Before I kick off today’s missive, let me thank Sam Collins and his wonderful audience for allowing me to fill in while he took some much deserved time off. As always, it has been a great pleasure and honor to share my daily views on the markets, and I hope it helped you navigate these tricky waters.
In the previous Daily Market Outlook, I mused that we could see a classic “turnaround Tuesday,” with stocks falling following Monday’s rally. That is exactly what happened, as all major U.S. indices closed sharply lower on the day, led by the small-cap Russell 2000, off 1.7%.
As a result, the iShares Russell 2000 Index (ETF) (IWM) closed below its 21-day simple moving average (yellow line) — a good barometer of near-term strength or weakness — for the first time since pushing above it in February.
IWM is also beginning to fall out of a well-defined rising wedge pattern. The ETF has been in seriously overbought territory since early March, so a sustainable breakout from here without a move lower is highly unlikely. The first downside target is in the $108.50 to $109 area.
The bigger story on my daily call with hedge funds, though, was the potential bullish reversal in the U.S. dollar index. After attempting to break below the diagonal support line intraday, it quickly reversed, resulting in a close above Monday’s highs.
We still need confirmation in the form of a follow-through buying day, but if we get it, stocks and commodities like oil should come under pressure again.
Speaking of oil, energy stocks, as represented by the Energy Select Sector SPDR (ETF) (XLE), rallied above the upper end of a rising wedge pattern last week, but closed well off those highs. So far this week, we are seeing follow-through selling.
On the lower panel of the chart, I added the PowerShares DB US Dollar Index Bullish (UUP). As you can see, it has moved in exact opposition to the rally in XLE.
Going back to my previous point, if the dollar can bounce from here, then energy stocks, commodities and the broader stock market could experience more selling.
This would be in line with weak seasonal patterns, as well, since May is historically one of the weakest months of the year.
Conclusion
It has been an epic melt-up since the bears exhausted themselves in February. But given the structural, cyclical, seasonal and technical headwinds we face, traders are likely better off selling into this rally.
Longer-term investors should wait for much lower levels before legging back into quality growth stocks.
At the very least, I think the S&P 500 will retest its February lows near 1,800. But a decline to the 1,600 to 1,700 area is probable before a continuation of this secular bull market can take hold.
Today’s Trading Landscape
To see a list of the companies reporting earnings today, click here.
For a list of this week’s economic reports due out, click here.
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As of this writing, Serge did not hold a position in any of the aforementioned securities.
