An Epic Battle

On a longer term weekly perspective, the US stock market SP500 index has rallied from the February correction bottom now to just below July 2015’s prior $2126 highs as it closed the week at $2096, just 30 handles lower. With the bulls knocking on the door of all-time highs, a breakout and hold could open up the door to a huge rally, as the resistance void that would be created has the possibility of producing a price vacuum sucking stocks much higher. If you want to see what that looks like go check what happened to the SP500 as price broke out to new all-time highs in the second quarter of 2013. I am not saying that is what will happen rather just that it is one possibility we need to be aware of.

The bears haven’t thrown in the towel just yet though. Last week’s candle formed a cautionary gravestone doji thereby adding the 2nd of the 3 necessary for a bearish reversal shooting star pattern. To confirm this pattern, the bears need to close the index lower next week, preferably below the first candle in the pattern otherwise the pattern will be considered dead and void. 

Taking a look at a shorter term daily chart below, you can see in the upper pane of RSI momentum we formed bearish double divergence. While divergence is not a sell signal, it is a warning price has gotten ahead of itself and warns of, at least, a pause, or worse, a correction.  For the past 2 ½ months price has been contained within the (red horizontal) trading range but finally broke out to the upside on Wed. Friday we fell back into the range warning of a false breakout. We still need confirmation and follow through next week but if the false breakout sticks, it raises concern about the potential of “from false breaks comes big moves in the opposite direction”. Notice too, how the volume (bottom pane) on the breakout was lackluster, well below its average telling us not that the bulls were strong but rather the bears were taking a break. One final feather in the bear’s cap is the fact price has formed a bearish rising wedge (blue dashed lines).  Because it has yet to confirm with a breakdown below the lower support channel line, it allows for the possibility of one more move higher before any break occurs (forming triple divergence).

My read is the bulls and bears are locked in an epic battle. With an eye on the longer view a slight edge must be given to the bulls. On the shorter term, the bears are out in the lead.  Add to this mixed message the fact we are in the throes of a dull seasonality period (June-August) which will likely keep any move (higher or lower) in check as most market movers are on vacation. So with no clear winner, patience is needed as there is not enough evidence on our longer term investing time frames to commit to either the bullish or bearish case.

Caution – Rising Wedge Ahead

Oil has been in a relentless uptrend since its Feb bottom at ~$26/bbl. The divergent low told me to expect a good rally but this has gone well beyond anything I expected especially when considering the fundamentals and head winds it faces. This trader’s fueled rally has now taken it up to an area of major resistance, $51-$53. As you can see, price has formed a divergent oversold high bearish rising wedge with falling volume.

Investing offers no guarantees but a confirmed break of this pattern (before it has a chance to confirm a close above resistance – otherwise all bets are off) to the downside provides an excellent exit for those long black gold. And for those blessed with excellent position management skills and ability to short, the first downside target of this pattern is the $41-$42 area offering a 15%-20% profit opportunity.

Small Cap Breakout? or Fakeout?

The US small cap stock index (IWM) has gone nowhere for more than 2 ½ years. Since peaking in June of last year it has been in a protracted downtrend falling 25% peak to trough and during that time formed a series of lower highs and lower lows as you can see in the 5-year chart below.

Just recently, the index broke above the downtrend line. One thing I like to see on resistance breaks as confirmation the break will hold, is for price to immediately fall back to the upper side of that resistance (now turned to support) line, hold and then move higher. This is exactly what happened and adds to the confidence and probability of higher prices ahead. Another bullish note is that price has crossed and held above the 200 day moving average which is just now beginning to curl higher.

While these signals are constructive, small caps are not out of the woods just yet. There is plenty of overhead supply that bulls will have to eat through which should make for a slow grind but most importantly the pattern of lower highs and lower lows still needs to be broken if this index is going to move substantially higher and worthy of long term investment capital.

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Sipping The Long Bond

In the early part of 2015 the US long bond proxy (TLT) peaked right at $134/share. I remember it well as the bond bears were out in force predicting the end of the world for those who owned bonds. They had a good reason to believe this was going to be the case, remember the FED started jawing very loudly about raising rates. And rising rates is not good for bond holders. From that point, TLT lost more than 16% (peak to trough) at the same time unwinding its overbought condition in its downward consolidation.  But a funny thing happened the fundamental story stopped working. The market apparently inserted its earplugs because TLT's price has been in an upwards trajectory since the June low and is now just $2 away from the Jan 2015 high.  This is a great example of why paying attention to just fundamentals or the talking heads can get you in trouble. Price is all you need.

As you can see in the weekly chart of TLT below, the past year and a quarter price has consolidated and formed a very nice cup and handle continuation pattern. This consolidation has the (red) 200 day moving average change from down, to flat, and to now up.  Additionally, the overbought RSI momentum condition has had time to unwind but not too much as to send it into the bearish zone. Finally, with cup and handle patterns additional validation comes from seeing volume decline when forming the handle of the pattern which is exactly what occurred.

As with all chart patterns, this cup and handle is no different and will need to confirm before it becomes valid. This would occur with price closing and holding above the rim of the cup (~$134), which it has not yet done. And because we are up against major resistance combined with the fact today is a FED day and their announcements (unfortunately) can and do move the markets, I am not convinced this “continuation” pattern will actually continue. It could just as easily turn out to be a major reversal level and the pattern fail. Either way, the ramifications to all markets could be enormous and as such all investors need to keep what happens to bonds front and center.

As a side note, knowing price patterns can greatly help increase your success rate when investing. But buying or selling in anticipation of the pattern development and confirmation provides no edge at all and, in my experience, will hurt your returns.