This Important Level Could Signal An Overdue Market Decline Is Starting

John Kosar's picture

Monday, June 16, 2014 - 1:15pm

by John Kosar

All major U.S. indices finished last week in negative territory, giving back a significant portion of their May gains. Interestingly, the decline was led by the defensive Dow industrials, while the Nasdaq 100 and Russell 2000 fared better, down just 0.5% and 0.2%, respectively. Despite the decline, all major U.S. indices except for the Russell are still in positive territory for the year.

The only sector of the S&P 500 that finished last week in the black was energy, gaining 1.7%. My own asset flow-based metric shows that the largest sector bet-related inflows over the past one-week, one-month and three-month periods were in energy. Largely due to these inflows, energy has outperformed with an 11.2% year-to-date gain versus 4.8% for the S&P 500.

Trend Still Bullish, but Beware of Seasonal Headwinds
In the May 12 Market Outlook, I pointed out an emerging bullish pattern in the SPDR Dow Jones Industrial Average (NYSE: DIA). I said, "A sustained rise above $165.51 would confirm a breakout from four months of sideways indecision in DIA that would target a 7% advance to $177."

The breakout I was expecting actually took place on the day of that report, and DIA has rose 2.3% to the June 9 intraday high of $169.58, before closing at $167.72 on Friday. The bullish implications of this pattern will remain valid as long as the upper boundary at $165.51 loosely contains DIA on the downside as underlying support.

However, 56 years of seasonality data warn that the market may struggle a bit between now and the end of the month. The chart below, which displays the weekly seasonal pattern for the second quarter based on data since 1957, shows that the last three weeks of June include three of the four seasonally weakest of the entire quarter.

So, even though the bullish chart pattern in DIA is my primary consideration right now, it is also important for investors to know that the market may be facing some seasonal headwinds between now and the end of June.

Watch This Important Level On The VIX
In last week's report, I pointed out that the CBOE Volatility Index (VIX), or the fear gauge, had declined below a historically low extreme of 12, and that the past four times this happened closely preceded significant declines in the S&P 500. I said, "I would view a sustained rise in the VIX above its 50-day moving average, currently situated at 13.22, as an indication that the marketplace is collectively afraid enough to trigger another minor decline similar to those highlighted on the chart."

The VIX finished last week at 12.18, just below its 50-day moving average at 13.01. The red highlights in the chart show that the past three times that the VIX made a sustained rise above its 50-day moving average coincided with the past three minor declines in the S&P 500, during January-February, in mid-March, and again in early April.

Accordingly, I would view a sustained rise above 13.01 this week as evidence that the long-term seasonal tendency shown in the first chart may be emerging again this year, and as motivation to keep a close eye on $165.51 support in DIA to determine if the ETF's bullish implications remain valid and intact.

Although positive 2013 price trends in the major stock indices remain intact heading into this week, the S&P 500 is in the midst of a historically weak seasonal period that may put a damper on further gains at least through the end of June. Therefore, I would view a sustained rise above 13 in the VIX this week as evidence that this 56-year seasonal pattern may be emerging again this year, and as a warning to investors to consider protecting 2014 profits against a potential and overdue corrective decline.

This article originally appeared on ProfitableTrading.com:
This Important Level Could Signal an Overdue Market Decline is Starting

John Kosar does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.