The Week Ahead: Focus On The Strong Sectors and Stocks

08/03/2012 5:40 pm EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

Friday's sharp rally probably wasn't enough to reverse the negative short-term outlook, but the long-term view is still strong, and there are several promising plays for investors who remain alert and use tight stops, writes MoneyShow's Tom Aspray.

For the first time since May, the monthly jobs report did not disappoint the stock market, as it surged to new rally highs in reaction to the best job growth in some time. The overall unemployment rate actually rose, but that did not stop the buying and the short covering.

The Spyder Trust (SPY) had its best day in quite some time, gaining 2%. The S&P 500 is now not far below the widely watched 1,400 level, and the Dow Industrials has settled well above 13,000.

However, even these impressive gains were not enough to turn the technical outlook positive. The market internals, like the Advance/Decline lines, are still lagging the price action. In my experience, the majority of strongly trending moves in the stock market are characterized by the market internals leading prices, not lagging them.

Last week, I took a slightly more cautious outlook on the stock market, as I dropped to about 55% invested with the other 45% in cash. As I discuss in more detail later, I will be ready to move to a more fully invested position once the outlook for stocks turns more positive.

Investing in stocks got a bit more attention this week, with the bond king, Bill Gross, and Professor Jeremy Siegel facing off on the wisdom of investing in stocks. Bill expects stocks to return just 4% in the near future, a bit lower than his October 2009 forecast for 5% growth.

Clearly, the 2009 forecast was way off, as the Spyder Trust (SPY) is up over 36% since November 2009. Of course, no one can dispute Bill’s brilliance or success, as one of his funds brought in over $2 billion last month.

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My approach to the markets also does not fit well with Professor Siegel's. His long-term forecasts for Dow 15,000 earlier this year coincided nicely with an interim high. Though it may get there, I tend to look at the stock market one step at a time.

The long-term performance of the S&P 500 with dividends can not be ignored. The chart (from www.simplestockinvesting.com) shows that $1 invested in the S&P 500 in 1950 grew to $500 in 2010 when dividends were reinvested (orange line). This compares with a value of just $60 without dividends reinvested (blue line).

Regular readers will not be surprised that I do not agree with the dismal outlook for stock investing. My approach is to select the strongest stocks in the strongest sectors with the most positive volume patterns. When yields on stocks are greater than those of bonds, as they are now, I look for those with attractive yields.

Combining the relative performance or RS analysis with market timing can be quite effective in boosting your returns in the stock market. At MoneyShow.com, you can find my columns going back to 2008, so you can take a look and judge for yourself

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This year has seen quite a few wide swings in three of the main asset classes, gold (GLD), bonds (TLT), and stocks (SPY).

GLD was up over 14% early in the year, but by early in the summer had given up those gains. Bonds as represented by TLT were down 9.5% in March, but up over 9% just a few weeks ago. Stocks have been positive since the beginning of the year, peaking at over 13% in early April. With Friday’s gain, stocks have once again taken over leadership.

Last week, the markets were buffeted by economic data and came out intact. The FOMC disappointed some by taking no new action after their meeting concluded last Wednesday, and on Thursday the ECB left rates unchanged.

There was more good news on housing, as the S&P Case-Shiller housing price index revealed that housing prices rose in all 20 districts that they covered. Consumer sentiment from the Conference Board also rose to its best reading since April.

This week we have a fairly light economic calendar, though Ben Bernanke is speaking on Monday and Tuesday. The latest data on productivity and costs are out on Wednesday, with international trade numbers and jobless claims on Thursday. Then on Friday, we get the import and export prices.

This light calendar suggests that any market moving news is likely to come from overseas.

NEXT: What To Watch

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WHAT TO WATCH
The market surprised many with its great finish to a somewhat choppy week. Even though the Spyder Trust (SPY) was only about 0.5% higher on the week, the NYSE A/D ratios Friday were 5:1 positive.

The negative divergence between the major ETFs and their Advance/Decline lines, which I discussed in Thursday’s column, have not been overcome. This does not mean the market cannot move higher, but it is not the strong technical reading that was evident in September 2010 or October 2011.

Of course, this could change in the next few weeks, but there are a few things that must occur to turn the outlook bullish.

For one, sentiment is not nearly as negative as it was in either 2010 or 2011. The AAII survey of individual investors has risen from 22% a few weeks ago to back over 30%. The financial newsletter writers have never gotten very bearish since the April highs, and are currently 39.4% bullish.

As I said in last week’s column, I am still comfortable with the decision to lighten up the equity position in the Charts in Play Portfolio (click here to look at the current portfolio).

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The NYSE Composite closed the week above the 61.8% Fibonacci retracement resistance, with more important resistance to follow at 8,000 to 8,098, which is the 78.6% resistance level. A close above this level will confirm a new uptrend.

The NYSE Advance/Decline line turned up sharply Friday, but is still within its trading range and below its recent highs, while prices are higher. The WMA of the A/D line is still rising gradually, and it would take a decline in the A/D line below the last two lows to start a new downtrend. There is important A/D line support at line d.

For the NYSE, the minor support at 7,700 held last Thursday. More important support waits at 7,540.
 
S&P 500
Spyder Trust (SPY) closed Friday well above the 78.6% Fibonacci retracement resistance at $138.98, and the next resistance stands in the $140 to $142 area.

As SPY has made higher highs since early July, the S&P 500 A/D line has formed lower highs (see arrows). Even with Friday’s strong action, the A/D line is still below its previous peak and its slightly declining WMA. The A/D line needs to move convincingly above the downtrend (line h) to signal a new intermediate-term uptrend.

A drop in the A/D line below last week’s lows would turn the outlook negative, as it would create a clear pattern of lower lows and lower highs. There is minor support now at $137.50 to $138, with the 20-day EMA now at $136.49.

NEXT: More Stocks and Tom's Outlook

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Dow Industrials
The SPDR Diamonds Trust (DIA) closed last week at trend line resistance (line a), with resistance from the May highs at $131.85 to $133.14.

The Dow Industrials A/D line is still well below the July highs and the longer-term downtrend (line c). This resistance is derived from the bearish divergence that formed at the early May highs.

The A/D line turned up sharply Friday, and could be starting a new uptrend, but it still needs to overcome its downtrend to turn positive.

There is initial support now at $128.42 (the 20-day EMA) and then at $127.51 which was Thursday’s low.

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Nasdaq-100
The Powershares QQQ Trust (QQQ) was the strongest last week, as it closed up almost 1.5%, as well as solidly above the prior three highs, which classifies as a bullish breakout.

The close on Friday above the 61.8% resistance at $65.29 makes the 78.6% resistance at $66.72 the next . major target. This also corresponds to the upper parallel resistance (line f) at $66.50 to $67. The May highs are next at $68.

The Nasdaq-100 A/D line held above the prior lows last week, and has turned up. It is still below its declining WMA and the prior high. The A/D line needs to move above its downtrend (line g) and the early July highs to turn positive.

For QQQ, there is first good support now at $64 and the 20-day EMA, with additional levels at $62.30 to $63.

Russell 2000
The iShares Russell 2000 Index (IWM) reversed sharply to the upside Friday, gaining over 2.6%, but it was still a bit lower for the week. There is substantial converging resistance in the $80 to $81 area, and then at $82, which was the July high.

The Russell 2000 A/D line (not shown) turned up Friday, but is still below its declining WMA. It needs to overcome the long-term resistance to indicate that it has bottomed.

There is support now at $76.20, with further levels in the $75.40 area.

NEXT: Sector Focus, Commodities, and Tom's Outlook

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Sector Focus
The iShares Dow Jones Transportation Average Index Fund (IYT) was up 2% on Friday, but still is badly lagging the action of the Industrials. It still needs a strong close above $94 to turn positive.

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Let's take a slightly different look at the sectors this time, courtesy of Stockcharts.com. This link will take you to a screen that has all ten of the major sector ETFs. This is a great way to get a quick look at what the sectors are doing.

I am focusing this week on just those sector ETFs that I have previously recommended. I will have a more detailed sector look this week.

The chart above shows the Select Sector SPDR Technology (XLK)and the Select Sector SPDR Consumer Staples (XLP), which both have made new rally highs. XLK was up over 2% on Friday, with XLP gaining 1.5%.

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The Select Sector SPDR Health Care (XLV) was up only 1.2% on Friday, but shows a very strong chart, as it is trading well above the April highs. The Select Sector SPDR Financial (XLF) was one of the strongest on Friday, gaining 2.5%. The chart shows that it is very close to breaking out above the resistance at $15.

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Crude Oil
The September crude-oil contract accelerated to the upside Friday, gaining over $4 a barrel, as the jobs number had traders hoping for increased demand.

There is important resistance now at $92 to $93.25 (line a). A close above this level should signal that the bottom in crude oil has been completed.

The daily OBV shows a pattern of higher highs after overcoming the resistance (line b).

Precious Metals
The SPDR Gold Trust (GLD) rebounded Friday, but still closed the week over 1% lower. The chart shows that GLD retested the breakout level (line c), which is an encouraging sign.

In last week’s article,I again discussed the seasonal pattern for gold to bottom in July. This analysis uses data going back to the 1970s.

Clearly, GLD needs to close above $158 to support my view that it has bottomed. The first good support now sits in the $151 to $152 area.

For the iShares Gold Trust (IAU), which I have also recommended, the key resistance level is at $15.90 to $16. Support for IAU now sits at $15.20 to $15.40.
 
The Week Ahead
Last week’s action has not clarified the short-term outlook for the stock market, while my longer-term outlook remains positive. I have been looking for a strong market in the last half of the year, but so far the technical readings have not yet confirmed that stocks are trending higher.

Until the outlook turns more bullish, I am comfortable with 55% commitment to the market, and have raised my stops further to protect against a downward reversal. I have been selectively recommending a few stocks and ETFs, because of my current market outlook, and also because I will be out for the last half of the month.

As I suggested last week, if you are not in the stock market but want to start adding some exposure, I would do some gradual buying in ETFs or even a low-cost fund. A dollar-cost-averaging approach would probably be the best, especially with a firm that does not charge commissions on ETF purchases.

This week’s action supports my view that stocks could be 8% to 10% higher later in the year, so stocks should still be a part of your portfolio.

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