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The Week Ahead: Will Crude Oil Crush the Recovery?
02/24/2012 6:00 pm EST
Select buying opportunities remain, but the combination of rising oil prices and latest deterioration in the financial sector adds risk and uncertainty to the markets.
Last week, the focal point in the political debate turned to the sharp increase in gasoline prices over the past few weeks. The Democrats are justifiably concerned that higher gas prices will reverse the improvement that President Obama has seen in the polls.
The Republicans have found a new reason to attack, but those who really understand the markets know that some things are difficult, if not impossible, to control. Even if driving was outlawed in India and China, it is hard to imagine that gas would get back to $2 per gallon.
Technically, crude oil completed a double-bottom formation in October which at the time projected a move to $105.33 per barrel. That target was easily exceeded this week, and the chart shows that we have surged above the $104 level (line a) and closed well above $109 per barrel.
One of my favorite technical tools, the on-balance volume, did a good job of identifying this low and is still pointing higher. The next resistance is in the $110-$112 area with the May 2011 high at $115.27.
The long-term seasonal patterns in crude indicate that it typically bottoms in February. In 2011, the April high in crude oil prices correlated nicely with the high in the small-cap Russell 2000.
Of course, the concern is that if crude reaches $115, gas prices will be well above the 2008 record price of $4.12 per gallon. It is likely to take a steadily improving economy to offset the impact of higher gas prices on the consumer. Last Friday, the Reuters-University of Michigan consumer sentiment showed a nice increase to 77.4, which was the highest reading since early 2008.
So far, the higher crude oil prices have not dampened the enthusiasm for stocks, as the markets continued to move higher again last week. The correction camp, which I have been a member of since early February, is getting more and more crowded. In the stocks section, you will see some charts that suggest we could have already seen the correction.
The ongoing saga in the Eurozone was ignored for the most part this past week. There was plenty of troubling news, as three large Eurozone banks, including France’s Credit Agricole SA, the UK’s Royal Bank of Scotland Group PLC, and Franco-Belgian lender Dexia SA disclosed huge losses, in part due to the declining value of their Greek debt holdings.
The European Union also downgraded its outlook for the region’s economies and now projects a 0.3% loss compared to an early forecast of +0.9%. Let’s hope that is far off the mark, as many economists were last fall.
There are also concerns about whether the $620 billion from the ECB last December will be enough to allow the regions other fragile economies to sell their bonds at favorable rates.
There should be more news about Greek debt this coming week, but many are not happy with the “haircut” the bond holders will need to accept. Commerzbank AG Chief Executive Martin Blessing said "The participation in the haircut is as voluntary as a confession during the Spanish Inquisition."
Overall, the US economic news was positive, as existing home sales were up 2.7%; jobless claims were unchanged, which was better than the market expected; new home sales declined 12.6%; and home prices are still declining, as the S&P/Case-Shiller Home Price Index reported a year-over-year decline of 1.2%.
While AIG surprised the Street with better-than-expected earnings that put the government’s holdings in the black, there were plenty of disappointments, including Dell Inc. (DELL) and Hewlett-Packard (HPQ). HPQ was one of the high-volume casualties I featured earlier today (see “3 High-Volume Decliners”).
This week, we have a full economic calendar, starting with the Chicago purchasing managers report, personal income, and pending home sales on Monday. Tuesday brings the ISM Manufacturing Index and construction spending. Fed Chairman Ben Bernanke is also scheduled to speak on both Tuesday and Wednesday.
On Wednesday, we get the ADP employment report along with the release of the Fed’s Beige Book. More jobs data is due out on Thursday along with productivity and the ISM Non-Manufacturing Index. The monthly jobs report and the latest reading on factory orders are due out on Friday.
WHAT TO WATCH
Since early February, I have been looking for a market correction and have recommended that new buying only be done where the risk can be well controlled. I have also suggested taking profits as the market has moved higher, and of course, raising stops to lock in profits.
The market has been climbing steadily all month, as the Spyder Trust (SPY) is currently up well over 3% for the month with little in the way of a pullback. In fact, as noted market analyst Larry McMillan has pointed out “It has been 44 trading days since the S&P 500 has even touched its 20-day moving averages. That is one of the five longest streaks of all time.”
Of course, some of the individual stocks and industry groups have corrected, which may have masked a correction in the overall market as new market leaders keep pushing stocks higher. If this is the case, maybe these two Dow giants, Merck Inc. (MRK) and McDonalds (MCD), will be able to propel the market even higher.
For MRK, a close above $39 will complete the pattern, lines a and b, and signal a move to the $41 area.
MCD tested resistance, line c, on Friday, but was not able to move through it. A daily close above $101.40 would have a Fibonacci price projection in the $105-$106 area.
If these stocks both break out to the upside, the Dow Industrials should have not trouble surpassing the 13,000 level.
The Spyder Trust (SPY) moved a few ticks above the 2011 high of $137.18 last week but has not yet closed above it. There is still converging resistance at $138.26, which is the 78.6% Fibonacci retracement resistance, as well as the Fibonacci equality target (100%) from the October rally.
The S&P 500 Advance/Decline (A/D) line broke short-term support two weeks ago and is just barely above its uptrend, line b. Still, it is making higher highs and higher lows but is not rising nearly as strongly as it was early in the year.
There is first good support now between $133.60 and $134.58 and the rising 20-day exponential moving average (EMA). A close below $133 is likely to signal a drop to more important support in the $130 area.
There is additional chart support in the $127-$128 area.
The SPDR Diamonds Trust (DIA) has been bumping into resistance in the $130 area as the financial press seems fixated on Dow 13,000. There is first support for DIA now at $128-$128.50
There is more important support now in the $125 area and the uptrend, line e. The November highs at $122.80 should be the first major support if a real correction gets underway.
The PowerShares QQQ Trust (QQQ) made further new highs on Friday and is now very close to upper trend line (line a) in the $64.60 area. There is initial support at $63 and a daily close below $62.63 will suggest a move to the $60.60 to $61.40 area.
The Nasdaq-100 Advance/Decline (A/D) line peaked on February 3 and has since failed to make new highs. This bearish divergence resistance (line b) is again being tested. Another failure to break out to the upside would be negative.
The negative divergence is consistent with a short-term top, but a drop in the A/D line below its flat weighted moving average (WMA) is needed to confirm.
Once above the recent high at $63.86, there is resistance from 2001 at $65.61. There is also a Fibonacci price target of $67.15.
The iShares Russell 2000 Index Fund (IWM) was not able to make new highs last week and has been in $2.30 range for most of the month. It is possible that the trading range (see ellipse) is just a continuation pattern that is setting the stage for another sharp rally. The July 2011 high was $84.30.
The Russell 2000 A/D line has continued to form lower highs since early February (line f). It now shows a slight pattern of lower lows and lower highs. A drop below the February 15 lows would be more negative. There is converging support for the A/D line at line g.
A daily close below $81 would suggest a drop to the $78-$80 area and the uptrend, line e.
The iShares Dow Jones Transportation ETF (IYT) has deteriorated further as it closed last week below the support in the $92 area. The higher energy prices have definitely taken its toll on the transportation stocks. More important support from the October and December highs sits at $90.80. The 38.2% Fibonacci retracement support level stands at $86.80.
The RS analysis is dropping quite sharply which is quite negative and does suggest lower prices. The break of the support at line b, confirmed the break of price support (line a).
The OBV is also dropping sharply as the volume on the decline has increased. It violated support, line c, on February 7th. It is now well below its declining WMA.
The Select Sector SPDR - Technology (XLK), Select Sector SPDR - Energy (XLE), Select Sector SPDR - Industrials (XLI), and the Select Sector SPDR - Consumer Staples (XLP) all made marginal new highs last week.
There has been a growing interest in the financial sector, but the chart of the Select Sector SPDR - Financial (XLF) shows signs of deterioration. It has key short-term support now at $14.30. A close below this level will suggest a drop to the $13.50 area, line d.
The RS line has formed lower highs, line e, and looks ready to drop back to support at line f. The OBV is still below its weighted moving average and a violation of the uptrend, line g, would be more negative.
The SPDR Gold Trust (GLD) closed above its key resistance last week, and I recommended a new long position on Wednesday (See “Another Golden Opportunity”). The initial buy level, but not the secondary one, was hit.
There is next resistance at $174 with further resistance in the $176-$177 area. The completion of the flag formation has initial upside targets in the $196 area, so there still is significant upside potential.
The iShares Silver Trust (SLV) closed above $33.50, which as I noted previously, would be a positive sign. The next upside target for SLV is in the $36 area with further resistance at $38. A pullback to the $33.60-$33.80 area should be a good buying opportunity, as it would take a drop below $31.50 to break the uptrend.
The Week Ahead
It has really been a tough market lately, but the combination of higher oil prices and deterioration in the financial stocks keeps me cautious. There are still good buying opportunities, including the two oil service and equipment stocks I discussed last week.
There are fewer stocks or ETFs that are close enough to support where the risk can be well controlled. This is the key consideration right now for new investing. If you are thinking about buying a stock or ETF, figure out where you would get out if it goes down. That may help convince you it is not a good idea.
If the Dow stocks are going to lead the next push to the upside, they may present some new opportunities, although those may be short-term trades.
I have continued to raise stops and take profits on the stocks I have recommended, and the current portfolio is available for review here.
Read Tom’s latest Trading Lesson, “Don’t Miss Another Big Rally”
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