The Week Ahead: Why Building the Wall of Worry Is Bullish

03/20/2015 5:00 pm EST

Focus: MARKETS

Thomas Aspray

, Professional Trader & Analyst

Some technicians are still concerned it's been too long since a larger correction, but MoneyShow's Tom Aspray argues that the uptick in bearish sentiment was needed and is consistent with his buy the dip strategy as the market is now ready to move higher.

The several weeks of concern over the FOMC meeting disappeared quickly after the FOMC announcement Wednesday as the S&P futures rose 25 points in just 15 minutes. The correction had been relatively mild as the Spyder Trust (SPY) lost just 3.7% from high to low.

Still, the negative sentiment seemed rather high as the irrational fear over the impact of a rate rise on the stock market did trigger some misguided selling. In last week’s column Don’t Get Fooled Again, I took a technical look at how stocks have often risen along with rates since 1998.

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Technically, the S&P 500 just corrected back to good support as the daily starc- band was tested on March 10 and 11.  Also, the initial monthly pivot support at 2042.83 was tested as the correction low was 2039. This low was just between the short-term 50% and 61.8% Fibonacci retracement support levels.

As I discussed in last Thursday’s Hope You Patiently Bought the Dip, the evidence is already emerging that the correction is over and a strong close Friday will further support this view.

The recent pullback was just a minor blip on the wall of worry that his been impacting the stock market since the 2009 low. The 9.8% decline from the middle of September 19 to October 15 was more frightening for most. The markets then were worried about a global economic slowdown thanks to the IMF’s cut in its global growth forecast, the increase in Middle Eastern conflict, and the fears over spreading Ebola epidemic.

Juts a few days before the October low, one analyst told an audience that the increasing Ebola epidemic was a reason to get out of all stocks. The Dow was down over 450 points on October 15, but with the following Friday’s gain of 263 points, there were already signs that decline was over.

Though some technicians are still concerned that it has been too long since a larger correction, I would make the argument that these short-lived corrections still add small bricks to the wall of worry. The needed increase in bearish sentiment (Calling All Bears) sets the stage for a resumption of the market’s uptrend and it helps the bull market last longer.

Sometimes this change in investor sentiment is evident from the AAII survey, but not always. From February 19, the bullish% dropped from 47% to just 27% last Thursday. The strategy to buy the dip and hold onto longs was supported by the fact that there were no signs of a significant correction from the market internals.  There will, of course, be a more significant correction, maybe this year, but is likely to come from higher levels.

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There are still plenty of active arguments on the wall of worry. Just yesterday, I heard an analyst comment that a major bear market and recession were likely next year. His argument was that everyone was fully invested and asset levels were too high. Others think that because the Nasdaq Composite is finally back to the 2000 highs, the bull market has to be topping out.

Both seem to be ignoring the evidence presented in this chart from the Investment Company Institute and the WSJ. It reveals that cash has been steadily flowing out of US stock funds since well after the bear market was over. This is in sharp contrast to how much money was moving into stocks funds prior to the 2000 top. This provides further evidence there is still plenty of cash on the sidelines to power the market higher.

On the same panel, another analyst shared his opinion that there was no relationship between the economy and the stock market. I hope those of you who read Avoiding Bear Markets have a different understanding of the relationship as a top in the stock market often warns in advance of a recession.

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As I noted in that article, one of my favorite economic indicators, the Leading Economic Indicator (LEI), generally tops out well in advance of a recession. It will often confirm the warning signs from the NYSE A/D line that a bull market is topping out.

Last Thursday, the Conference Board reported that the LEI rose 0.2% in February. That followed a 0.2% gain in January and 0.4% rise in December. The chart shows that the LEI is still in a strong uptrend.


NEXT PAGE: What to Watch

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A long-term look at the asset classes since the March 2009 bear market low shows how the Spyder Trust (SPY) has been the outperformer as it is up over 204%.  Though the iShares MSCI Emerging Markets (EEM) is up over 89% during the same time period it has been flat for the past two years.

The SPDR Gold Trust (GLD) and the iShares 20+ Year Treasury Bond (TLT) have been lagging the US stock market as they are up 22.8% and 25% respectively. Yields reversed to the downside with the FOMC announcement and the yield on the 10-Year T-Note is back to the 2.00% area as I suggested last week.

The economic calendar is full this week starting on Monday with the Chicago National Activity Index and Existing Home Sales. On Tuesday, the Consumer Price Index will be released along with the flash PMI Manufacturing Index, New Home Sales, and the Richmond Fed Manufacturing Index.

The Durable Goods are out on Wednesday and are followed by the flash PMI Services Index on Thursday. The final 4th quarter GDP comes out on Friday along with the Consumer Sentiment.

What to Watch
It appears that the correction is now over, though we may see a short-term pullback this week but more new highs are expected in the weeks ahead.  The correction in the S&P 500 was less than 4%, pretty much as I expected.  Since earlier in the month—Does Your Portfolio Need Adjusting—I have been advocating buying on the dip and many of the buy zones have been hit.

We managed to ride out the correction without being stopped out in our positions in the Spyder Trust (SPY) or the iShares Russell 2000 (IWM), which were established at the lows from early in the year. New longs were also established in the PowerShares QQQ Trust (QQQ) as well as the EuroZone ETFs.

Our positions in the semiconductors are also doing well as the Market Vectors Semiconductor (SMH) had a classic correction before turning higher last week. I have also been recommending stocks in the healthcare sector as the XLV is up over 9% already this year.

There are still quite a few stocks that are still completing their corrections and I will be looking for additional buy candidate or those that have formed bullish reversals.

The CNN's Fear and Greed Index was in the Extreme greed territory one month ago, but was back in fear territory last week. As I have mentioned before, though I do not necessarily agree on how the index is constructed, it is sometimes interesting to watch.

I noted last week that some of the weekly studies were close to important support, which made the close this week important. Clearly, the strong close has caused further improvement in the technical studies but not all are confirming prices. Therefore, higher prices again this week could get the volume indicators back to positive levels. The daily A/D lines do look strong.

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Another very strong weekly close will increase the odds that stocks can melt up as suggested last month. One of the indicators that has improved is the % of S&P 500 stocks above their 50-day MAs as it bottomed out at 50.96% on March 13. The five-day MA has turned up from one standard deviation below the mean, consistent with the end of the correction.

The NYSE Composite dropped 30 points below the monthly projected pivot support (credit to John Person) and was below the daily starc- bands before it bottomed out. The correction took prices close to the quarterly pivot at 10,597.

The strong weekly close is impressive as it is just barely below the February high and the long-term resistance at line a. The weekly starc+ band is now at 11,571 and an upside breakout has targets in the 11,800-12,000 area.

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The 20-week EMA is now at 10,857 with the 20-day turning up and a bit higher at 10,922.

The weekly NYSE Advance/Decline will turn up this week after holding well above its rising WMA. There is good trend line support now at line d. The A/D line did make a new high at the end of February.

The daily A/D line (see chart) just tested its long-term uptrend on the correction and has moved back above its WMA, which is starting to flatten out.

The weekly OBV is still below its WMA but has turned up after holding above the prior lows. The OBV has long-term support at line e.

NEXT PAGE: Stocks

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S&P 500
The Spyder Trust (SPY) dropped back to the rising 2- week EMA before closing higher last week. The correction low at $204.40 was well above the monthly projected pivot support at $201.60.

There is initial resistance now at last Wednesday’s high of $211.27 with the all time high at $212.24. The daily starc+ band is at $213.35, with the weekly now at $218.61.

As I noted last week, the S&P 500 A/D line was forming a bullish zig-zag formation. It is now well above its WMA, which is starting to turn higher.

The weekly on-balance volume (OBV) did not confirm the most recent highs as indicated by line c. The OBV has to move above its WMA and the previous high to get back in gear with prices. The daily OBV has just moved above its WMA.

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Dow Industrials
The SPDR Dow Industrials (DIA) has already moved above last Wednesday’s high as it held the 50% support on the recent correction with a low of $176.23. It is positive that it did not come close to the monthly projected pivot support at $173.45.  

The weekly relative performance could be in Phase 1 of my RS analysis that was discussed in last week’s trading lesson. As I detail in the lesson, a move above the recent highs and the downtrend line f, would signal that it is a market leader (Phase 2).

The weekly OBV looks much stronger on DIA than it does on the SPY as it has moved back above its WMA as volume picked up last week with the higher prices.

The Dow Industrials A/D line (not shown) needs a strong close in the next few days to break its downtrend.

Nasdaq 100
The PowerShares QQQ Trust (QQQ) just dropped slightly below the monthly pivot at $105.70 as the low was $104.68 on Friday, March 13.  The daily starc- band was tested for several days before the bottom was in place.

The daily starc+ band is now at $109.68, which is just above the all time high. The weekly starc+ band is at $114.21, which is a reasonable upside target.

The daily Nasdaq 100 A/D moved back above its WMA last Monday and has reached its all time highs. Therefore, new highs are likely this week and the strength of the A/D line is positive.

The daily OBV is now well above its WMA and is not far below the December highs. The weekly OBV still shows a multiple month negative divergence.

The 20-day EMA and initial support is now at $107.10.

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Russell 2000
The iShares Russell 2000 (IWM) continues to lead the other major averages as it is outpacing the SPY by over 2% so far this year. It has moved well above the February highs with the daily starc+ band at $126.93 and the monthly projected pivot resistance at $129.09.

The IWM held above the monthly pivot at $120.11 on the recent correction and the rising 20-week EMA now at $119.22.

The daily Russell 2000 A/D line broke above its resistance, line f, a week ago which was a bullish tell. It made me a bit more confident that stocks would move higher after the FOMC meeting was out of the way. The weekly A/D line (not shown) has also confirmed the new highs

The daily OBV surged above its resistance, line h, on Tuesday, which was a quite bullish sign. It has moved even further above its WMA, which is now clearly rising. The weekly OBV has also broken out to the upside.

We are long the SPY and  IWM from our January recommendation and added QQQ on the recent correction. The stops were updated last Thursday in Hope You Patiently Bought the Dip.

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

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Sector Focus
The iShares Dow Jones Transportation (IYT) was up over 2% for the week and is now slightly positive for the year. It looks ready to breakout of the recent trading range I discussed recently in Diverging Transports Not a Concern yet.... This, of course, would reaffirm the positive signals from the Dow Theory that some were concerned about.

The daily RS analysis suggests that IYT is close to resuming its role as a market leader. It did start to turn higher before the rest of the market, which is positive.

Most of the sector ETFs regained much of their losses from the recent correction. The big winner was the Select Sector Health Care (XLV) as it was up over 4% for the week. I reviewed the technical outlook for XLV last week.

The Sector Select Technology (XLK) was up 2.6% last week and is now up 3% for the year. It is still behind the Select Sector Consumer Discretionary (XLY), which has a yearly gain of 6.3%.

The Select Sector Utilities (XLU) and Select Sector Energy (XLE) also improved last week as XLU was up over 3% and it triggered a weekly HCD buy signal on Friday. The XLE was also up close to 3%.

The Select Sector Consumer Staples (XLP) is just barely positive for the year while the Sector Select SPDR Financial (XLF) is a bit lower.

The Select Sector Material (XLB) was down for the week, but is up 1.4% for the week.

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Interest Rates
The yield on the 10-Year T-Note closed the week below 2.00% last week confirming my view that a low was not in place yet. I will be watching the action over the next few weeks closely to see if there are any signs of a real bottom.

Crude Oil
Crude oil prices rose over 4% last week, which is an encouraging sign. I doubt now that crude will break to significant new lows. There are some positive signs from the daily studies on the energy stocks, which could really help the overall market.

Precious Metals
Both the SPDR Gold Trust (GLD) and the Market Vectors Gold Miners (GDX) closed the week higher. The daily studies are still negative and are not yet indicating that a tradable low is in place.

The Week Ahead
The action last week was quite positive as those who went short ahead of the FOMC meeting were hit quite hard. The market bears are getting quite inventive pointing to the Ides of March and some obscure technical reasons. Some who have been negative on the market for the last year or more are now worried what will happen when the Fed does raise rates. One can always find and excuse to stay out of the markets, but a rate increase is likely not imminent.

It does appear that the market has ended its short-term corrective mode. The Nasdaq Composite looks ready to close above the 5000 level. The better relative strength of the small-cap stocks is positive as they rarely lead the market higher if the market is forming an important top.

Last week's action has supported the view that many stocks were just undergoing normal corrections. Focusing on market leading sectors and stocks still seems like the best approach.

For those of you who want to get more invested, there should be some good buying opportunities in the weeks ahead. Those who were underinvested should have done some selective buying over the past few weeks.

As I said last week, if you are in bonds, there is no clear reason yet to modify your bond portfolio at this time. Also, I am not convinced that the precious metals have bottomed.

Don't forget to read Tom's latest Trading Lesson,
The Ultimate Stock Picker's Secret.

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