Despite a solid late-week bounce, the charts and sentiment numbers really don't support another rally at this point, says MoneyShow's Tom Aspray. He shares the key levels he's watching that could predict a deeper correction, and suggests a few plays to concentrate on once the fog clears.
Stocks rebounded late in the week, but only after the averages broke a few levels of support that many thought would hold.
The indexes did close the week higher, and well above the worst levels, as the S&P 500 did break under the 1,600 mark during the week. The Dow also had its best day since the first of the year.
The market did get quite oversold by Wednesday's close. The McClellan oscillator dropped to -311, which was its lowest reading since November 23, 2011. It was my analysis then that we were near a short-term low, but still thought it would take another drop before the correction was over.
Just like then, a break of last week's lows is still possible. This is based on technical analysis, as well as the length and power of the rally so far in 2013. The Spyder Trust (SPY) was down over 5% from the May high to last Thursday's low, but the drop so far has only lasted ten days, and a three- or four-week correction would be more typical.
The huge reversal in the Japanese markets over the past two weeks has certainly gotten the world's attention. The Nikkei-225 futures were up over 47% for the year on May 22, but by Thursday's close had corrected to just +16%.
This has corresponded with weakness in the yen. Yen futures had dropped over 16% before rebounding, but are now only down 11% for the year.
Japan ETFs have been hit hard; the iShares MSCI Japan Index Fund (EWJ) has retraced over 50% of its rally from the 2012 lows. This is also the case for the Wisdom Tree Japan Hedged Equity (DXJ), which peaked at $53.50 and hit a low last week of $42.
The latter is my favored play for investing in Japan...and I think that this is just a correction. I expect the Nikkei-225 to resume its uptrend and the yen to fall considerably more over the intermediate term.
The reversal in the Japanese markets and the correction in other global markets was based in part on fears that the Fed would stop its accommodative policy as rates have moved higher.
Last week, I noted that T-Bond yields had completed a reverse H&S bottom formation, which projects even higher yields, but that does not require a change in Fed policy. This has put additional pressure on bondholders, who get more worried as there are signs of economic improvement.
As the chart shows, the total return from investment-grade corporate bonds has dropped from 2% in early May to -1% now. With yields expected to move even higher, bond prices have further to fall, and will reach a point where stocks will look even more attractive.
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