The Week Ahead: Waiting for QE3

08/05/2011 5:28 pm EST

Focus: MARKETS

Thomas Aspray

, Professional Trader & Analyst

After a week like this one, it seems like the markets have nowhere to go but up…and although a rally is likely this coming week, we aren’t out of the woods by a long shot, writes MoneyShow.com senior editor Tom Aspray.

It took the much stronger than expected jobs report to stem the bleeding in the US markets on Friday, as the close was mixed. The Dow Industrials ended higher while the S&P 500 and Nasdaq both closed lower.

Overall, global equities had the worst week since the middle of the financial crisis. Clearly, global investors have no confidence in their governments to act in a responsible manner.

The prolonged wait for the debt ceiling to be raised just reinforced the view of many that the majority of our leaders in Washington are ignorant about the role that confidence plays in the financial markets. The “2+2=5” outlook of many politicians has additionally led many to question not only their economics background, but also their understanding of basic math.

The focus on deficits instead of growth is the same mistake that was made in the early 1930s in the US, as well as in Japan after its top in 1989. It took World War II to spur US growth, and Japan has still not recovered after more than 20 years.

No one is happy with the size of the deficits, but cutting back at this point will put more out of work and make any recovery more difficult.

The condition of US infrastructure is embarrassing; with a recent study by the World Economic Forum ranking the US in 23rd place for infrastructure, right between Spain and Chile. (Ask someone in Europe what they think of Spain’s infrastructure, and you might get a laugh.)

The crisis in the Eurozone is also a large part of the problem, as the calm over the recent plan to solve Greece’s debt crisis did not last long. The European Central Bank recently bought Portuguese and Irish bonds, but forgot to buy the similarly imperiled Spanish and Italian bonds—and then raised rates, making the situation much worse.

The Spanish and Italian economies are two of the more significant economies in the Eurozone, and so the pressure is on for the Euro countries to act big and act soon.

The rush out of equities globally has coincided with a rush into bonds and gold. The monthly chart for the US T-bond futures shows that prices are now near the weekly starc+ band, which reflects an extreme in prices.

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Yields on short term debt have seen an even more dramatic decline, as the yields on the five-year T-Note have dropped from 1.84% in early July to a low of 1.12%.

Besides seeing bonds as the safer buy, many are hoping that there will be a “QE3” of some sort in the near future, which will push bond prices even higher. A new stimulus might involve the Fed purchasing bonds as in QE2. I think the Fed may, however, find another way to add liquidity, and this could cause a reversal in the bond market.

Adding to the market volatility last week was the intervention to slow down the sharp increases in the value of the Swiss franc and the Japanese yen. The upper chart on the left is of the Swiss franc, which has gone up about 10% in the past month.

The Swiss economy is still growing strongly, but there are fears this won’t last if the currency continues to rise. For Japan, a strong yen could kill any chances they have to keep their economy in recovery mode, especially after the disasters earlier in the year.

This week is relatively slow for new economic data, with the Productivity and Costs report out Tuesday along with the Federal Open Market Committee announcement. On Thursday, we get the International Trade Report, along with jobless claims, followed by retail sales and consumer sentiment on Friday.

NEXT: WHAT TO WATCH

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WHAT TO WATCH

Pretty much everything was hit this week, but there were a few standouts. One was Dendreon Corp (DNDN), which was down 67% Thursday. Today it was reported that two of the best known hedg.e funds lost over $300 million on DNDN’s.

Last week, the ETF’s that represent the major stock indexes violated their 50% support levels from last summer’s lows, which has caused some serious technical damage. A sustainable rally is likely this week or next, but then we need to be aware of the more important support that is derived from the bull market lows in 2009. Such a rally is likely to provide an opportunity to raise some cash and put on some portfolio hedges at more favorable levels.

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S&P 500
The Spyder Trust (SPY) tested its uptrend (line a), and came very close to the 61.8% retracement support at $115.68. The 200-day moving average (MA) is still rising, but there is now very strong resistance in the $124.50 to $127 area.

The S&P 500 A/D line dropped very sharply last week, and is now close to more important support (line b). This coincides with the March lows and the November 2010 highs. This drop in the A/D line means that it would take several weeks at a minimum before the A/D line could bottom, which is needed to set the stage for a decent rally.

The major 38.2% support from the 2009 lows is at $110.28, which is about 5.5% below Friday’s lows.

Dow Industrials
The Spyder Diamonds Trust (DIA) plunged sharply through the neckline of the head-and-shoulders top formation I discussed last week. It got as low as $111.26 on Friday, while the neckline had been just above the $119 mark.

The longer-term uptrend (line d) was also broken, and this creates a strong band of resistance in the $118 to $120 area.

The 50% support level was also violated, with the 61.8% support from the July 2010 lows next at $108.57. This brings into play the major 38.2% support at $104.24, which is derived from the 2009 lows.

The Dow Industrials’ A/D line did drop below the June lows last week, but is still well above the stronger support (lines e and f).

NEXT: Tech's Surprising Strength and Sector Focus

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Nasdaq-100
The tech sector has continued to hold up better that the other market sectors, even though the PowerShares QQQ Trust (QQQ) broke with the support at $53.50 and the 38.2% retracement support early Friday.

There is now more important support at the 50% retracement of $50.42, with the uptrend (line c) now just below $50. There is stronger chart support as well as the 61.8% retracement level at $48.19.

The Nasdaq-100 A/D line has slightly broken its recent lows (line d), but is so far holding up much better than the A/D lines of the other major averages.

There is initial resistance now at $55.50, with much stronger levels at $56.60 to $57.30.

Russell 2000
The iShares Russell 2000 Index Fund (IWM) cut through the June lows (line e) like a hot knife through butter, proceeding to fall through the 38.2% and 50% support levels.

The next support is at $69.50, which is the 61.8% support from 2010, with the uptrend (line f) at $67.66.
Looking at the major retracement support calculated from the 2009 lows, the 38.2% level comes in at $66.74. This also corresponds to good chart support.

It is not surprising that the Russell 2000 A/D line has dropped below the support that goes back to last fall (line g). Much more important support for the A/D line also exists (line h).

Sector Focus
The Dow Jones Transportation Average gave a great warning of the recent plunge when it failed to rally with the other major averages in the latter part of July. The on-balance volume (OBV) also did not confirm the July highs, and the confirmation of this divergence generated a sell signal.

The major 38.2% support lies at 4,294, which is about 8.3% below current levels. A drop to these levels would be severe.

All of the major sectors were under pressure last week, but utilities held up the best, dropping about 6%, while basic materials were hit the hardest and are down 13%. Technology was the third best performer, down just 7%.

Next week I will take a more detailed look at the critical support levels in the Select Spyder ETFs.

NEXT: Oil, Gold, Treasuries, and Tom's Outlook

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Oil
Crude oil was hit like everything else last week, dropping $5 on Thursday. The weekly chart of crude oil shows that before Friday’s rebound, prices came very close on the continuous contract to the weekly starc- band (as well as the $80 level).

The OBV is below its WMA, but also still holding above long-term support (line b).

Interest Rates
The yield on the ten-year Treasury note have continued to plunge.

After peaking in early April at 3.61%, they dropped as low as 2.42% on Friday. This is a decline of 33%. Yields have dropped so fast that a rebound is likely.

Precious Metals
The weekly chart of SPDR Gold Trust (GLD) shows another new high this week, with GLD exceeding the weekly starc+ band and closing very near it. Highlighted on the chart (in yellow) are similar instances that were followed by corrections in GLD.

The weekly OBV is strong and confirming the price action, but is also quite a ways above its WMA. A pullback to the OBV would not be surprising, nor would it alter the major uptrend.

The iShares Silver Trust (SLV) was strong early in the week, but then reversed to close well off the best levels, which is a short-term negative.

The Week Ahead
The action last week did not give anyone much of a chance to raise some cash by selling stocks on a rally.  I do think a better rally is likely in the coming week despite the mixed close on Friday.

It may take some concerted action by central bankers to calm the market, and that could be enough to tempt some of the value investors or money managers back into stocks.

If we do get a decent rally, the market is not out of the woods, as a drop below last week’s lows is likely before a sustainable bottom could be formed. A margin increase for gold futures could spark some profit taking in the metals.

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