The Week Ahead: Is the Correction Really Over?

06/07/2013 10:00 pm EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

Despite a solid late-week bounce, the charts and sentiment numbers really don't support another rally at this point, says MoneyShow's Tom Aspray. He shares the key levels he's watching that could predict a deeper correction, and suggests a few plays to concentrate on once the fog clears.

Stocks rebounded late in the week, but only after the averages broke a few levels of support that many thought would hold.

The indexes did close the week higher, and well above the worst levels, as the S&P 500 did break under the 1,600 mark during the week. The Dow also had its best day since the first of the year.

The market did get quite oversold by Wednesday's close. The McClellan oscillator dropped to -311, which was its lowest reading since November 23, 2011. It was my analysis then that we were near a short-term low, but still thought it would take another drop before the correction was over.

Just like then, a break of last week's lows is still possible. This is based on technical analysis, as well as the length and power of the rally so far in 2013. The Spyder Trust (SPY) was down over 5% from the May high to last Thursday's low, but the drop so far has only lasted ten days, and a three- or four-week correction would be more typical.

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The huge reversal in the Japanese markets over the past two weeks has certainly gotten the world's attention. The Nikkei-225 futures were up over 47% for the year on May 22, but by Thursday's close had corrected to just +16%.

This has corresponded with weakness in the yen. Yen futures had dropped over 16% before rebounding, but are now only down 11% for the year.

Japan ETFs have been hit hard; the iShares MSCI Japan Index Fund (EWJ) has retraced over 50% of its rally from the 2012 lows. This is also the case for the Wisdom Tree Japan Hedged Equity (DXJ), which peaked at $53.50 and hit a low last week of $42.

The latter is my favored play for investing in Japan...and I think that this is just a correction. I expect the Nikkei-225 to resume its uptrend and the yen to fall considerably more over the intermediate term.

The reversal in the Japanese markets and the correction in other global markets was based in part on fears that the Fed would stop its accommodative policy as rates have moved higher.

Last week, I noted that T-Bond yields had completed a reverse H&S bottom formation, which projects even higher yields, but that does not require a change in Fed policy. This has put additional pressure on bondholders, who get more worried as there are signs of economic improvement.

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As the chart shows, the total return from investment-grade corporate bonds has dropped from 2% in early May to -1% now. With yields expected to move even higher, bond prices have further to fall, and will reach a point where stocks will look even more attractive.

NEXT: What to Watch

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Markets typically correct during times of uncertainty, and further fears over what the Fed will or will not do have helped to reduce the too-high bullish sentiment.

It has been my view since April 12 that the stock market had gotten too far ahead of the economy, and that a correction would help to bring stock prices back to reality. This process is now underway, so there will be some good buying opportunities as we head into the summer months.

Meanwhile, bearish sentiment has increased, but it can still move higher before it reaches levels normally associated with a market low.

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The most negative news last week was the ISM Manufacturing Index, which dropped below the 50 level, indicating a contracting economy. This is not consistent with many of our other measures, but we would not want to see several consecutive readings below 50. Of course, the big hurdle was the jobs report, which was a big positive for the market.

The important economic data comes at the end of this week, with jobless claims and retail sales on Thursday, along with business inventories. Then on Friday we get the latest reading on inflation with the producer price index, as well as industrial production figures.

What to Watch
Despite a powerful rally after the jobs report on Friday, it could not reverse the momentum from the negative weekly close the previous week.

Last week, I was expecting further selling this week, but was looking for a bounce in the S&P 500 "from the 1,585 to 1,600 level." The S&P 500 did reach a low of 1,598, but then closed the week at 1,643.

With most of the averages up over 1.2% for the day, the market internals were not even 2:1 positive. So the first few days of the coming week will be important, as a review of the technical studies still indicates the rally will fail in the 1,650 to 1,660 area.

In last Thursday's Should You Buy This Dip?, I reviewed the daily technical studies, which revealed that they had broken their support and were now below their declining WMAs. This is consistent with a further correction.

The percentage of bullish individual investors saw a sharp drop, to 29.4%, with almost 39% now bearish. Financial newsletter writers are also less bullish now, down to 45.8% from 52.1%.

The number of NYSE stocks above their 50-day MAs, as discussed in a recent Trading Lesson, peaked near 78 at the May highs, but dropped down to the 48 level last week, relieving the overbought condition.

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The March high in the NYSE Composite, at 9,144, held last week, although the index came quite close to its daily Starc- band, which is now at 9,063. The weekly Starc+ band sits at 8,965, and the 38.2% Fibonacci retracement support from the June 2012 lows follows at 8,757.

The McClellan oscillator rallied back to the -114 level by Friday. In an oversold bounce, it could reach the 0 to +50 level.

The daily NYSE Advance/Decline line dropped below its WMA on May 23, then violated its uptrend (line c) last week. The daily WMA is now clearly declining, as the A/D line has just rebounded back to its uptrend.

NEXT: Stocks

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S&P 500
The weekly chart of the Spyder Trust (SPY) shows that it exceeded the trend line resistance (line a) from the 2010 and 2011 highs last month, and the weekly Starc+ band was also reached. It did manage to close the week just under 1% higher.

The low for the week was $160.71, so the more important support at $159.71 and the April high has held. The rising 20-week EMA is now at $157.60, with the minor 38.2% retracement support (not shown) at $155.94.

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The weekly on-balance volume (OBV) has turned up from its WMA, which is a positive sign, and could mean that the correction is already over. There is long-term OBV support at line c.

The daily S&P 500 A/D line and OBV (not shown) are still below their declining WMAs despite the rally at the end of the week. The close Friday was just above the flat 20-day EMA, with further resistance at $165.10 and then $166.30.

Dow Industrials
The SPDR Diamond Trust (DIA), after triggering an LCD the previous week, was able to close the week with nice gains, and well above the low of $148.31. The early April highs also held for the DIA, while the monthly pivot support now sits at $147.64.

The weekly relative performance broke its uptrend (line e) before moving back above its flat WMA. The OBV dropped down to test its WMA, but closed the week higher.

The daily Dow Industrials A/D line (not shown) has turned up, and did hold above its uptrend. Resistance for DIA now waits at $152.91 to $153.73.

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Nasdaq-100
The PowerShares QQQ Trust (QQQ) closed the week pretty much unchanged after breaking the prior four weeks' lows. The low of $71.47 was not far above the September high (line a) of $70.58. The rising 20-week EMA is now at $70.27.

The weekly relative performance is holding above its slightly rising WMA, and is trying to bottom. The weekly OBV closed the week back below its WMA, and is close to support (line c). A decisive break of this level would be negative.

The Nasdaq-100 A/D line (not shown) has turned up sharply, but is still below its WMA. The next resistance now waits at $73.82 to $74.21.

Russell 2000
The iShares Russell 2000 Index (IWM) dropped to a low of $95.73, violating the monthly pivot at $96.65 before closing the week higher. A retest of the breakout level (line d) would take IWM as low as the $94.24 area.

The weekly relative performance did not confirm the recent highs, as it formed lower highs (line e). It is still above its WMA. The OBV looks much stronger, as it has turned up after testing its uptrend (line f) and its rising WMA.

The daily OBV has also moved back above its WMA, so both are positive. The Russell 2000 A/D line closed the week below its WMA, and held above its uptrend last week. There is next resistance in the $99.20 area.

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

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Sector Focus
The iShares Dow Jones Transportation (IYT) closed the week up almost 1%. It was covered in detail in last Friday's report, along with two of its strongest industry groups, the airlines and transports.

The table below shows not only the percentage change for the past week, but the past two weeks. It shows that the Select Sector SPDR Utilities (XLU) and Select Sector SPDR Consumer Staples (XLP) were the weakest, down 2.1% and 3.2% respectively over the past two weeks.

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Meanwhile, the Select Sector SPDR Technology (XLK) was up slightly last week and flat for the past two weeks. The Select Sector SPDR Financial (XLF) was up 1.2%. The Select Sector SPDR Industrials (XLI) and the iShares Russell 2000 Index (IWM) were the only other higher closes over the past two weeks.

The daily chart of the Select Sector SPDR Financial (XLF) shows what may be just a short-term corrective pattern, as XLF bounced from the lows at $19.22 and the daily Starc- band.

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The daily relative performance has turned up from its WMA and shows a pattern of higher highs. The OBV has also held up well, and is fairly close to making new highs. The weekly RS and OBV analysis are also strong, closing the week at new highs. The weekly Starc+ band is now at $20.73.

Crude Oil
Crude oil closed the week strong, as it was up over $4 per barrel and volume increased nicely. Next resistance, basis the August contract, is at $97.38 to $98.22. The weekly OBV has also turned up once more.

Precious Metals
The gold futures were hit hard on Friday, and it looks like another wave of selling is underway. A break below the recent lows (line d) of $130.66 in the Spyder Gold Trust (GLD) would be quite negative. The daily OBV shows no signs yet of bottoming.

The Week Ahead
The market should tell us by the middle or the end of the week whether we are going to see a further correction, or if the correction is over. If we are going to break out to the upside, I would expect the market internals to get better. They were not that impressive on Friday.

The sentiment does not seem to be negative enough to me to support another full-fledged rally phase. Instead, another few weeks of worry about what the Fed might do or about the health of the economy should be enough to turn the majority more cautious. This would be a positive sign for the stock market.

I hope you have take the time to get your portfolio ready for the summer, and especially have shortened the majority of your bond portfolio, as rates moved higher again last week.

If I am wrong, and the correction did end with Thursday's lows, I will be looking at the financial and technology sectors for new buying.

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