The Week Ahead: How Low Will Stocks Go?

05/04/2012 6:00 pm EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

It was a rough week for the stock market, and the technical action favors further weakness, writes MoneyShow’s Tom Aspray. In this type of environment, he prefers a patient approach, but does see a new opportunity in the SPDR Gold Trust (GLD), which appears to be bottoming.

Last weekend’s headline in The Wall Street Journal, "Dow Notches Biggest Weekly Gain in Month,” may have encouraged some to buy, but hopefully not at Tuesday’s highs. The Dow Industrials closed Friday down 2% from those levels.

By the end of the week, the selling was broad-based, as the Spyder Trust (SPY) was down 1.9%, the PowerShares QQQ Trust (QQQ) lost 2.9%, and the small-cap Russell 2000 (IWM) was also down 2.9%.

Things could have been even worse: if you became enamored with your Keurig coffee maker over the weekend and decided to buy Green Mountain Coffee Roasters (GMCR) when it opened last Monday, you were in real pain

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The weekly chart of Green Mountain shows that it peaked last September at $115.98, then dropped to a low of $34.06 in November. The relative performance, or RS analysis, turned negative in October, when GCMR was at $92.

Despite February’s rally, in early April, both the RS line and the on-balance volume (OBV) were already breaking down, which warned of an earnings disappointment. The stock was down over 48% for the week.

As I go into more detail later, the stock market is likely to be under further pressure this week. It will be important to see how the market reacts once we get down to the April lows.

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Early last week, there were some positive signs in the economy. The ISM Manufacturing Survey (chart on left) rose to its highest level since last spring. New orders accounted for most of the gain, which is a positive, as was the slight decline in inventories.

However, construction spending numbers, also released last Tuesday, were weaker than expected. The market was also surprised by the weak numbers from ADP, as they reported only a 119,000 increase in jobs. The sharp drop in the ISM non-manufacturing composite (chart on right) added to the market’s concern, helping push the market lower heading into last Friday’s jobs report.

Even though the monthly jobs report showed a slight decrease in the unemployment rate, the number of new jobs was much lower than expected. It has raised new fears that the economic recovery is losing steam.

In particular, construction employment has barely rebounded from the early-2011 lows. If the May report (to be released on June 1) is also weak, it would send an even stronger warning.

In terms of data, the markets will get a rest this week, as jobless claims and international trade numbers do not come out until Thursday. On Friday, we get the Producer Price Index and the University of Michigan’s consumer sentiment survey.

Of course, over the weekend, elections in France, Germany and Greece are likely to bring the Euro debt problems back into focus. The ECB left rates unchanged last week, which disappointed some who were hoping for another rate cut to help their floundering economies. The pro-austerity stance of the ECB is clearly a factor in the elections.

As I pointed out on April 13, the German Dax index broke below its March lows in the middle of April. This was confirmed by the breaking of the uptrend in the blue-chip Euro Stoxx 50. Therefore, we need to watch our market even more closely.

NEXT: What to Watch

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WHAT TO WATCH
As I discussed last week, the Advance/Decline (A/D) lines, which had diverged from prices at the April highs, had rebounded back to or slightly above resistance. They have all turned down sharply with Friday’s drop.

The A/D lines are now back below their weighted moving average, and very close to short-term support, which in turn could be violated on a further decline Monday. If the A/D lines decisively break below the April lows, it will increase the chances of a sharper stock-market decline.

The sentiment picture actually got a bit worse last week, as the AAII survey of individual investors saw almost an 8% jump in the number of bulls, to 35.4% as of May 3. Last fall, near the market lows, only about 25% were bullish.

The financial newsletter writers also became a bit more bullish as the rose just over 1% to 43%. It is even worse that only 20% are bearish as opposed to a reading of over 45% bearish last fall.

Many of the inverse ETFs, as I discussed on Friday, show potential double-bottom formations. This includes the ProShares Short S&P 500 ETF (SH), which I recommended on April 19. All were up sharply Friday, but have not yet completed their bottom formations.

The major market averages are likely to stabilize near the April lows. If we only get a weak rally from those levels, it will be a stronger sign to become more defensive.

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S&P 500
The Spyder Trust (SPY) gapped lower Friday, breaking below the support in the $137.50 to $138 area in early trading. The short-term uptrend (line a) is at $136.22, with the April lows at $135.75.

If these levels are broken, there is further support from early March (line a) in the $134.36 area. Additional chart support stands between $130 and $132.50. The major 38.2% Fibonacci retracement support from the October 2011 lows is at $128.90, or 1,289 on the S&P 500.

The A/D line was able to move slightly above the bearish divergence resistance (line c) last Monday, but then dropped sharply. The uptrend (line d) is now being tested, and if broken, the A/D line should drop back to the April lows. The next major support from the November and December lows is at line e.

NEXT: Dow, Nasdaq, and Tom’s Outlook

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Dow Industrials
The SPDR Diamonds Trust (DIA) was the only major average to make new rally highs Tuesday, but closed the week lower. From the weekly chart, the next key support is from the April 23 low at $128.16.

There is additional support at $126.92 (line a), which if broken on a weekly close would complete a double-top formation. The major 38.2% Fibonacci retracement support follows at $122. DIA is in the middle of its weekly Starc bands, with the Starc- band now at $123.55.

The RS analysis improved last week, as it moved back above its WMA. This is a sign of money moving back into the higher yielding large-capitalization stocks.

The weekly OBV is now looking more negative, as it formed lower highs last week (line b), and failed to confirm the new highs. A drop in the OBV below support (line c) would generate a stronger sell signal.

The Dow Industrials’ A/D line (not shown) also did not confirm the new highs last week, and has now dropped back below its WMA. It is still above the support from the April lows.

The DIA has strong resistance now in the $131 to $132 area.

Nasdaq-100
The rally in the PowerShares QQQ Trust (QQQ) back to the resistance in the $67.50 to $68 region now looks more like a last-gasp effort. The QQQ also gapped lower Friday, reaching the $65 area and the lower daily Starc band.

The next support sits at $64.45, with stronger levels in the $63 area. The long term uptrend (line c) is at $61.80, with the major 38.2% Fibonacci support next after that at $61.48.

The daily RS line started a new downtrend in mid-April, and has just turned lower after testing its declining WMA. A drop below the most recent lows (line d) will be more negative.

The daily OBV violated its uptrend (line f) in early April, then dropped sharply in the middle of April, as selling was quite heavy. The OBV just barely made it above its declining WMA last week, and fell well short of the downtrend (line e).

The Nasdaq-100 Advance/Decline (A/D) line formed a negative divergence at the April 2nd highs and closed Friday very near the April lows. The A/D line is acting weaker than prices which is a negative sign.

NEXT: Small Caps, Sector Focus, and Tom’s Outlook

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Russell 2000
The iShares Russell 2000 Index Fund (IWM) may have just formed the right shoulder of a head-and-shoulders top formation. A close below the neckline at $78 would complete the formation, with the next support in the $76 to $77 area. The downside target from the H&S top sits around $71.40 to $72.

The Russell 2000 A/D line peaked in February, and has formed lower highs (line a). This was a sign of weakness, as is the pattern of lower lows (line b).

There first resistance stands at $80.50. It would take a strong close above the right shoulder at $82.60 to negate the top formation.

Sector Focus
The Select Sector SPDR Energy (XLE) was the weakest of the sector ETFs, dwn over 4% for the week despite a sharp rally early on that reached the $72.40 level. A break below support at $68.80 should signal a decline to the lows from late last year in the $63.80 to $64.80 area (line c).

The weekly OBV just rallied back to its declining WMA and resistance (line d) before reversing. This is a negative formation.

The Select Sector SPDR Technology (XLK) and Select Sector SPDR Financials (XLF) were both down over 2%. The Select Sector SPDR Consumer Discretionary (XLY) and Select Sector SPDR Health Care (XLH) held up better, losing around 1.4%. The Select Sector SPDR Consumer Staples(XLP) remained pretty much unchanged for the week.

NEXT: Oil, Precious Metals, and Tom’s Outlook

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Crude Oil
The July crude oil contract collapsed last week, ending down more than $6.40 per barrel. While this likely indicates a lack of confidence in the economy, it should be good for US consumers as we enter the summer driving season.

There were signals last month that crude oil was not going to follow its normal seasonal pattern this year.

The next good support is in the $97 area (line a), followed by stronger levels around $93.50 to $94.

Precious Metals
The SPDR Gold Trust (GLD) dropped Thursday, but then some buying came in Friday as stocks were collapsing. The daily chart support (line c) is holding, with initial resistance just above $162. The long-term downtrend (line b) is in the $169.50 area.

Last Monday, there were signs that gold was acting sold out, and both of my recommended buy levels in GLD were hit by Thursday. The daily OBV has broken its downtrend (line e) and shows a bullish zig-zag formation.

The selling pressure in the iShares Silver Trust (SLV) appears to be drying up, but unlike gold, there are no signs yet of a bottom.

The Week Ahead
The stock market’s sharp drop last week reinforces the view of a further correction. The main question is whether we will see just a drop back toward the recent lows, or a more serious decline that could take the S&P 500 down to 1,320 or even the 1,290 area.

The fake-out rally last week and the technical formations have me slightly favoring the deeper decline, but the strength or weakness on the first rally will give us additional information.

A bounce is likely this week. I will update my market outlook this Thursday, May 10, as I will be traveling next Friday. Also, in Monday’s daily chart feature, I will be adjusting stops and will likely recommend some profit taking on existing positions in the Charts in Play portfolio.

Now more than ever, I would favor a very a patient approach, and only look to do new buying at stronger support. I will look to add to positions in the inverse ETFs on a market bounce next week.

I will also be looking for another entry point in the SPDR Gold Trust (GLD), as the price action and sentiment suggest we are close to a bottom.

  • Since I will be traveling, the next Week Ahead column will be released on Friday, May 18.
  • Also, don’t forget to read this week’s Trading Lesson, Is This the Year to Buy in May?

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