The Week Ahead: Is the Worst Over?

05/06/2011 4:48 pm EST

Focus: MARKETS

Thomas Aspray

, Professional Trader & Analyst

What a way to start off a month! It certainly was a memorable week in the markets.

The post-mortem analysis is likely to continue this week—but whether the markets continue to rebound or not, last week’s action certainly took some of the weak speculators out of the market.

The multiple hikes of margins on silver by the CME Group finally reached the tipping point last week, as silver (and most of the other commodities) crashed. Earlier in the year, a margin hike in crude also caused a sharp drop.

As I noted last Thursday, it is my view that commodity correction should end this summer, providing a buying opportunity into what I see as a positive long-term trend.

The rush to close out too-expensive or too-risky commodity positions spilled over to the stock market by mid-week. But this was healthy for the intermediate-term trend.

Last week I even recommended a cautious approach, as the sentiment was a bit too bullish. It should have come down this week, but there are still too many bullish newsletter writers for my liking. Many individual investors are likely to stay out of the market after this week.

Consumer sentiment in the overall economy may see some improvement, as the sharply lower crude-oil prices may translate to lower gas prices before the Memorial holiday. The technical outlook for crude oil and the energy sector as a whole has been damaged by this week’s drop, yet some individual oil companies have just come back to good support.

We'll see just a few economic reports this week, starting Tuesday with the international trade numbers and followed by producer prices, retail sales, and weekly jobless claims on Thursday. We get another read on inflation Friday with the Consumer Price Index.

Overseas markets were also quite active. Early last week, the Reserve Bank of India raised rates further in an attempt to quell inflation, and the country's stock market had a one-day drop of 2.4%. Many of the other emerging markets have pulled back to support, and last week’s lows need to be watched closely.

The euro was hit hard after the ECB did not raise rates, as most expected, and implied that that rates would stay unchanged for a while. That wasn't the only turmoil in Europe, as Portugal agreed to a $116 billion rescue plan, and then Greece spent all day Friday denying rumors it was leaving the Eurozone.

Of the major overseas markets, Germany continues to perform well, and the country ETFs—such as iShares MSCI Belgium (EWK) and iShares France (EWQ), that have held above the April lows. Australia and Canada, because of their natural-resource exposure, were hit harder and are now back to strong support from last year.

WHAT TO WATCH

S&P 500
The Spyder Trust (SPY) held support in the $133 to $132.50 area, as it corrected 3% from Monday’s high to Thursday’s lows. A break below these lows will indicate a drop to the $130 area.

The SPY surpassed resistance at $135 early Friday, but closed well off the best levels. SPY needs a daily close above $136 to signal a move to the $138.50 to $140 area.

Positive market internals Friday have caused the NYSE A/D line to turn higher, but positive advance/decline numbers are needed early this week to keep the rally alive.

chart
Click to Enlarge

Dow Industrials
The Dow Industrials—and therefore, the Diamonds Trust (DIA)—held up the best last week, as DIA retested the breakout level (line b) before Friday’s rally.

The next key barrier on the upside is in the $129 to $130 area (Dow 13,000) which also corresponds to the resistance at line a. If this level is surpassed, watch the May 2008 highs of $131.

The Dow Industrials A/D line shows a long term pattern of increasing highs (line c), which means the intermediate trend for these large caps is positive. Key support for DIA now sits at $125.50.

Dow Transportations
The Dow Transportation Index had a minor setback last week. The railroads were boosted early in the week, followed by the airlines Friday, as they liked lower crude prices.

The next targets are in the 5,750 area—and a move to the 5,900 to 6,000 area still looks possible.

Nasdaq-100
The PowerShares QQQ Trust (QQQ) did pull back to the support at $58.30 last week, as the low was $58.09. This level should be watched closely on any market weakness. The next targets are in the $59 to $60 area.

Russell 2000
The iShares Russell 2000 Trust (IWM) is a market I will be watching closely, as the small-cap stocks often top out first. The key support level to watch is $81.40 to 82.40, and if it is broken IWM could drop back to the uptrend in the $80 area.

The action of the Russell 2000 A/D line has me concerned, as it failed to make new highs last week (line e), and on Thursday violated its short term support at line f. This is clearly a sign of weakness, and there is more important support for the A/D line at line g.

NEXT: Sector Focus

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Sector Focus

  • My outlook has not changed much in the sectors—I still like the Consumer Staples Select Sector SPDR (XLP) as I discussed in “Get Ready to Buy Consumer Staples.”
  • The Health Care Select Sector SPDR (XLV) is still also favored for new purchases if you are underinvested in stocks. Before buying any stock or ETF, I suggest sure you first determine your stop, so you can be sure you are comfortable with the risk.
  • I updated the technical outlook on both the Energy Select Spyder (XLE) and the Financial Select Spyder (XLF) on Friday, as heavy selling in the energy stocks has weakened the technical outlook for XLE.

chart
Click to Enlarge

Oil
Certainly, US consumers care more about what, if anything, the historic drop in oil prices may mean as we approach the summer. The July crude-oil contract plunged 16.7%, from last Monday’s high at $114.28 to Friday's low of $95.18.

The chart shows that the 50% support level was broken intra-day, with the next good retracement support at $92. Typically, after such a decline a market will develop a wide trading range. Heavy volume on the decline has taken the OBV below its breakout level (line a).

For July crude, that trading range should be between $97 and $107—but the good news is that if crude oil stays in this range, gas could also get cheaper. It is also interesting that prices are almost back to pre-Egypt levels.

US Dollar
The dollar had a nice bounce last week, as it finally found support just below 73. The failure of the ECB to raise rates and plunging commodities clearly helped.

It is already at first resistance in the 75 area and has almost reached its downtrend (line b). The 38.2% retracement resistance is at 76.31, with the 50% at 77.39.

The volume was heavy last week, so the OBV has turned up, but is still below its downtrend (line c). The weekly OBV, as discussed last time, does not yet suggest that a major low is in place.

Gold
The SPDR Gold Trust (GLD) finally reached the top of the support zone that runs from $142.50 to $138. On Thursday, I went into a complete discussion of why I do not think gold has completed a major top.

The first strong resistance is now at $148.50, and a close above $150.50 is needed to reassert the uptrend.

Silver
The carnage in the iShares Silver Trust (SLV) is likely to leave scars for several years, as the support at $35.50 was easily broken with the low of $33.58.

The 50% support is at $31.30, and the 200-day MA is at $27.74. The recent highs for SLV may hold for quite a while.

I would expect the volatility in SLV to remain high. The band of resistance in the $39.20 to $41 area may contain the rallies for a while, with massive resistance at $43.50.

The Week Ahead
The failure of the stock market to hold its gains into the Friday close makes the action early next week more important. A higher close next week should signal a move to the 13,000 level in the Dow and 1,400 for the S&P 500.

Though I still think that the long-term trend for stocks is positive, as we near the end of May I would still suggest raising some cash. New buying should be selective, and accompanied by strict risk control.

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