Why Wall Street Should Watch These Two Charts

Should you 'sell in May' this year?

by 4/26/2014 8:44:30 AM
Stocks quoted in this article:

Stocks spent most of the week blazing a trail higher, with the S&P 500 Index (SPX) extending its longest winning streak in seven months. The bulls were initially encouraged by a round of blowout earnings from high-profile names like Apple Inc. (NASDAQ:AAPL), and the week's batch of economic data was largely better than expected. However, the party came to a screeching halt on Friday, as escalating tensions between Ukraine and Russia took center stage, and the broad-market indexes erased their week-to-date gains. This week, Todd Salamone underscores the importance of round-number levels, and explains why we could remain choppy in the near term.

  • The two millennium levels in focus
  • The potential "head and shoulders" pattern on the radar
  • Rocky White dives into the "sell in May and go away" theory

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: Round-Number and Year-to-Date Levels
By Todd Salamone, Senior VP of Research

"With the SPX chopping between support in the 1,840-1,850 area and now potentially bound by overhead resistance at 1,900, the battle between bulls and bears rages on, witnessed by the action in the Wilshire 5000 Total Market Index (W5000 - 19,877.60) the past several weeks. This index touched the round 20,000 millennium mark on Feb. 28 for the first time ever. Since the end of February, it has been engaged in a brutal trading range, with 20,000 being touched on 15 of the past 26 trading days. Bulls and bears hope this consolidation is resolved soon, but with other major benchmarks flirting with key support and resistance areas, a breakout or breakdown could be far into the future, unfortunately ... the short-term trajectory could remain choppy, so trading opportunities should be actively sought on both the bull and bear side ..."
-Monday Morning Outlook, April 5, 2014

"$RUT & $COMP highs this week both around 2013 close...Round # support below, YTD B/E resistance above- not pretty"

"Wilshire 5000 20k area continues to pose major problems for bulls $W5000 $RUT $SPX $SPY #psychological barrier"

-@ToddSalamone on Twitter, April 25, 2014

If you are a technology bull, it isn't looking very good at the moment. A favorite among many investors, Apple Inc. (NASDAQ:AAPL), popped after announcing earnings and a buyback that equates to about 6% of its shares. But AAPL couldn't save the day for tech. Facebook Inc (NASDAQ:FB), Texas Instruments Incorporated (NASDAQ:TXN), and Netflix, Inc. (NASDAQ:NFLX) announced strong earnings and experienced positive initial reactions, but ultimately reversed, even as many sell-side analysts raised targets on FB shortly after earnings were released. Throw in negative reactions from Amazon.com, Inc. (NASDAQ:AMZN), QUALCOMM, Inc. (NASDAQ:QCOM), and Pandora Media Inc (NYSE:P), and it amounted to another disappointing week for technology bulls, as earnings seemed to be a potential catalyst to push the Nasdaq Composite (COMP - 4,075.56) -- a key tech benchmark -- above resistance.

However, last week's COMP high was 4,177, site of 2013's close and the index's year-to-date (YTD) breakeven mark. The high fell just short of the COMP's 80-day moving average -- a trendline that has been mostly supportive since this time last year, but has marked resistance on two separate rally attempts this month. This key moving average has "doubled" up with its YTD breakeven mark to create a formidable resistance level during this month.

A glimmer of hope for bulls is that the 4,000 level continues to be supportive. That said, it appears that there is the potential for a bearish "head and shoulders" formation if the neckline at 4,000 is broken. Therefore, if selling continues in the days ahead, key in to the 4,000 area, as a break of this level would leave the COMP vulnerable to a move to 3,600.

Daily Chart of COMP since March 2013 with 80-Day Moving Average, YTD Breakeven, and Round-Number Support
Chart courtesy of StockCharts.com

Meanwhile, whereas a millennium mark has served as support on the COMP, the 20,000 millennium mark on the Wilshire 5000 Index (W5000 - 19,763.25) continues to be a major speed bump, as we cautioned weeks ago. In fact, stocks have become increasingly unstable on moves above 20,0000, as there were seven consecutive closes above 20,000 in March, three consecutive closes above this level in the beginning of April, and one close above 20,000 earlier this week, before stocks declined to close the week. The W5000 enters this week's trading just above the 19,700 area, which marked a peak in mid-January and support in March. For what it's worth, 19,706 is the site of its 2013 close, which sheds some light on the importance of this area in recent months.

W5000
Instability above 20,000 following a 7% rally in February
Daily Chart of W5000 since February 2014
Chart courtesy of StockCharts.com

With the W5000 in a range over the past several weeks, other benchmarks continue to ping back and forth between round-number levels and YTD breakeven marks, suggesting the dance around 20,000 is likely to continue. For example, the Russell 2000 Index (RUT - 1,123.03) and Dow Jones Industrial Average (DJIA - 16,361.46) each came within a few points of their respective YTD breakeven marks at 1,163 and 16,576, before turning lower. Now, round numbers such as 1,100 and 16,000 may come into play as potential support levels. The S&P 500 Index (SPX - 1,863.40) and S&P 400 MidCap (MID - 1,347.22) are two benchmarks that come into the week in positive territory. The MID is trading 5 points above its YTD breakeven point of 1,342, and the SPX 15 points above its 2013 close at 1,848, after getting turned back at 1,880 -- its March high -- to close the week down by less than a point.

Amid the choppy action, there continues to be rotation out of "risky" high-beta names, but some sectors -- such as energy, airlines, chemicals, and financials -- have held up relatively well. In addition, earnings reactions have been mixed for the most part on key names. Traders should continue to shorten or lengthen their time frames, and be open to opportunities on both the long and short sides, as this trading range may continue into the foreseeable future.

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