The Weekly Charts

What do they say?

Commentary: The stock market continued its steady ascent higher, closing out last Friday at its highs for the week. After gapping higher last Monday, the markets continued to press the action the entire week, revealing very little weakness. By Friday, many of the indexes actually cleared some key levels and may be signifying a big shift in the markets underlying sentiment.

As surprising as it sounds, the S&P 500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF has rallied in a straight line from its October breakdown and is now back to the top of the consolidation that began in August. In fact, by the end of the week, SPY had a higher closing price than at any time since the markets fell apart late in the summer. While the strength in the markets has to be respected, traders should also realize that the sharp rally that began a few weeks ago has really only retraced about half of the decline from the July highs. The market will need to take a breather soon if it intends to make a serious push to this year’s highs.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF also pressed to new highs after setting new lows just last Monday. While an oversold bounce was expected, the extent to which the market has rallied has been a little surprising. Much like SPY, DIA also closed at its highest price since the breakdown occurred in August. Both indexes are close to setting a higher high as well, which could have interesting implications for the markets. A higher high would suggest that the correction is over. However, DIA has some serious resistance near $118, and getting above that may be difficult to do quickly. It may take the markets more time to build enough strength for a sustained rally.

The Nasdaq 100 started to show some relative strength last week, and fully assumed its role as a leader again this week. The Powershares QQQ ETF (Nasdaq:QQQ) ETF roared to a higher high this week as it cleared its September high near $57. Two of its largest components, Apple, Inc. (Nasdaq:AAPL) and Google, Inc. (Nasdaq:GOOG) had huge weeks and obviously helped carry the ETF. However, this is the behavior that bulls would like to see, as it shows market participants are chasing returns rather than sticking to safety. Now that QQQ has cleared the September highs, it sets the stage for a pullback that will culminate in a higher low. It is very unlikely that QQQ will clear its July highs without this pullback, so traders should still remain cautious in the near term, as the odds of some sort of pullback are very high.

The small caps, as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF, are still trying to catch up, although they did have the strongest week on a percentage gained basis. However, IWM didn’t come close to a closing high like its peers and still needs some work before clearing its July highs. However, if the markets do prove to have bottomed, this is the most volatile group and it’s most likely to experience the largest gain. Traders should continue to watch the August high near $74 as a key level. As the last group to move, any push above these levels could confirm a bottom for the markets.

The Bottom Line
The markets have certainly displayed renewed vigor in the past few days. Also, many individual names are starting to act better, lending validity to the strength in the indexes. However, traders should not let down their guard just yet. Overall, the markets haven’t made a real dent in the decline that started in July. Traders should also be on guard any time a market or stock makes nominal new highs, as in the case for QQQ this week. Often, these highs end up acting as a trap, much like the recent lows in SPY from just a few sessions ago. In order to have a truly healthy rally, the markets will need to digest the recent gains soon, without letting sellers regain control. If that happens, it could set the stage for a year end rally that could carry to new yearly highs. So while the picture has definitely improved, the market is not quite out of the woods yet. (For more, see Technical Analysis: Introduction.)

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