June 11, 2013
Chad Karnes, Chief Market Strategist
Is the recent weakness in stocks just another dip buying opportunity or is something larger looming?
The technicals suggest that something larger is brewing, and I am watching a few key things to tell me if indeed we are seeing a significant market top.
Are Technicals about to Align with the Fundamentals?
On June 7 in a piece titled, “The Earnings Game," I wrote an article outlining why investors should be cautious of the current fundamental picture and why price multiples are likely too high at current prices.
The longer term fundamental backdrop does not look favorable for stocks as earnings growth stalls, and now the technicals are getting close to confirming a longer term breakdown.
This article focuses on the current technical picture of the market, and is the second part to a four prong strategy we use at ETFguide.com. Fundamentals, technicals, sentiment, and most importantly, common sense, should all be involved in the investment decision.
The Short Term
In the 5/29 Technical Forecast, published twice a week, I outlined why selling a breakdown of the S&P at 1642 offered a high reward: low risk opportunity for short term traders:"
“With an expected target of 1600, the profit:loss should be around 3:1x.” The S&P (NYSEARCA:SPY) fell below 1642 on Friday, 5/31, and on 6/6 hit my initial target of 1600 for a quick few % profit."
This trade was suggested for more short term traders (NYSEARCA:SPXU), but it is still important for all investors as the cracks in a foundation always start off as small before they become larger.
The current pullback in price is already the largest since the rally that started in November 2012 kicked off. This in and of itself may suggest that something else indeed is going on, but there are other warning signs too.
A large part of technical analysis is recognizing trends that are in place and also recognizing when those trends change. One way to monitor trends is by following the market’s pivot points.
As outlined in our 6/2 Technical Forecast, this was the first time price (SNP:^GSPC) closed below its monthly pivot two days in a row. This is a warning that the technical trend may be starting to roll over.
Beyond the S&P 500 there are other technical warning signs of a market that has likely gotten too far ahead of itself.
In economics the stock market is considered one of the primary leading economic indicators. Similarly technicians like to look at commodity prices such as copper and lumber as leading indicators of the world’s fundamental backdrop. If copper and lumber prices are rising, demand outpaces supply, if they are falling, it doesn’t, and that could be troubling.
In an article I published on 5/15 entitled, “Timber!” when the Homebuilders ETF (NYSEARCA:XHB) was trading above $32 I warned that lumber prices had the bottom drop out of them in the previous month and were likely warning of a deteriorating housing (NYSEARCA:IYR) and homebuilding market. XHB has since fallen below $30 and is starting to confirm that warning sign from lumber prices.
IYR has fared even worse, down over 10% from its price peak 5/22.
Another industrial metal, copper (NYSEARCA:JJC), was a focus in our May Profit Strategy Newsletter and shown in the following chart. It too is warning of a major technical breakdown in worldwide copper prices.
Next Stop Is...
I am watching two key price levels to warn of a longer term trend change. For the S&P 500, the 1600 level is where a technical gap from May 3 resided and was filled last week. Thus far 1600 has held as support. If buyers don’t continue to step in there, then a final support level that needs to hold is a few percentage points below 1600, and is the key to the uptrend since November (reserved for subscribers).
Many investors may not care about the short term fluctuations of the market. But just like a storm brewing, it first must start out as a harmless rain shower, before suddenly morphing into a dangerous thunderstorm. Right now we are just in a rain shower. But if these two key technical levels fail, we may quickly find ourselves in a major thunderstorm.
The ETF Profit Strategy Newsletter focuses on fundamentals, technicals, sentiment, and common sense to follow the world’s markets. We publish a twice weekly Technical Forecast to stay ahead of key trends in the markets.
Twitter @ ETFguide