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Busted: The 'New High' Myth Haunting Today's Traders

Tracking 85 years of summer stock returns

by 5/31/2014 10:30:33 AM
Stocks quoted in this article:

This past week, we caught a glimmer of what a post-trading-range environment might look like, as both the Dow Jones Industrial Average and the S&P 500 Index ended the week at new all-time closing highs. Bullish traders took tentative control of the reins, despite a mixed bag of economic news at home and continued uncertainty in overseas markets. As a result, many of the indexes we visited last week overcame prominent resistance, but will the breakout be able to last? Todd Salamone shares his outlook this week, while Rocky White crunches the numbers to see what the summer months might have in store for stocks.

  • What kept small-caps from participating in last week's rally
  • Why we may not be vulnerable to a market top
  • Are stocks headed for the summer doldrums this year?

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: Charting Three Major Benchmark Breakouts
By Todd Salamone, Senior VP of Research

"... there appears to be caution among many technicians, who have a laundry list of concerns. These include: a RUT and SPX divergence, seasonality, low volume, a low VIX, weakening 52-week highs, and the potential for a bearish 'head-and-shoulder' formation, even as a bullish inverse 'head-and-shoulder' pattern is a distinct possibility ... Such caution is confirmed when analyzing recent equity option activity, as equity option buyers are expressing the highest degree of pessimism since July 2013 ... Plus, the four-week moving average of the percentage of bullish respondents in the American Association of Individual Investors (AAII) poll is again at pessimistic extremes that have preceded rallies"

"The sentiment backdrop is growing more favorable for the bulls, but price action has to become more favorable, too, especially with the DJIA, SPX, and W5000 trading at historical resistance areas. A sustained move above these resistance areas, and the RUT moving above recent resistance from its 160-day moving average (currently situated at 1,135), would likely create more short covering or cause potential investors to move off the sidelines"
-Monday Morning Outlook, May 24, 2014

"The number of individual stocks hitting new highs has generally trended lower on a daily basis for much of the year ... A smaller swath of stocks hitting new records as the market rallies suggests there is less participation in the recent run-up. Such a trend is a potentially worrisome development as it is comparable to what took place in 2000 and 2007, the past two times the market peaked"
-The Wall Street Journal, May 29, 2014
"Diverging $SPX price action/52-wk highs didn't seem to matter in '10-'11 $SPY"

"Wilshire 5k bull inverse 'head and shoulder' breakout- target 21.2k - Fear was potential bearish H&S"

-@ToddSalamone on Twitter, May 29 and 30, 2014

The popular strategy "sell in May and go away" did not work this year, with the S&P 500 Index (SPX - 1,923.57) tacking on a 2.1% gain during the month. Even the much-maligned small-caps, as measured by the iShares Russell 2000 ETF (IWM - 112.86) eked out a small monthly gain.

The good news for bulls is that important benchmarks we have been following -- with the exception of the IWM -- broke out above resistance levels that we have been keying on for weeks. For example, the Dow Jones Industrial Average (DJI - 16,717.17) broke out above its 2014 breakeven mark at 16,576.66. The blue-chip index has spent five consecutive trading days above this level -- the longest such duration in 2014 -- and finished the week at a new closing high.

Meanwhile, the Wilshire 5000 (W5000 - 20,348.35), which has typically become unstable on moves above 20,000, moved above its March and April highs and has now experienced six consecutive closes above the key 20,000 millennium mark. The longest streak above 20,000 is seven consecutive days. Accompanying the move above the March and April highs, the W5000 formed a bullish inverse "head and shoulders" pattern, which we find intriguing, especially after many technicians as recently as two weeks ago were cautioning potential bearish "head and shoulders" set-ups on some indexes.

Wilshire 5000 -- bullish inverse "head and shoulders" pattern targets 20,200
Daily W5000 chart since October 2013

Not to be forgotten is the SPX, which took out century-mark resistance at 1,900, which abruptly turned away rally attempts in early April and mid-May. The SPX also experienced a bullish inverse "head and shoulders" pattern that targets 1,980. But we see the 2,000 area as the next major resistance level for the SPX, as this is a round-number millennium level that is also 200% above the March 2009 low.

SPX broke out above 1,900 -- next MAJOR resistance is in the 1,980-2,000 area
Daily SPX chart since January 2014

The one benchmark that did not break above resistance was the IWM, which briefly peeked above its 160-day moving average, but failed to hold above this trendline on a weekly closing basis. The 160-day -- which was supportive at the February lows and acted as resistance twice in May -- is situated around the 113 strike, which is home to more than 55,000 calls in the June 6 weekly option series. In the immediate days ahead, it would not be surprising if the IWM drifts back into the 112 area, where there is big option open interest that expires next week. This is also an area that fills the bullish gap created last Tuesday, at the beginning of the holiday-shortened trading week.

IWM 6/6 weekly open interest configuration – call "wall" at 113, potential support at 112
IWM open interest configuration, 6-6 expiration

Looking beyond next week, we remain bullish, with most indexes at or near record-high territory, but traders displaying negative sentiment that is more consistent with market bottoms than tops. We highlighted examples of this last week, specifically referring to global managers (who have soured on U.S. stocks), retail investors, and equity option speculators (who have displayed increasing levels of doubt as benchmarks traded in sideways ranges).

Finally, we thought it might be of value to provide some charts that address concerns we have seen prominently discussed among the technician world -- that is, the decreasing number of SPX components hitting 52-week highs, even as the SPX reaches new highs.

The first chart below displays the current situation that has technicians concerned, as many think trouble lies just ahead. As you can see, the SPX has been trading at higher and higher levels, even as the percentage of new 52-week highs has decreased.

But if you proceed to the second chart below, you will also find that this is something we have seen before, as the SPX reached 52-week highs in 2010-2012, without these highs being confirmed by a higher percentage of components hitting 52-week highs. The point is that the divergences in 2010-2012 did not foreshadow major problems ahead.

In fact, while varying degrees of a diverging pattern of 52-week highs among individual stocks and the SPX was seen ahead of the 2000 and 2007 peaks, the actual peaks did not occur until the divergence disappeared and the percentage of underlying stocks hitting 52-week highs confirmed the price action. It is almost as if when the water was declared safe, it was actually at a point of maximum danger. This might suggest that we are not vulnerable to a major market top until the very stocks that are not achieving 52-week highs finally participate.

SPX with percentage 52-week highs, 2013-present

SPX with percentage 52-week highs, 2010-2012

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