Rally continuing?

Commentary: The general markets have managed to stage an impressive bounce from their recent lows as they climb the proverbial “wall of worry”. While a bounce from oversold conditions was not surprising, many participants have been surprised to see the markets shrug off a major natural disaster and a  brewing civil war in the Middle East. For the week, the markets ended higher, although volume was quite subdued when compared to prior weeks. The true measure of this market’s appetite will be tested soon as the markets have bounced into possible resistance areas relatively quickly.  

The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY), has rallied by more than 10 points from its March lows, and in very short order. Many traders expected the $130 level to reject SPY, but after a brief pause, it continued its march higher. In fact, the bounce is eerily similar to the one that occurred in September, where traders who weren’t quick to react were left behind. SPY is currently testing the top of a broadening wedge that has been forming and could find some resistance in this area. Traders should carefully monitor how SPY behaves in the coming days to see if this pattern can be cleared. An ideal scenario for bulls would be for SPY to trade in a tight range just above $130 as it builds some energy for a sustained breakout.

Source: StockCharts.com

The bounce in the Diamonds Trust, Series 1 (NYSE:DIA) ETF was also quite impressive. DIA easily regained its 50-day moving average and then rallied toward its March highs. DIA is now testing an important area near $122.50 and may need to consolidate before a true breakout can be sustained. While volume has been weak, the price action has been impressive, and several Dow components have strong looking charts.

Source: StockCharts.com

While SPY and DIA have experienced sharp bounces, the Powershares QQQ ETF (Nasdaq:QQQ), which represents the Nasdaq 100, has continued to underperform. QQQ has just made it to its 50-day moving average and is testing a clear resistance area near $57. This could be a warning that the markets aren’t ready to truly resume heading higher. The Nasdaq has been leading this market since the rally began and a sustained rally would be virtually impossible without this group.

Source: StockCharts.com

The other index ETF that should be looked to for leadership is the iShares Russell 2000 Index (NYSE:IWM) ETF. While Friday’s close left an ugly candle, this is the only index that has come close to testing its February highs. This is actually a good sign, despite the weak close. IWM likely needs to rest here as well, as a sustained breakout may be difficult without at least a little consolidation. The $80 level will be a key area to watch on any market weakness next week.

Source: StockCharts.com

The Bottom Line
What a difference a week makes. Last week, the markets started to show some life but the expected outcome was for the bounce to run its course and the markets to retest the lows. While I wouldn’t necessarily rule this scenario out, the markets did accomplish some good things this week and the technical picture has changed substantially. The lows formed in March are now very key levels to watch. Due to the strength of this bounce, the markets should not even sniff these levels if this bounce will turn into a significant rally. Last week we mentioned that V bottoms are rare; one reason for this is that participants who bought the lows are now sitting on handsome profits. With the market’s currently testing resistance, it will be interesting to see if current longs will be anxious to book some profits. Chasing after a two-week rally will likely be punished, so once again, patience needs to be stressed to anyone watching from the sidelines. Despite the recent strength, the technical picture remains neutral at best. The markets are still under key resistance levels and likely need some time before a true breakout. 

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