Last week we thought the major indexes could continue higher but the advances were much greater than anticipated returning the S&P 500 Index to the operative upward sloping trendline that should now act as overhead resistance. See the SPX chart in the Strategy section below.
Market Strategy
Along with the relative underperformance of the small capitalization stocks that may not improve anytime soon due to valuation concerns despite a stronger dollar that should benefit domestic companies over the large capitalization stocks with considerable international exposure, the rotation out of cyclical stocks that began several months ago continues. For example, the one, three and six month relative strength leaders included health care, utilities, and consumer staples all near the top of the lists. Referring to the market cycle chart below, we see they outperform in the early part of market contractions, suggesting the market may now have some trouble exceeding its previous highs.
iShares Transportation Average (IYT) 153.44. However, the notable exception is the Transportation sector, usually an early expansion group showing no signs of slowing and is just 2.84 points or just 1.82% below the high made on September 19 at 156.28, having declined to 137.05 on October 15.
Keep in mind, the upcoming congressional elections on November 4, just over one week away, may also be influencing the current market advance adding another reason to question the rebound sustainability since markets often sell off after expected events occur.
S&P 500 Index Trendline Update
Two weeks ago, we?included a chart of the S&P 500 Index showing the close below the operative multipoint intermediate upward sloping trendline from the November 16, 2012 low of 1343.35 touching lows made on February 5, 2014 at 1737.92 and on August 7, 2014 at 1904.78.
In addition, we noted the trend is lower until it closes back above the trendline that will most likely act as resistance. On Friday, the slope of the trendline crossed at 1968.48, just 3.90 points higher than Fridays close and today it will be 1971.12. In the event it exceeds this resistance, it will likely continue up to challenge the September 19 high of 2019.26 where it will encounter additional resistance at the previous high. See the chart below.
A new trendline will be established when the S&P 500 Index makes a new high above 2019.26.
In the event SPX is unable to close back above the USTL, it will put the uptrend in doubt. Then when considering the continuing underperformance of the small capitalization stocks and the relative outperformance of early contraction issues such as consumer staples, health care and utilities shown in the cyclical rotation chart above along with the VIX futures premium under 10% the situation remains cautious despite the strong advances seen last week.
Accordingly, we suggest keeping hedges in place until SPX closes well above the USTL and the VIX futures premium now at 5.40% returns to the normal 10% – 20% range.
Summary
An equally rapid advance likely helped by some short covering followed the quick S&P 500 Index decline down to 1821.61 on October 15 after closing below the upward sloping trendline on October 9. The S&P 500 Index is now right up against overhead resistance created by the upward sloping trendline that may contain the advance however expectations for results of upcoming congressional elections could also be a factor in last week’s advance.