high this week. Relative strength in XLY is very positive for the market going forward because the consumer discretionary sector is the most economically sensitive sector and has the highest correlation to the S&P 500. Relative weakness would be a concern and suggest that the economy was stumbling. There are no such signs right now.
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Chart 6
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Chart 7
Chart 7 shows the Industrials SPDR (XLI) outdoing XLY with a steep rising channel throughout 2013. The industrials sector produces capital goods used in the construction, manufacturing and services industries. Strength in this sector suggests that the output side of the economy is strong, which has been confirmed by strong numbers from the ISM Manufacturing Index over the last several months. XLI is currently at the upper trend line of this channel. Again, it may be overbought and ripe for a correction, but there is no topping pattern here and the ETF shows relative strength. The indicator window shows the price relative in a strong uptrend with a new high just last week.
FINANCE AND TECHNOLOGY SPDRS START OUTPERFORMING AGAIN... Even though the Finance SPDR (XLF) and the Technology SPDR (XLK) performed well in 2013, they did not start outperforming until late in the year. Chart 8 shows XLF breaking triangle resistance in early October and working its way to new highs the last two months. Overall, it is possible that a large rising channel is taking shape with key support marked in the 19 area. Note that the upper trend line extends into the mid 30s in 2014, which implies a massive move should this uptrend extend. It also means that XLF could finally exceed its 2007 high. The indicator window shows the price relative turning up the last two months and breaking the July trend line.
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Chart 8
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Chart 9
Chart 9 shows the Technology SPDR (XLK) within a rising channel the last thirteen months. With a big move from early October to late December, the ETF hit the upper trend line and stalled this week. As with the rest of the market, XLK is short-term overbought and ripe for a correction. However, any pullback would be viewed as a correction within a bigger uptrend. The lower trend line marks support in the 33 area as we head into 2014.
