The S&P 500 finally broke out last week, completing a bullish, inverse head-and-shoulders (H&S) formation. This breakout follows completed bases by many other major indexes including the Dow Jones industrial average, Nasdaq composite index, Dow Jones Transportation index, and S&P MidCap 400 index.
Drilling down to the sector level, we have seen breakouts in the industrials, technology, consumer discretionary, consumer staples, and telecom. Utilities and financials are very close to breaking out, and it is probably just a matter of time.
Not to be left out, European and Asian stock markets broke out late last week, as well as emerging market indices. Besides the drubbing in commodity prices and their respective stocks, what’s not to like?
Based on the width of the 500’s H&S pattern of 122 points, we could see a measured move up to the 1517.47 level, and potentially further. However, before we get too excited, there are a handful of technical resistance points that the index will have to muscle through. The toughest equation right now, as far as resistance is concerned, is the big rallies last year off of the 1407 level. In one case, the rally extended all the way to the all-time highs of 1565 level.
This zone of chart resistance is heavy, so we do not envision cutting through this layer like a hot knife through butter. There were actually three rallies last year, two that started below the 1400 zone, with all of them running up to at least the 1520 area. Investors who still hold stock after buying into those rallies were dead wrong on the market, and represent overhead supply. We think that it will take time and volume to eat through this supply of stock.
On a more short-term perspective, a 50% retracement of the major correction targets the 1419 level, while a 61.8% retracement equates to a rally to 1454. The S&P 500 has rallied just above the 65-week exponential average as well as the 80-week exponential average. These longer-term averages many times represent key resistance during a major correction or bear market. The 200-day simple average sits up at the 1433 level. So, as you can see, there is a lot of overhead to deal with, however, we think the real heavy lifting has already been accomplished and that the intermediate-term trend is now firmly higher.
The U.S. Dollar has bounced recently, and with it, a loud pop was heard in the commodity markets. The leaders of the market since January, and also long-term leaders, got whacked at the knees. Over the last eight trading days (as of the close of trading May 1), agricultural products plunged over 10%, oil & gas sub-industries dropped anywhere from 7% to 9%, chemicals fell over 6%, with oil and gold prices getting hit hard. Fortunately, this rotation out of weak dollar beneficiaries helped many other areas of the stock market, and mostly those that have been lagging for some time. In the same 8-day period, healthcare facilities soared over 20%, wireless telephone rose over 12%, consumer finance jumped over 12%, food distributors and food retail rose over 10%, airlines climbed about 10%, and commercial banks went up about 9%.
Is it time for the long-term leaders of the stock market (since 2000) to pass the baton to the sub-industries and sectors that have gotten beaten down the most during the major correction that we just went through? Probably, at least for the near- to intermediate term. However, before we call the end to the long-term bull market in commodities, we will have to call an end to the bear market in the U.S. Dollar. We think it is way too early for that major counter-trend call. In addition, sectors like financials and consumer discretionary have fallen so far and for so long that there is a mountain of overhead resistance that must be worked through, and this will take many, many months, in our view, so these sectors are not likely to be leaders from a long-term perspective.
The U.S. Dollar index has seen a very minor bounce from about 71 to about 73.5. To put this rally into context, the U.S. Dollar index was at 120 in early 2002, and except for a pretty strong counter trend rally in 2005, the dollar has consistently headed south. In the near term, we think the Dollar index could rally up to initial chart resistance in the 75 to 78 area before another move to the downside. There is also major trendline resistance in this area. Longer term, even if we have seen the lows for this bear market in the dollar, we are fairly certain that before there is any major upside or major reversal in the trend, the index would have to put in a very large base of many months, most likely years given the size of the decline as well as the length of the decline.
We have said many times near market bottoms, that for equities to turn higher with any conviction, sentiment would also have to become more bullish. We are certainly seeing that of late, and as money comes in from the sidelines, and opinions change from extreme bearish back to bullish, this just adds fuel to the rally. Investor’s Intelligence poll of newsletter writers has seen a big shift in sentiment recently, a bullish sign, in our view. Over the last six weeks, bullish sentiment has increased to 40.9% from 30.9% while bearish sentiment has declined to 31.8% from 44.7%. This is the second largest decline in bearish sentiment over a six-week period since 2002 and 2003.
Bullish sentiment on the MarketVane poll has increased to 51% from 42% in the last seven weeks. Put/call ratios have dropped as investors have dumped their bearish put positions and have accumulated bullish call positions. The 5-day equity-only put/call ratio has fallen to 0.67 from a record 1.09 in mid-March. The 10-day CBOE put/call ratio has dropped to 0.97 from 1.28 in mid-March.
This unwinding in bearish sentiment should continue, in our view, as the overall sentiment picture is nowhere near the frothy or excess bullish levels we have seen at intermediate-term or long-term market tops.