I'm always looking for inter-market, inter-sector, inter-whatever relationships to help shed light on where we are and where we might be going. Very often this type of analysis reveals indications of investor risk appetite (risk-on vs. risk-off mode), whether it's on the rise, plateauing or waning. By picking up on clues about underlying sentiment, one can frequently gain a bit of a jump on timely inflection points or if the market is likely to continue in the current direction.
Viewing the hourly S&P 500 Index chart, the market has steadily climbed over the last several days, successfully getting through resistance levels along the way.
Source: Stockcharts.com
As shown above, recently the Index was able to breach resistance at about 1680, pulling back yesterday. Granted, it has yet to be considered what I would call a significant breakout since price hasn't risen above resistance with room to spare, but nonetheless a breakout it is. Or more specifically a breakout with a pullback, with a price retreat being a very common occurrence post-breakout and such a retrace can be considered healthy, re-energizing momentum as evidenced by the now oversold stochastic (red circle in chart above). Also note the blue circles in chart highlighting a bullish inverse head-and-shoulders formation.
The question now is will the market (Index) continue to ascend or will at this current level a double-top begin to form? Based on what I'm seeing (already mentioned a few above), the former is more likely.
It's always good to check how the Russell 2000 Index is performing versus a larger index like the S&P 500.
Source: Stockcharts.com
The hourly chart above shows the S&P 500 recently making a new high, yet the Russell 2000 had successfully made a new high several days ago -- a bullish confirmation. The smaller-cap Russell 2000 Index is a much flatter representation of the market than the S&P 500 and in effect serves as more of an A/D line. Also, small-cap stocks have a higher sensitivity to the economy compared to their larger-cap brethren and give a better indication of economic conditions.
I've discussed here many times the implication of inter-sector relative returns. The chart below shows the XLY (Consumer Discretionary) versus the XLU (Utilities).
Source: Stockcharts.com
When the XLY:XLU line (lower inset) is rising, it means the XLY is outperforming the XLU, and vice versa. XLY outperforming XLU is generally indication of risk-on mode, bullish for the market, and a declining relative return line with XLU outperforming XLY generally infers risk-off mode is taking hold, bearish for the market. As I say many times, no indicator is perfect (which is why one needs to follow many), but I show periods (blue lines) where the XLY:XLU line has diverged from the market (S&P 500, upper inset), giving ample warning for turning points. More recently, the XLY:XLU line made a new high in May and has continued to rise -- a bullish confirmation.
Another near-term bullish occurrence has been momentum. I've discussed here once before the concept of "good overbought" and "bad oversold," which in a nutshell refers to extreme, longer-duration momentum. When momentum is extreme and has been consistently so over a period of time, it suggests the trend will continue in that direction, even after a correction. We observed good or bullish overbought momentum for the market (S&P 500) in May and here we are at a new high.
Note the S&P 500 hourly chart below:
Source: Stockcharts.com
It shows the July rally with consistently extreme-positive momentum, with the stochastic and RSI indicators highly elevated over several days (red boxes). In my experience, such powerful momentum represents significant thrust which tends to have a carry-over effect. The S&P 500 has retreated from its breakout, but given the observed "good overbought" condition I would expect another run at new highs to follow.
Speaking of momentum and thrust, I would finally mention that the venerable Ned Davis of Ned Davis Research (NDR) released a report on Monday discussing this subject. According to NDR, the S&P 500 registered a BUY thrust signal in early January (1/4/13 to be exact). Since 1970, the S&P 500 has registered 16 BUY thrust signals (not counting the current one) and in every instance the market was higher a year (253 trading days) later. We'll wait and see if the record improves to 17 out of 17....
It's nice to see the market stands a good chance of finishing the year higher, but my focus above is more near-term, covering the next few weeks. I have found the best one can do in hopes of making fairly accurate market calls is to function within a rolling 3-4 week window, making adjustments as needed. Within such a time frame, things continue to look bullish to me.
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