LONG TERM OUTLOOK & REVIEW -- Friday 30-Aug-02 -- 1:00PM New York
*** MARKET OVERVIEW ***
The Dow, S&P 500 and Nasdaq 100 all broke below important short-term support levels this past week, but stopped short of breaking below the 8-Aug to 14-Aug consolidation. This consolidation preceded the breakout advance and holds the key to future direction. The short-term support breaks on Tuesday/Wednesday were enough to exit longs, but not enough to call for a trend change. The decline over the last five days retraced 50-62% of the prior advance and corrected an overbought condition created after the three week advance. Thus far, the decline could be normal, but further weakness would spell trouble. For now, the medium-term trends are neutral as KEY support levels held, but KEY resistance levels were established with the 22-Aug reaction highs. This has created a large trading range over the last two months that has yet to be resolved. As such, we can look forward to more choppy trading until either the downtrend continues with a key support break or reverses with a key resistance break.
Style-wise: Relative to the Wilshire 5000, large-growth slipped over the last ten days, but remains the strongest of all six styles. Mid-value appears to be the main beneficiary of the weakness in large-growth. The price relative for the Mid-cap Value Index (IJJ) broke to a new reaction low in early August, but has since moved above this support break. The move is positive, but not enough to upgrade mid-value just yet. Small-value remains the weakest of all six styles. Because opening prices for ETFs are based on actual trades, gaps are more prevalent. All six gapped lower on Wednesday and broke important short-term support levels. Medium-term support levels have yet to be breached, but these gaps should be considered bearish and breakaway unless filled.
Sector-wise: Relative to the Wilshire 5000, recent breakouts in pharma and utilities continue to hold as these two sectors show good relative strength. Consumer services and consumer non-cyclicals look over extended, but their price relatives continue to extend higher as both perform relatively well. There was a strong bounce in the price relative for the Cyclicals SPDR (XLY) over the last few weeks, but this looks like a reaction and the larger trend suggests an ultimate failure. Elsewhere, the price relative for Basic Industry SPDR (XLB) broke double top support earlier this month and figures to underperform. Likewise, the July/Aug breakdown in the Energy SPDR (XLE) price relative does not bode well for long-term outperformance.
This week we will take a look at the following: Nasdaq 100, S&P 500, Dow Industrials, Trendlines
NDX LONG-TERM -- On the weekly chart, the Nasdaq 100 started a reaction rally with a move above the upper trendline of the small descending price channel, but remains in a long-term downtrend dominated by the larger descending price channel. The three week advance began to unravel last Friday with a week close that formed a long upper shadow. The advance carried the index above its 10-week SMA and the candlestick is essentially a shooting star. A black candlestick this week would confirm the shooting star as bearish and argue for a continuation of the prior decline.
On the daily chart, the three-week advance retraced 38% of the prior decline and met resistance around 1050. This week’s decline broke trendline support around 990 and the pullback from 1050 sets this level as KEY medium-term resistance. The move to 927 retraced 62% of the prior advance (856 to 1052) and NDX may find support between 900 and 950. For now, the shallow retracement (38% vs. 62%), trendline break and gap down are the dominant features.
Long-term trend: Bearish – NDX remains in a long-term downtrend or secular bear market. There may be mini-bull moves (1-4 months) or sizable reaction rallies along the way, but the overriding trend remains down. Since the late June support break at 1050, NDX has traded in choppy fashion. Until there is a break above key medium-term resistance at 1050, the large consolidation favors the bears and continuation down. Should the index consolidate further between 950 and 1050, an inverse head-and-shoulders pattern would take shape with neckline resistance at 1050. This has yet to happen, but remains a possibility that would form a fairly nice base.
Potential Support: 870 KEY Resistance: 1350
SPX LONG-TERM -- On the weekly chart, SPX declined from 1174 to 776 and became oversold in the process. The move from 1000 to 776 in less than three weeks smacks of capitulation and ended with a large hammer. This hammer was confirmed two weeks later and the index retraced about 50% with an advance to 965. The advance formed a rising wedge and met resistance from the Oct-98 support-turned-resistance line. So far, we have a classic bear market rally marked by a support break (~960), return to support break, normal retracement (~50%) and rising wedge. It is almost too classic, but those are the facts. The advance alleviated the oversold condition, but the pattern and base are not conducive to long-term bottoms and the beginnings of a major advance. In other words, I am still treating this as a reaction rally within a larger downtrend or secular bear market.
On the daily chart, the rising wedge becomes clear and this week’s decline to 903 retraced about 50% of the prior advance (833 to 965). The rising wedge trendline break and support break at 930 are the dominant medium-term chart features. The index recovered from its opening low yesterday to form a doji just above support. A subsequent move back above 930 would forge a higher low and negate the prior support break. This would question the rising wedge break and be enough reason to close any existing shorts. In addition, a new trendline would be drawn with the early and late Aug lows.
Long-term trend: Bearish – The long-term downtrend is still undeniable and there is not enough of a base to warrant a bullish stance. However, the medium-term trend is still questionable. Excluding the Fed-induced decline on 13-Aug, the index advanced from 833 to 964 with a straight shot and is entitled to a correction. While I am taking the trendline break and support break at 930 seriously, the support zone around 900 also looks strong. A bounce back above 925 would be quite positive and could keep the medium-term uptrend alive.
Potential Support: 840 KEY Resistance: 1050
DOW INDUSTRIALS -- On the weekly chart, the Dow retraced less than 50% of its prior decline with an advance to around 9000. This level provided support in late June/early July and is now providing resistance with a shooting star forming two weeks ago. A long black candlestick this week would confirm the shooting star as bearish and argue for at least a support test back to around 8000. On the daily chart, the rising wedge trendline break and support break at 8800 are clear and make the medium-term trend neutral at best or bearish at worst. As with the S&P 500, there is a large support zone around 8500 that keeps the bulls alive. The move below 8800 (SPX 930 and NDX 990) was a shot across the bow to exit longs. A subsequent move back above 8800 would negate the support break and force a rethink. As long as the Dow holds below 8800, the decision to favor the bears is academic. INDU Chart Links: daily, weekly, monthly, PnF, breadth
ROBUST TRENDLINES
I put some thought into these rising wedge patterns and would like to share the initial findings. The jury is still out, but the analysis below may help in the future. Picking the right highs and lows to base trendlines can make the difference between a real break and a false break. We have all seen the rising wedge over the last few weeks in a number of indices and stocks. However, the placement of the lower trendline is open for debate. If you will recall, the upper trendline was colored light gray until a robust reaction high formed. With the recent decline over the last five days, a robust reaction high formed and there are two solid points upon which to base the upper trendline.
For the lower trendline, the same rules should apply: a robust reaction low should form for each trendline point. First, the late July low occurred with a spike and “V” reversal (like Sept-01). This virtually assures that the lower trendline will be steeper than the upper trendline and makes a rising wedge almost a forgone conclusion. If drawn from the 24-Jul open around 795, the trendline is less steep and confirms support around 912.
It seems that the late July low is more a part of the prior decline than the actual rising wedge. After all, the Aug-5 low is the first reaction low of this advance. If we do not include the late July low and require subsequent lows to form with a decline greater than 5% over at least three days, there is only one low left. The early August low becomes the first point and the rising wedge is still only potential. This week’s low could be the second trendline point, but we need to see at least a 5% advance over three days. Another move above 963 would be required for a valid reaction low to form. (Note: The zigzag indicator can be used to identify movements greater than 5%).
While all this may only cloud the issue, it provides a framework to establish valid lows and highs for trendlines. It is not a black and white issue though and requires a bit of “art.” The head-and-shoulders reversal (<930) on the 30min charts provided a signal this past week and this happens to jibe with the lower trendline as it was drawn. Confirmation from another pattern or chart style (intraday or PnF) increases the robustness of a signal or can validate a questionable trendline.
a repost of TDTrader's market summary
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