In The Week Ahead: 4 Signs The Market Is Sputtering

John Kosar's picture

Monday, August 22, 2016 - 5:15pm

by John Kosar

The U.S. stock market looked sluggish for the second consecutive week, with all major indices moving 1% or less. The best performer thus far in 2016 has been the small-cap Russell 2000, which closed last week up 8.9% year to date. 

The two strongest sectors of the S&P 500 last week were energy (2.5%) and materials (1.2%). This is more evidence of the strength in the commodity space that I have been talking about since the first quarter. Of the 38 commodity-related ETFs that I track, only grains and solar remain in major downtrends, as defined by their 200-day moving averages.

Where's The Pullback?

For the past several weeks, I have been warning of the stock market's vulnerability to a pullback or correction before prices move appreciably higher. While the market hasn't yet declined, it hasn't moved meaningfully higher either. In the past month, the benchmark S&P 500 is up just 0.5%.  

So, what's holding the market up?

In our first chart, we see that daily total net assets invested in the SPDR S&P 500 ETF (NYSE: SPY) have been above their 21-day moving average since July 1, indicating a trend of monthly expansion that my research shows has fueled every short-term advance in SPY in recent history.

Even though the market is just as vulnerable to a decline as it was a month ago -- if not more so -- as long as new investor assets continue to come into the market, stocks should continue to tread water and may even move marginally higher. 

But history suggests this won't last forever. SPY assets are on the verge of dropping below their 21-day moving average again. If they do so, I will view it as evidence that investors' bullish conviction has eroded. At that point, the pullback I've been expecting should get under way.

Another Sign of Upcoming Weakness

During the past several weeks, I have focused on three metrics as reasons why a significant market advance is unlikely without at least a minor pullback first:

1. Major overhead resistance in the market-leading Nasdaq 100; 
2. Historically low volatility according to the Volatility S&P 500 (VIX); and
3. August-September seasonality in the S&P 500. 

And we now have a fourth to add to that list: options volume.

The next chart plots the S&P 500 in the upper panel with the daily CBOE Put/Call Ratio in the lower panel. The Put/Call Ratio shows a historically low amount of put volume versus call volume, which tells us that option traders are currently unconcerned about a market decline.

However, history tells us that this is precisely when we should be the most concerned, as similar readings in this indicator have either coincided with or closely led most near-term broader market peaks during the past year.

Treasury Bonds Still Look Vulnerable

In the Aug. 8 Market Outlook, I pointed out that the iShares 20+ Year Treasury Bond ETF (NYSE: TLT) was hovering just above its 50-day moving average. I said a sustained decline below that line would signal a bearish minor trend change and portend more near-term weakness.

Since that report, TLT has been unable to resume its minor uptrend and continues to look vulnerable to a decline.

I would view a sustained drop below $138.62 this week as evidence that a near-term peak is in place at the early July high. This would clear the way for a test the Feb. 11 high at $135.25, which is 2.5% below Friday's close. 

Silver Losing Its Shine?

About a month ago, I pointed out that gold prices were at a decision point from which either a new rush of investor assets was going to come into the marketplace to extend the rally, or a correction was going to begin. In last week's report, I said recent weakness in the SPDR Gold Trust (NYSE: GLD) targeted a decline to $122.75 that would remain valid as long as the recent highs held as overhead resistance.

Silver futures finished last week at $19.32 per ounce, just above the $19.27 July 21 low. A sustained decline below $19.27 this week would confirm a bearish double-top pattern that would target a drop to $17.70 -- 8.4% below Friday's close.

A breakdown in silver this week would be indirect evidence that more near-term weakness is likely in gold prices.

Putting It All Together 

For weeks, I have said that near-term downside risk currently exceeds upside potential in the U.S. stock market. However, I will view the next market pullback as an intermediate-term buying opportunity as long as the decline does not break any critical underlying support levels. 

Additionally, more evidence is emerging that suggests an overdue decline is coming in precious metals prices, particularly gold and silver. Like with stocks, as long as this decline does not break major support, I will view it as a buying opportunity within the prevailing positive trend.

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This article originally appeared on ProfitableTrading.com: 4 Signs The Market Is Sputtering

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.