Market Update

Judging from the hourly S&P 500 futures chart, the market looks to be in or entering corrective mode.

Source: Finviz.com

After hitting a new high of about 1680 on May 22nd, the S&P 500 made a lower high on May 28th and has been carving out what appears to be a symmetrical triangle formation. Granted the chart is hourly, meaning very short-term, but the direction of the eventual breakout from this triangle will likely dictate the near-term trend of the market. 

Stepping much further back, I thought I'd also show a long-term sentiment chart from DecisionPoint's blog:

The chart's lower inset shows the Rydex Asset Ratio, which is derived by dividing money market and bear fund assets by bull and sector fund assets. The higher the Ratio, the more bullish and optimistic the sentiment. Note the reading hasn't been this high since the market peak of 2000. Yikes.

Time to get cautious on TSLA

When I first wrote about Tesla (TSLA) on April 4th, it was breaking out above $40.

Source: Stockcharts.com

Wow, you talk about a classic chart. After the gap-up breakout to $44 on high volume, price retreated back to the $40 level on receding volume before resuming its ascent. It's since been off to the races.

Earlier this month, the stock gapped up further on very high volume, but this time notably taking place on the heels of an already-impressive 35% move. And more recently shares have again gapped up on high volume. High-volume price gaps occurring well within a strong advance often suggest a near-term top is imminent. Note the parabolic chart pattern, the exponential rise in a fairly short time frame (150% rise in less than two months!). The recent buying looks to be climatic and emotion-driven.

This is not to say the stock is doomed or will fall off a cliff any time soon. In fact, such stellar performers typically do not die sudden deaths, but if/when they do correct it's more of a protracted, eventual decline. One reason for this is when high-flyers crack for the first time, many investors believe it's finally their time to get in, that they've been given a golden opportunity to enter before the next big move. Such buying tends to support the shares at the initial break, so again my point is these headline-grabbing stocks do not typically reverse and give up all their gains in a heartbeat. It's also too soon to tell if TSLA will even crack or meaningfully correct at this point.

Given what I've written, the stock is obviously not at a good entry point. However, for those already holding the stock, the prudent step at this point would be to establish a trailing stop-loss threshold, allowing price to dictate an exit. In the chart above, I included a few shorter-term moving averages. It appears as if the 10-day MA would offer the most conservative stop-loss limit at approximately $94, followed by the 15- and 20-day moving averages. 

Needless to say, even if you do get stopped out, one can always reassess and re-enter the stock at a later date. And who knows, maybe by then the company will have positive annual earnings....

U.S. Dollar Remains Bullish

As I've written in the past, the U.S. dollar (USD) continues to look bullish.

Source: Finviz.com

As shown in the daily chart above, the USD is exhibiting not one but two classic bullish formations. The first (in red) is a cup-and-handle formation with a recent breakout. The second (blue circles) is a double-bottom formation with the "W" pattern occurring at the 79 level.

Stepping back, the weekly chart also depicts a bullish picture.

Source: Finviz.com

Over the last several years, a triangle formation has been taking shape, and note that since 2011 a more acute triangle formation has developed. The breakout observed this year (red circle) is needless to say a bullish occurrence and I would expect the USD to approach its prior high of 88, established back in 2008, 2009 and 2010.

Assuming the USD remains in an uptrend, it does not bode well for commodities in general.

Source: Stockcharts.com

The weekly chart above illustrates quite clearly the inverse relationship that tends to hold over time between the USD and commodities (as represented by the CCI (Reuters-CRB Index)). The rolling 50-week correlation is consistently negative, meaning longer-term the bear market for commodities that appears to have started in 2011 is not likely to end anytime soon.

Is the market finally correcting? (Stocks going down -- huh??)

On the heels of Japan's stock market plunge, it appears as if the U.S. market might be hinting at a correction of its own.

Source: Finviz.com

The hourly futures chart above shows the S&P 500 down about 3% from its Wednesday peak. Granted, nothing like the near 8% plunge suffered by the Nikkei, but nonetheless the market is clearly showing near-term signs of what could develop into a corrective phase. As with the Nikkei hourly chart I discussed yesterday, note the S&P's false breakout on Wednesday followed by an abrupt reversal, with the index collapsing about 50 points before attempting to rally overnight. But as often happens, and seen in the Nikkei chart, such a recovery rally following a swift decline is frequently anemic, attaining a lower high before rolling over. Next level of support appears to be the 1615-1620 area, and after that the 1590-1600 range.

To risk sounding like a broken record (oops, CD?), many lingering divergences remain in place, including the relative performance of smaller-caps (IWM) versus larger-caps (SPY).

Source: Stockcharts.com

In the chart above, the upper inset shows the relative return of the IWM vs. SPY (red line), with the S&P 500 depicted in the background (black line). Note the declining orange line pointing out the bearish divergence as the relative performance of IWM vs. SPY has not surpassed its prior high registered in March. This divergence also occurred late last year (shown in chart) and has occurred numerous time over the years, more often than not giving a heads-up before market weakness ensues. Also note for the red relative return line both the RSI and MACD exhibiting bearish divergences of their own, with lower highs put in as the S&P 500 has climbed higher.

And referring back to the Nikkei once again, it would be worthwhile keeping an eye on this index.

Source: Stockcharts.com

As shown in the chart above, for several months now the Nikkei and S&P 500 have been highly correlated, tracking together quite closely. If the Japanese market is beginning to show indications of meaningful weakness, could this be a foreboding sign for the U.S. market?

The Nikkei 225 Cratered Overnight

As I write this the Nikkei 225 index is down about 8%, as per overnight futures.

Source: Finviz.com

You can see in the hourly chart above that after rising about 1500 points in just the last two weeks, the index lifted off yesterday in what looked to be a parabolic surge higher. But as often happens, an extreme and abrupt continuation move like that runs out of incremental buyers (demand) and the ascent stalls and even cracks. The chart above shows such a crack, also showing the very-common anemic run at a new high that follows but fails, making a lower high. And then poof -- look out below. With the Nikkei currently residing at 14,665, all gains achieved since May 10th have been wiped out.

The daily chart of the Nikkei offers more perspective.

Source: Finviz.com

It's textbook stuff, the breakout in November followed by a brief pause, then a steady climb to new heights. The index kicked into another gear in April and soared towards the 16,000 level, getting a bit parabolic as it created a sizable gap from the rising trend line. All in all, and as I've been expecting with the U.S. market, such a correction is not surprising.

I would say at this point the next level of support for the Nikkei is the 1350-1400 area, which is where price based before lifting off earlier this month and is also where the trend line currently resides. It's too early to definitively state whether or not this is the "final" parabolic blow-off top. And I would also add that given the country's fairly recent initiation of Abenomics, added volatility and extreme moves in the index could become the norm for the foreseeable future.

More concerning charts....

I continue to survey the market landscape, trying to get a better sense of just how much further this rally has to go. I've written here before that I expected a correction last month, however I obviously underestimated the magnitude of internal strength in this recent move higher, despite the many developing bearish divergences. Until a few weeks ago, I maintained a bullish outlook on the market, a stance dating back to last September. During that period, I fully detected and appreciated the impressive underlying thrust that would propel the market to new highs. But again, it's only been during these last several weeks that I've increasingly observed disturbing negative divergences, many of which I've discussed on this blog.

I will emphasize that it's very important to avoid getting seduced into a particular mindset at any point in time. Becoming "married" to a viewpoint and constantly seeking out confirmation of this view is a behavioral finance cardinal sin. I am always trying to poke holes in my current take on things, ever fearful that I might have missed something. That said I continue to uncover items that just serve to foster more concern.

For one, the market's advance as per the S&P 500 appears stretched historically:

Source: Stockcharts.com

The chart above shows the 120-day rate-of-change (ROC) in the upper inset and the S&P 500 in the lower inset. The more/less 6-month ROC is just shy of 20%, a level that in the past has identified peaks in the market.

In addition, I continue to find nagging bearish divergences.

Source: Stockcharts.com

The chart above shows the relative performance of the PowerShares S&P 500 High Beta Portfolio vs. the Power Shares S&P 500 Low Volatility Portfolio (represented by the red line), with the S&P 500 appearing behind it (black line). Admittedly, the history is short given the PowerShare funds have not been in existence all that long, but you can see that when the S&P 500 rises, higher beta stocks tend to outperform lower beta stocks as represented by the rising red line. Over the last few weeks, we have indeed seen this red line surge with the S&P 500's advance, however also note that this red line has yet to surpass its prior high achieved in February. Until the red line is able to surpass that prior high, it remains categorized as a negative divergence. You'll see I flagged such negative divergences in the past with orange lines and they do often give a decent heads-up before overall market weakness takes hold.

Finally, I found the following chart to be very interesting, and possibly alarming.

Source: Stockcharts.com

The weekly chart in the middle shows the relative performance of the TSX Venture Index versus the TSX Composite (represented by the red line), with the S&P 500 overlaid in the background (black line). The TSX Venture Index is comprised of 500 small- and micro-cap Canadian stocks, compared to Canada's TSX Composite which is primarily a large-cap index. The Canadian equity market in general is heavily natural resource-oriented as the country is dominated by energy and mining companies. As a result, Canada's economic fate is very much dependent on and sensitive to the global economy.

Over time, the return of the TSX Venture/TSX Composite ratio has tended to move in tandem with the S&P 500. If anything, the red line has frequently led moves in the S&P 500 with it rising well ahead of the S&P 500 low in late 2002, peaking in 2006 before the S&P 500 peak a year later, and bottoming in late 2008 a few months before the S&P 500 low in March 2009. And yet since the start of 2012, there has developed a massive divergence between the red and black lines. Note also that in the past, when the TSI indicator and Stochastic Oscillator have registered oversold levels -- as is the case now -- the S&P 500 has typically been at a significant low. That does not appear to be the case this time around.

I don't wish to overstate the relationship between the TSX Venture/TSX Composite and the S&P 500 as I'm certainly aware of what has occurred with smaller-cap mining stocks, no doubt severely depressing the relative performance of the TSX Venture Index. However, it is a relationship that has broken down completely over the last year or so and I felt it was worth mentioning, do with it what you will. 

As I've strongly suggested of late, I remain wary and cautious about the market's recent leg higher.

Gold is following the script

Two weeks ago, I wrote, "Gold has retraced a bit more than 50% of its recent decline. Typically we should see a retest of the prior low, with gold price retreating to the 1350-1400 level."

At $1367, gold is now just about smack-dab in the middle of that 1350-1400 range.

 Source: Finviz.com

Gold thus far has more or less followed the script when it comes to what often happens after a fairly massive and abrupt technical breakdown. Price typically rallies off the climatic low, retracing about 50% of the decline ("filling the gap"), but then rolls over and retreats back towards the prior low (a retest). 

The price of gold should hold above the prior low level of approximately 1350 for the chart to remain constructive. It should build a base within this 1350-1400 range before looking to resume its ascent. However, if gold breaches the 1350 level and hits new lows, all bets are off as the next level off support appears to be around 1200. 

Two things I'd like to point out in gold's weekly chart:

Source: Stockcharts.com

 

The first is notice the huge volume spikes. Often such extreme levels of volume can indicate climatic turning points, either to the upside or downside -- "blow-off" tops or bottoms, as they're often called. There is what appears to be a climatic, high-volume top in 2011, and more recently this year what appears to be a climatic, high-volume low. As discussed, it has yet to be determined if this low will hold, but nonetheless for now it does have much of the markings of a significant low.

The other thing I'd point out in the chart is the many hammer candlestick patterns (in green boxes). When these occur after price declines, they very often identify the likelihood of a trend reversal, a bullish indication. Note in the chart when such hammers have appeared after price retreats, more often than not the trend has reversed and a rally -- albeit widely varying in duration -- has ensued.

Again, the jury is still out on what gold will do from here, but it's clear that right now the metal is at a key juncture.