Don’t Count On Another Rally Failure

The buyers finally took over the stock market last week as the S&P 500 recorded gains of 2.45% Tuesday, 0.95% Thursday, and 3.06% on Friday. From a technical standpoint there was improvement in the futures on Monday. Given the failing sharp rebounds so far in 2022 many are not expecting the stock market to continue higher as some are looking for more investor pain in the second half of 2022.

I have been looking for a more sustainable market rally for some time especially after the selling climaxes just before the May lows. There were several indications from both a technical and sentiment standpoint that the market was near a low. Instead, the market was hit with another wave of heavy selling in June that dropped the averages to convincing new lows.

In last week’s survey from the American Association of Individual Investors (AAII), only 18.2% of those surveyed expect stock prices to be higher in the next six months. It also revealed that 59.3% of investors are bearish as they expect prices to be lower in the next six months.

This is one of several contrary indicators that continue to show extreme readings. When there are too few bullish investors or too many bearish investors the stock market is historically likely to move higher not lower.

When hedge funds and large money managers have a relatively high level of cash it is often a good time to buy. In the May BofA survey, those who manage just under $1 trillion have the highest cash levels since September 2001. From the lows that month, the S&P 500 began a 15-week rally that took the index 24% higher. Such a rally now would certainly change the market sentiment dramatically.

Of course, these contrarian measures have been sending warning signals since March but other than the rally from March 15^th (point 1) through March 29^th (point 2) the rallies in April and early May were brief. There was a better rally from the May 20^th low that ended with the downside reversal on June 9^th, point 3. The analysis on the SPY
PY

SPY
as well as the S&P futures analysis both turned positive on Friday, June 24^th.

So after last week’s impressive gains how much higher can the averages go? Also is this just a bear market rally or could it be the start of a longer-lasting move to the upside?

The Nasdaq 100 ($NDX) was the week’s top gainer up 7.4% barely outpacing the 7.4% gain in the Dow Jones Utility Average. The $NDX is still down 25.8% year-to-date (YTD) and is still the weakest of these markets.

The widely watched S&P 500 was up 6.5% with the iShares Russell 2000 gaining 6% and the Dow Jones Industrials not far behind as it rose 5.4%. The market internals were over 10-1 positive early Friday and on the NYSE for the week there were 2646 issues advancing and 847 declining.

The weekly chart of the Invesco QQQ
QQQ
Trust (QQQ) which tracks the $NDX, closed above its 20-day EMA but is still 8.4% below its declining 20-week EMA at $319.73. This is the area that some will be looking at for a failing rally but the weekly downtrend, line a, is at $341.99. This is just above the 50% retracement resistance from the November 2021 high.

As QQQ made lower lows, line b, the weekly Nasdaq 100 Advance/Decline line formed higher lows, line d. Since data was first available in 2009 it has never formed such a bullish divergence. A move in the A/D line above the May high will confirm the divergence. Similar formations in the NYSE All A/D line have corresponded to important market turns which raises the possibility that an important low may have been formed last week.

It is way too early to be planning for a major low and the market will need to be watched closely for signs the rally has fizzled. All of the daily A/D lines are positive but a higher weekly close is needed this week to further support the positive technical outlook.

For the past few weeks, I have noticed signs that the yield on the 10 Year T-Note was topping out. Last week’s action supports this view as the prior week’s yield had a high of 3.473 % and moved above the weekly starc+ band. The yield declined further last week and a drop below the May low of 2.708%, line a, will complete the top formation.

The weekly MACD and MACD-His have formed lower highs or negative divergences which is consistent with a top in yields. The daily MACDS are negative and also formed bearish divergence at the recent highs. Lower yields should be supportive for stocks and could reduce some of the inflationary fears.

The daily chart of the Market Volatility Index ($VIX) has formed a series of lower highs, line a, since the start of the year. This is in contrast to the lower lows in the market averages. Often times in a strong market decline the VIX will form consistently higher highs. The VIX now looks ready to break the support at line b. This would indicate a drop to the 20 area.

The MACDs has formed lower highs like Bitcoin
BTC
did before its recent plunge. Both MACDs turned negative on Friday which should also be supportive for stocks in the weeks ahead. Those who used VIX options to hedge their portfolio during the market’s decline are likely to be disappointed again.

Three sectors, Consumer Discretionary (XLY
XLY
), Health Care Select and Real Estate Sector (XLRE
XLRE
) were up 8% or more last week. The volume in the sector ETFs has not been as impressive as it was in some of the stocks.

Resource Connection (RGP) showed up on my daily scan after Wednesday’s close and it was up 12% Friday with four times the average volume. The relative performance analysis shows that it has been a market leader since early May. In fact, there were also stocks on my weekly scan that had record daily volume for the year in Friday’s trading.

It would not be surprising to see some light selling early in the week as many are not likely to trust Friday’s market action. For all new positions it is important to measure the risk on all new positions and until the A/D lines are trending higher would not be an aggressive buyer.