In The Week Ahead: What The Correction Is Waiting For
StreetAuthority Network
All major U.S. indices closed in the red last week, continuing their recent pattern of see-sawing between positive and negative weekly closes. With the exception of the tech-heavy Nasdaq, they remain essentially unchanged for 2015.
It is noteworthy that the weakest of the major indices last week were the small-cap Russell 2000 and Nasdaq 100, which lost 3.1% and 1.3%, respectively. These two market leaders are the very indices that must remain strong to keep the broader market afloat this summer. If they don't, it is likely that we will see our first real stock market correction since the quantitative easing era began years ago.
Materials, up 2%, and energy, up 1.1%, were the strongest sectors last week. The two weakest sectors were health care, down 2.3%, and consumer discretionary, which lost 1.7%.
In the March 23 Market Outlook, I told readers it was time to protect profits on bullish positions in the consumer discretionary sector, as it had outperformed the S&P 500 by 6% since I identified it as an investment opportunity in early December. Last week's sharp decline suggests that the bearish reversal I was looking for is starting to materialize.
Regarding energy, in the March 30 Market Outlook, I said that my own ETF asset flow based metric suggested an emerging opportunity to overweight the sector. Energy has by far been the strongest sector of the S&P 500 over the past month. Since my report, energy is up 8.5% compared to just 2.3% for the S&P 500. Moreover, my metric continues to show strong positive asset flows into energy, which suggests that its recent strength and relative outperformance is likely to continue further into the second quarter.
Technology Between a Rock and a Hard Place
In last week's Market Outlook, I pointed out that the Nasdaq Composite was closing in on a major overhead obstacle -- its March 2000 all-time high at 5,133. I said that major benchmark highs like this one are seldom meaningfully and sustainably broken without at least a multiweek corrective decline first.
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The Composite did indeed reverse lower from a test of this level on April 27. It is now positioned right on top of minor underlying support at 4,970 to 4,963. This support represents the October 2014 uptrend line and 50-day moving average, a widely watched minor trend proxy.
Nasdaq Composite Market Outlook Chart
I view the area between 5,133 and 4,963 as an important decision point for technology stocks, and the broader market that they tend to lead. The Nasdaq Composite must immediately follow through on Friday's rebound to keep its larger advance alive. Conversely, a sustained breakdown below 4,963 would indicate that a long overdue market correction is beginning -- as long as it is accompanied by a tangible increase in investor fear.
No Fear, No Correction
For the past couple of months, I have been consistently focusing on the Volatility S&P 500 Index (VIX), also known as the fear gauge. In my view, it has best represented the most important reason that we haven't seen a stock market correction yet, despite quantitative easing ended in October. That reason is investor complacency, or a lack of fear.
The next chart shows that, since mid-February, the VIX has managed to remain below its 50-day moving average, a metric I use to determine whether investors are complacent or fearful on a day-to-day basis. Each time the VIX tested and held its 50-day moving average from below coincided with a near-term bottom in the S&P 500, with the most recent being last week.
S&P 500 VIX Market Outlook Chart
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Therefore, although I would view a decline below 4,963 in the Nasdaq Composite as evidence that a broader market correction is beginning, it would need to be accompanied by a sustained rise above 14.12 in the VIX to confirm it.
Copper Looks Like it Will Continue to Shine
In the March 2 Market Outlook, I identified a buying opportunity in copper and suggested buying Freeport-McMoRan (NYSE: FCX) because of its positive correlation to copper prices. FCX has since risen 10.7% to Friday's $23.95 intraday high, which is the highest level seen since Dec. 10.
FCX Market Outlook Chart
The next formidable overhead resistance level is situated at $26.62, which is the 200-day moving average and 12.5% above Friday's close. The latest asset flow data, according to the futures market and related ETFs, suggests FCX can reach this widely watched major trend proxy later this quarter.
With quantitative easing six months behind us, the U.S. stock market remains particularly vulnerable to a summer correction. I would view a decline below 4,963 in the market-leading Nasdaq Composite this week, accompanied by a sustained rise above 14.12 in the VIX, as evidence that one is beginning.
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In the event of a correction, I continue to view select commodities, such as copper, as solid alternative investments, since a rise in the price of these assets dovetails nicely with an emerging increase in interest rates.
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