Weekend Update: Does the Bounce Have Staying Power?

The last two weeks have been the weakest we have seen since the November rally began, losing some 3-4% from the highs. But the SP500 held its breakout retest on Thursday and rallied hard to finish the week on better than expected job growth for May. The number reported Friday morning was perfect. Expectations were to see 160,000 new jobs created for May and the reported number was 175,000. So better than expected but also not blow out. The reason the number was perfect was because the selloff that occurred over the past two weeks has been fueled by the idea that the fed will be reducing or "tapering" (the new media buzz word of the month) it's easy money policy starting soon. What has been said by fed officials is that they will begin to address the reduction of QE when the labor market recovers substantially and the economy is able to stand on its own. Two possible worst case scenarios were being floated around the media concerning this jobs report:
1. The report would come in weak and would show that stimulus has not aided in an economic recovery and a recession was likely ahead.
OR
2. The report would surprise to the upside big and would be the signal that the fed could take their foot off the gas thinking the economy was ready to hold its own.

Again these were just theories but they do have some merit and likely would send the market lower as the sugar high revving up the market would be taken away. But what actually happened? Jobs came in "slightly" better than expected, showing that the labor market is still improving although slowly and that not enough evidence is in place yet for the fed to step away. Perfect scenario, more stimulus AND an improving economy and labor force. The other encouraging note from the jobs data was that a few hundred thousand new members entered the work force seeking employment. Which is a big jump from prior reports showing a renewed confidence that continued job growth is ahead.

So good news. We like positive stories and all but as you know by now we really care about how that news is digested and reflected by price. We could get all the rosy, pie in the sky news we want but if the market sells off, we still lose money. Often it's not what the news is that's important, but how the market responds that counts. This weekend we are going to take a quick look at the SP500 pullback into key support, and also check out a few short term charts that reflect our gameplan going forward.

After pulling back for two weeks we saw the market bounce right at the key support level we have been watching; the 1,600 level represents the long term breakout level from prior market peaks and also is now where the ascending trend support comes into play since the November rally. This will continue to be the level of interest going forward and will determine whether we are aggressive or conservative. The action this week was absolutely textbook having the triangle pattern fulfill exactly at 1,598 and then reversed. We discussed last week that this is what everyone seemed to be expecting and it happened to play out...That's not typical, but that's why we watch what actually happens and not what we think should happen. I get concerned when everyone seems to be in consensus with a particular outcome, so it was interesting to see the market cooperate with such an obvious setup. I am also starting to think that the Fed wants to keep the markets above "key" levels for confidence purposes and 1,600 on the SP500 and 15,000 on the DOW are those key levels. Yes this market is manipulated, but does that make the gains any less profitable? No, it does not. So enjoy it and focus on the price action, not on conspiracy theories.

Now lets take a look a little closer at the 30 minute chart showing the pullback and bounce in greater detail:

The shorter time frame shows a couple positive developments that, given a move above 1,646, a rebound rally back to all-time highs would be expected. First we see the 2 week downtrend resistance line broken and held with a late day surge to the neckline of our reversal pattern. Next we see that price has or is forming a bullish reversal head/shoulder bottom. We would need to see a breakout above the 1,646 level which would also make a higher high killing the downtrend (remember the definition of a downtrend is lower lows and lower highs, seeing a higher high invalidates a downtrend). Any weakness we see in the early part of next week should not exceed the 1,622 level which would be the low of the left shoulder. A trade below that would put this setup in jeopardy. Based on this action we want to be positioned heavily long the market above the 1,646 level and we would want to be very minimally positioned if this bounce should fail, breaking down below the 1,600 level. As of the close Friday I am currently 70% invested across all accounts and would look to get nearly 100% invested on a breakout for the short term reversal trade. I am also prepared to sell most of my holdings should we fail this bounce and roll over from here. I would likely sell down to about 25% invested below 1,600 and targeting a much deeper correction.

I personally feel that this bounce has legs and is likely to move higher. Looking around the market I am seeing this very same pattern setting up in many stocks I watch and hold. Lets take a quick look at a couple.

DDD

A breakout above 47 would setup a trade back to the range highs and 10% possible upside from the neckline area. While a rollover below 43 would send this breakout to the downside and we would want to step aside. But still, a positive looking chart.

HD

Home Depot is setting up well here with a nice looking reversal pattern. It also completed a smaller pattern today that was developing over the prior two trading day's action. In a bullish environment one pattern will often set up another...That's what I believe we are seeing here. Watch for a breakout above 79.15.

AMTD

Here is a look at one of my holdings, TD Ameritrade, the online stock broker. This is interesting because this stock has already put in a reversal pattern and has broken out to the upside. This stock has been performing well for some time and has been a market leader for most of the rally. It's nice to see leading stocks hint at price action for some of the more lagging ones. AMTD is showing that it is likely that the broader markets will follow through on the reversal price action in the near future.

These are just a few examples that I have shown, but if you look around your watchlists you will likely see many stocks setting up like these. Its these internal signals that we look for in determining underlying strength and I like what I'm seeing.

Just because the setup looks good however doesn't guarantee an outcome so always be vigilant to all possible scenarios and prepare a plan for your worst case scenario.

I discussed changing the format of the blog last week and I still intend on doing so as we move forward, but this week's events prompted me to share this info with you. All of the holdings we mentioned at the end of last week's post are still invested and there were no changes to our portfolio. The two prospects for buys last week were AAPL and CMI, however both failed to trigger a buy and we will still wait and see how those continue to play out. As of this weekend we still have 12 invested positions with 7 in cash. When these holdings change I will let you know. Hopefully this next week won't be as eventful as this one was and we can discuss in more detail exactly what we are watching in our current portfolio holdings.