By: John Kosar of Street Authority
The major U.S. indices were mixed last week, closing on Friday just slightly on either side of unchanged. The tech-heavy Nasdaq 100 and small-cap Russell 2000 were the strongest performers. As long as the May trend of relative outperformance by these two market-leading indices continues, so should the current broad market advance.
The two strongest market sectors last week were consumer discretionary and utilities. My own asset-flow based metric shows that the biggest increase in sector bet-related assets over the past one-week and one-month periods was in utilities, which supports more upcoming strength in this sector.
A strengthening utilities sector is often driven by declining long-term U.S. interest rates, which we saw last week as the yield on the 10-year Treasury note declined by 9 basis points to 2.53%. This encourages yield-seeking investors to accept more credit risk (via utility stocks) in exchange for potentially higher returns. Therefore, as long as long-term interest rates continue to decline, it should drive more investor assets into utilities and buoy Treasury prices, which move inversely to yields.
Small Caps, Tech Should Continue Leading the Way
In the May 19 Market Outlook, I pointed out that the Russell 2000 had tested and held major underlying support at 1,083, saying: "As long as the Russell remains above it this week, I would view this level as a potential springboard for a new leg higher in the overall market."
Two weeks later, in the June 2 Market Outlook, I noted that the Russell was testing minor overhead resistance at its 50-day moving average, then at 1,137, following a 6% advance. I said, "It must make a sustained move above this minor trend proxy to clear the way for more near-term strength.
The chart below shows that the Russell has since broken 1,137 resistance and has also risen above 1,163, the 61.8% Fibonacci retracement of the index's March 4 to mid-April decline.
Since rebounding from 1,083 support on May 15, it has advanced 10%, while the positively correlated SP 500 has coincidentally risen by 5% during the same period. According to retracement theory, the Russell is now clear for an eventual retest of the March 4 high at 1,213.
In the April 28 Market Outlook, I pointed out that Google (NASDAQ: GOOGL) was positioned right on top of major support at its 200-day moving average and showed that previous instances of this had coincided with important bottoms in the stock in October, September and April of 2013. In that report I said that GOOGL's reaction to $516 would be viewed as a coincident or leading indication of the upcoming direction of the Nasdaq 100.
GOOGL has risen by 12% in the two months since then, and recently exceeded the 61.8% retracement of its March 7 to April 28 decline at $572.
Like the situation in the Russell 2000, this clears the way for additional strength in GOOGL and an eventual test of its March 7 high at $613. The positively correlated Nasdaq 100 has coincidentally risen by 9% during the same period.
Since technology and small-cap stocks typically lead the broader market both higher and lower, these two charts suggest the potential for more near-term strength in the SP 500.
U.S. Treasury Prices at a Key Decision Point
In the June 16 Market Outlook, I wrote that the iShares 20+ Year Treasury Bond (NYSE: TLT ) was testing its 50-day moving average as support while oversold. I said: "I view this as another potential near-term buying opportunity... as my work currently suggests the potential for U.S. 10-year Treasury yields to decline below 2.4% between now and year end as long-dated Treasury prices continue to rise."
TLT bottomed three days later on June 19, rose 3% into Friday's high and is retesting formidable overhead resistance at $114.62. As you can see on the chart, similar monthly oversold conditions coincided with near-term bottoms on March 7 and Dec. 31.
TLT's current position just below $114.62 overhead resistance and just above underlying support at the 50-day moving average, currently at $112.01, sets up an important decision point for the ETF from which its next significant directional move is likely to begin.
A sustained rise above $114.62 would clear the way for more strength, and would support our current expectations for a decline back to the 2.4% area in the yield on the 10-year note. Conversely, a decline back below $112.01 would clear the way for more weakness and a potential retest of major support at the 200-day moving average, currently at $107.46.
Putting It All Together
In last week's Market Outlook, I said, "Frothy investor sentiment warns of the market's vulnerability to a meaningful third-quarter correction." That situation has not changed and continues to warn of a pullback/correction between now and Labor Day, one that could be particularly nasty considering that the stock market has essentially moved straight up since November 2012.
However, as long as market leaders like the Russell 2000 and Google continue to rise and/or outperform the SP 500, it is too early to assume that a top is in place and a correction is imminent. Finally, keep an eye on TLT this week, as a strong rise in long-dated U.S. Treasury prices could represent a subtle defensive shift by investors that eventually leads to a stock market correction.
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