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Market Sending Mixed Messages


•  Last Friday, the S&P 500 ETF (SPY) broke through resistance at its previous All-Time High (ATH)

•  Traders had not expected this so quickly, but the S&P 500 index itself ($SPX) has still not broken through its ATH

•  Momentum is declining for the S&P 500 index, the NASDAQ index, and other key indices

•  Was the SPY breakthrough a fluke – or the beginning of a new leg of the bull market? We examine the data...

Last week closed with the SPDR S&P 500 ETF (SPY) ending the Friday session at 285.06, setting a new all-time high (ATH). This may have shaken up our thesis from last week in which we postulated that SPY would pull back further after bumping up against the same level as its January 26 all-time high the week before last (Friday, August 10).  See our mid-week blog post, "Has the S&P 500 Formed a Bearish Double Top?"

Typically, the level of a prior all-time high – especially after a volatile, seven-month correction – will serve as resistance for at least a week or two. After returning to a previous all-time high, stocks usually pull back a bit to a lower level of support while additional buying power builds just below the ATH level. We postulated that this lower level of support would be the 20-week moving average, around the 274–276 level. We also said that we expected the prior all-time high to be broken in the coming week or two and that a 'bearish double top formation' would NOT occur.

However, last week the S&P 500 ETF pulled back near its 10-week EMA at about 280 on Wednesday, and then returned to its highs by the end of the week – in the process setting a new All-Time High when it closed on Friday at 285.06. The prior high on January 26 was 284.16, and Friday's close was just 0.32% above that level.

Chart 1 below shows this breakout to a new ATH on Friday with a yellow highlight and a green arrow in the upper right corner (click to enlarge).

S&P 500 Analysis
Chart 1: The SPDR S&P 500 ETF (SPY) may have surprised us last week with an unexpected breakout above its prior all-time high, which usually serves as resistance for at least a while (click to enlarge).

Is it possible that the difference of 0.32% is an erroneous trade and stocks will indeed pull back again to a lower support level? Yes, it is possible. Especially so because momentum is declining rather than surging as usually occurs at the breakthrough of a prior ATH. Notice that the Market Trend Indicator in the lower window of Chart 1 above is weakening a bit.

However, chart-watchers should keep in mind that the S&P 500 index ($SPX) itself, upon which the SPDR S&P 500 ETF (SPY) is based, has not yet even reached the all-time high that it set on January 26 at 2872.87. In fact, the S&P 500 index is currently (UPDATE Monday, Aug. 20) at 2857.05 - 0.55% below the all-time high set last January 26. So for the underlying S&P 500 index itself, resistance has not yet even been reached. This is actually a somewhat unusual situation to have such a large discrepancy between the S&P 500 ETF and the underlying S&P 500 index.

Chart 2 below shows the S&P 500 index ($SPX) that is the basis for the SPDR ETF (SPY) that was analyzed above. We shall see in the next few days as this small gap closes up what will happen in the market. Whatever develops is going to be the overriding driver of stock prices in the near term.


Chart 2: The S&P 500 index ($SPX), which is the basis for the S&P 500 ETF above (SPY) has not yet broken through – or even met its prior all-time high set January 26.


This brings us to Chart 3 below, which shows the NASDAQ index ($NDX) - the US stock exchange for market leaders such as Apple, Facebook, Amazon, Netflix, and many more - may be forming a textbook Double Top at 7500 (upper right, red dotted line). The NASDAQ index also made an all-time high on the Wednesday before last (August 8).

In the lower window of Chart 2 below, you can see that the Price Momentum Oscillator (PMO) has been declining since late June, indicating that the index is losing upward momentum, and that decline may be accelerating. (Click the chart to see a larger version.)


Nasdaq Chart Analysis
Chart 3: The NASDAQ 100 Index ($NDX) may have a textbook double top in place at 7500. A potential textbook 'Head and Shoulders' formation is also possible (click to enlarge).


However, there are two substantial support levels at the 40-week EMA (green dotted line) and a support level just below 7200 (blue dotted line) that, if broken, will be a reason to watch for a continued and perhaps accelerating decline of this index.

We've identified a potential left shoulder in blue on Chart 2 above, and the blue dotted line at about 7200 will become the 'neckline' of a head and shoulders formation should the two support levels be broken, and NASDAQ stocks continue downward.

Chart watchers have also identified a similar, potential 'Head and Shoulders' formation in the S&P 500.  If you'd like to learn more about 'Head and Shoulders' chart patterns, there is an excellent article in the ChartSchool at StockCharts.com.

Indices such as the Russell 2000 (small-cap stocks), the Dow Industrials, and critical sectors such as Financials are all showing flattening charts with declining momentum. On the other hand, the market-leading Technology sector (XLK) continues on its near-straight-line upward trajectory.


Keep in mind that our quantitative strategies never take into consideration the subjective identification of chart patterns such as 'head and shoulders' formations. Instead, from a technical perspective, our strategies identify critical technical levels and essential moving averages, that, when combined with other technical readings, and a plethora of important fundamental criteria - from as many as 38 critical data sets - will provide high-probability signals for increased risk when it occurs.

When our strategies identify that risk has increased, each strategy will pull back in the way that's appropriate for its holdings. For example, some strategies will sell leveraged-long positions and move to non-leveraged long positions. Other strategies will switch from long positions to a cash-proxy holding, such as the iShares 1-3 Year Treasury Bond ETF (SHY).

When a bear market does begin, some strategies will switch to inverse positions while others will hold cash, and if conditions become extremely negative - such as occurred during the Financial Crisis, some strategies will switch to a -2x Leveraged Inverse ETF while others, more conservative, will continue to hold cash.  Each strategy has a carefully-design system to automatically reduce exposure when risk conditions increase, and some of the more aggressive strategies will produce significant profits as the market declines by rotating to the optimum inverse position for conditions.  However, we're probably quite a ways from that taking place.


The reason that we sometimes provide a chart analysis to accompany weekend strategy updates, or perhaps a blog post such as the blog post we published this past week, is that investors want to have an idea of what to expect in the future. We find that our subscribers are more likely to stick with their positions if they are not caught by surprise by unexpected trades by their strategy.

For example, if a strategy downshifts to less-risky, a neutral, or even an inverse position, we find that our subscribers appreciate knowing why these changes are taking place. Hence, we provide the occasional market analysis to keep you abreast of changes.

At this point, stocks are still in a bullish uptrend, and while momentum is declining, no critical support levels have been broken. In fact, just the opposite - as the S&P 500 ETF set a new all-time high last Friday.


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