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Positive divergences in some technical indicators suggest rally potential that is largely unexpected, prompting selective new buying in health care stocks and profit taking in a popular inverse ETF.

Global sentiment for stocks early Monday was almost as negative as it was last October with sharply lower trading before the NYSE opening. In early trading, the S&P futures were down over ten points from Friday’s close, but then managed to close the day with just minor losses.

As I noted here last week, not all of the regular sentiment readings are currently negative enough to suggest a major market low, although the financial media has been painting a dire picture.

More importantly, if the positive divergences in many of the technical indicators—especially the market internals—are confirmed, it will favor a rally that is much stronger than the bears expect.

Stock index futures are higher before the opening Wednesday, and confirmation of the positive divergences could occur before the end of the week.

We have been doing some light buying recently and have two new recommendations in the health care sector. We will also look to take some profits on an inverse ETF position.

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Chart Analysis: The daily chart of the Spyder Trust (SPY) shows a pattern of lower lows, line b. The 38.2% support level at $128.92 was violated last week, as was the still-rising 200-day moving average (MA).

• There is now minor resistance at $130.50 with the 38.2% retracement resistance from the April highs at $133
• A close above last week’s high at $133.93 is needed to reverse the short-term downtrend
• The NYSE Advance/Decline (A/D) line has turned up after forming a positive divergence at Monday’s lows, line d
• A/D line needs to overcome the resistance at line c to confirm this positive divergence
• The McClellan Oscillator had a low of -134 on Monday, which was well above the May 18 low of -335. This bullish divergence, line f, is a positive sign
• A move in the Oscillator above +85, line e, will confirm the positive divergence
• If Monday’s price lows are broken, there is further support at $125.60-$126.50

The double-bottom formation in the ProShares Short S&P 500 ETF (SH) was noted here in early May and was confirmed by the close above resistance at line g.

• The upside target at $38.60 was hit in mid-May, and Monday’s doji high at $39.17 may mark a short-term top
• Declining 200-day MA and further resistance is at $39.88
• Daily on-balance volume (OBV) did not make a new high with prices on Monday, line i. This is consistent with a short-term top
• OBV will have to drop below last week’s low to confirm this negative divergence
• Initial price support is at $38.50 with stronger support at $37.40-$37.80

NEXT: 2 Selective New Buys from the Health Care Sector