The Week Ahead: Volatility Is Not Your Friend

05/13/2011 6:00 pm EST


Thomas Aspray

, Professional Trader & Analyst

The odds are against stocks making a sustained comeback in the short term. Unless you’re an intra-day trader, the best advice is to hold on for the ride and make sure protective stops are in place.

The rollercoaster ride continued last week in both the stock and commodity markets—if you’re keeping track, the S&P 500 was up three days and down two.

The commodity markets were also very choppy, and there are some worrisome signs in the energy patch. The Energy Select Spyder (XLE) and many of the biggest oil companies, including ExxonMobil (XOM), Chevron (CVZ) and Schlumberger (SLB) have completed top formations. (For full technical appraisal, please see Big Oil’s Big Top.)

It looks as though my view is at odds with the big hedge funds, as The Wall Street Journal reported on Friday that several of the largest hedge-fund managers were bullish on the energy sector.

With Friday’s sharply lower close, the stock market is in a precarious position for the short term, and the odds now favor further selling this week. This high volatility is not an investor or a swing trader’s friend, but those who trade intra-day may be having a good time.

The number of bulls according to the AAII sentiment numbers continues to decline, and is now at 30%, not far above last summer’s lows. For specific price levels to watch, see below.

The economic numbers met analysts’ expectations, but next week the economic calendar is much more crowded. On Tuesday, we’ll have the latest reading on housing starts, along with industrial production numbers for April. FOMC minutes will be released on Wednesday, while Thursday brings existing home sales and jobless claims.

The storm clouds seem to be again darkening in Europe, a year after the $158-billion bailout plan for Greece was announced. Now France and Germany are apparently lobbying for a debt extension, though the ECB is not convinced this is a good idea. The downgrade of Greece’s debt did not help the situation.

China’s consumer prices were a bit lower in April, after setting a record in March, while the trade surplus was much greater than expected. There were signs that the tightening was having some impact, as monthly iron ore imports dropped 11%. Even more dramatic was copper, as it dropped 14% from March, and is now down 40% from last year.

As I warned last week, many of the emerging markets had fallen back to support, and the violation of the recent lows makes a further decline likely. The stronger dollar is a negative for these markets.

The sharp decline last Wednesday set the stage for heavier selling on Thursday and I suggested to “Fasten Your Seatbelts.” Thursday’s rebound was encouraging, but the bears again took over Friday, as early gains were met with heavy selling and the major averages closed lower.

The new highs by both the NYSE Composite and the S&P 500 A/D line in early May are positive for the intermediate-term trend. A break of the May 5 lows in the major averages, which now looks likely, will signal a decline to stronger support.

S&P 500
The Spyder Trust (SPY) hit Thursday’s high at $135.36 early Friday before turning lower. On a short-term basis, the key support is at $133.02. A break of this level will indicate a decline to the $131.70 to $132.40 range, if not the support from the April lows at $130.40 to $129.50 (line a).

The SPY has initial resistance at $135.36, but needs a daily close above $136.11 to signal a move to the $138.50 to $140 area.

The S&P 500’s A/D line made a new high on May 10 (line b), consistent with a positive intermediate trend. The weak A/D numbers Friday have taken the A/D line back to its uptrend (line c). Even slightly negative A/D numbers Monday will cause a break of this uptrend, with longer-term support at line d.

Click to Enlarge

Dow Industrials
The chart of the Diamonds Trust (DIA) is very similar to that of the S&P 500. Key short-term support for DIA now sits at $125, not far above Friday’s close. A break of this level will signal a decline to between $122.60 and $123. The major supports are at $120.65 and the April low.

Initial resistance stands at $127.16, with further levels at last week’s high of $127.67.

Dow Transportations
The Dow Transportation Index led the charge into early May, but after a strong close last Tuesday reversed course to close near the lows. The previous lows at 5,368, from May 5, were exceeded by a few points Friday.

The 38.2% retracement support is at 5,313, with the 50% support at 5,235.

The PowerShares QQQ Trust (QQQ) has stayed in a tight range since the early May highs at $59.34 (line e). QQQ was actually up last week, barely, so the tech sector could lead the market once the current correction is over.

There is initial support at $58.24 to $58.09. There is additional support at $57.70, with stronger at $56.50 to $57 and the uptrend (line f).

The Nasdaq-100 A/D line made convincing new highs in early May (line g), and is still well above its uptrend (line h). The March and April highs in the A/D line need to hold if the uptrend is broken.

Russell 2000
The iShares Russell 2000 Trust (IWM) continues to act weak as its A/D line failed to make new highs in early May. This divergence is a short-term negative.

There is first support at the commodity-crash lows of $82.40, with more important levels at $81.40 and the longer-term uptrend. A close above the recent highs at $85.54 would improve the short-term outlook.

NEXT: Sector Focus, Commodities, and Conclusions


Sector Focus

  • The bright spots continue to be the Consumer Staples Select Sector SPDR (XLP) and the Health Care Select Sector SPDR (XLV) which made new rally highs last Friday, though they closed off the best levels. These are the two sectors I have been recommending for new purchases if you are underinvested in stocks. If you are tempted to buy, wait at least until mid-week.
  • The Financial Select Spyder (XLF) broke below the March and April lows on Friday, and continues to be the weakest sector. Many of the largest financial stocks look very weak technically.
  • The Material Select Spyder (XLB) has gotten hit hard over the past two weeks as it is down over 7% from the early May highs. It has already reached more important support in the $38.40 area and could be closer to bottoming.

The July crude-oil contract is trying to hold above the low of $95.18, which if broken could set the stage for a drop to the $90 to $92 area. The wide trading range I expected last week is still the most likely scenario, as last week’s rally failed just above $105.

Click to Enlarge

US Dollar
The US dollar was the big story last week as the dollar index and the PowerShares DB US Dollar UP ETF (UUP) rallied sharply on heavy volume.

The daily downtrend for UUP (line a) is at $22.38, with additional resistance in the $22.80 to $23.20 area. This level could limit the upside over the next few weeks.

There is initial support now at $21.40 to $21.20 and the rising 20-period EMA. The OBV has not yet broken its downtrend (line b), but the volume has been strong over the past two weeks.

Interest Rates
There were quite a few developments in the bond market, as the rush into bonds has been overwhelming. Here are a few highlights:

  • an explosion in dollar-denominated perpetual bond offerings in Asia
  • MIT floats a 100-year bond that is well oversubscribed
  • and emerging-market bond funds see net flows for the sixth straight week

In terms of the ten-year Treasury yield, those who were expecting higher rates and sold the ten-year short have been hurt over the past month, as yields have dropped from 3.62% to 3.13% this week.

This decline broke the uptrend (line c) and has taken yields close to its flat 200-day MA. The 50-day MA is still above the 200-day, which is positive, and the intermediate trend for yields still appears to be up.

The SPDR Gold Trust (GLD) hit a low Friday of $144.29, which was well above the prior week’s low of $142.55. GLD could be forming a short-term bottom.

There is initial resistance at $147.35 and a close above $148.50 should signal a test of the $150.50 level.

The iShares Silver Trust (SLV) broke convincingly through the previous lows at $33.58, and hit $31.97 before bouncing. It held above the 50% support level of $31.30.

Continued volatility is to be expected in silver, with the first resistance now at $36.50, and those who are short are likely using stops above $38.50.

The Week Ahead
Last week’s rally failure in the stock market likely means a deeper correction is underway. The S&P 500 needs two consecutively strong closes to turn the market’s momentum positive.

The breakdowns in the financial sector and toppy action in many of the big oil companies are likely to weigh down the major averages. The decline should set that stage for higher prices down the road.

As I have been recommending for several weeks, this is a good time to raise some cash—and be sure to have stops in place on your long positions.

Those not in the stock market could consider a dollar-cost averaging strategy, so that by later in the summer your desired allocation to the stock market is established. Any new buying of individual stocks or ETFs should wait until the market stabilizes and there is lower volatility.

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