A Tale of Two Markets

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.
-Charles Dickens "A Tale of Two Cities"

We are in a tale of two markets. Depending on where you look for opportunity you are either seeing groups in full meltdown or breaking out to new highs. If you listen to business media the walls are caving in, if you follow Relative Strength plenty of names are making new all-time highs. For this reason we continue to focus on winners and ignore or sell losers.

It Was the Best of Times...

With the SP500 recovering most of the damage from its recent sell-off, it appears that we will be testing the highs before testing the lows. The Bulls have asserted themselves at these key levels and are trying their best to move the market higher. The Hammer pattern we have seen so often looks to be resurfacing despite the failed attempt 2 weeks ago.

SP500 weekly Hammer formation

The market was defended at the weekly uptrend support and saw strong follow-through after last week's selling exhaustion. We have seen this action before (just check out February of this year for a nearly identical formation) and supports higher prices to come.

Portfolio Stocks Trading at New Highs

More than half of our Portfolio holdings traded at new all-time highs this week. They are demonstrating their ongoing relative strength and are leading this market higher.

GILD

UNH

NKE

BRKB

HAIN

VIX Retreats Back Below 20

With the VIX immediately trading back below 20 and the breakout level, it looks as though last week's surge did in fact mark a panic capitulation for many market participants. If the VIX can now hold below these levels the market should have an upward bias.


+ US Jobless Claims Continue to Come in at New Recovery Lows
+ Global Central Banks Remain Highly Accommodative
+ Long-Term Equity Trends Remain Higher
+ US Interest Rates Remain Near Their Historical Lows  

It Was the Worst of Times...

Despite the bounce in stocks this week the market remains under critical trend resistance. 

SP500 weekly below flattened 20 WMA

Just glancing at the last 2-years of the rally you can see clearly how the rising 20 WMA has acted as strong uptrend support on any pullback attempt. Now we are seeing something different. Even after a remarkable recovery of 140 S&P points, the market is now just touching the underside of the flat 20 WMA. The slope of the moving average has for the first time topped out and has begun to roll over as well. Remember previous support should become new resistance once broken. 

Also note we have the first confirmed lower swing low for 2-years. If the market fails to move to new highs, we have to assume after seeing a lower low that a lower high will follow. 

SP500 Sector Stocks Trading Above the Rising 20 WMA Remain at 2-Year Lows. 

On the surface the SP500 is made up of 500 equally impactful companies. However the Index is "cap-weighted" meaning the largest stocks have the largest effect. Basically the SP500 is made of 500 stocks but only about 90 of them really matter for its general trend direction. I track those 90 stocks on a weekly basis to see what the underlying strength actually is. When the majority of the largest S&P stocks are trading below their 20 WMA and trend support, there will tend to be a pull on the index as a whole and it will be prone to breakdowns. When more stocks begin to turn higher than are turning lower, the market receives a positive boost and rallies are more sustainable. 

Currently only 38 out of 90 SP500 Sector Stocks are trading Above their rising 20 WMA's. This means only 1/3 of the most influential SP500 stocks are in uptrends. Upward momentum will be under pressure when the majority of its component stocks are in downtrends or transitioning.  

Big Breakdowns from Major Multinational Companies 

Exiting KO

After a strong breakout move, KO tanked below its breakout level, through the 20 WMA and prior support area. Volume also increased on the selling this week and we will take our quick exit. 

Longer term the higher lows are still intact, but in a struggling market environment, failed breakouts are the last place I want my capital committed in. 

IBM weekly bars

Incase you were wondering, this is not a "buy" recommendation for IBM right here. Every possible technical tool I can use suggests downside is to follow. Lets take a look at each one of these windows:

1. Price (the most important arbiter) broke its uptrend off the '09 lows in April of 2013. It has since formed a Rounded Top pattern and is now setting its second major swing low with this week's gap lower. 

2. This is what Distribution looks like. The last 4-years of data shows that volume was at its highest during "selling" weeks. Large blocks of sell orders were being dropped on the market over a long period of time while IBM's stock lost upward momentum and began to trade sideways. This is how a market tops out; Institutions close a large position over time by gradually selling shares. Once the selling pressure becomes too steady the stock can no longer move higher and breaks down. 

3. We want to be invested in the strongest stocks in the market. IBM has been in a downtrend vs. the SP500 since 2012. This is about as weak as a Relative chart can look. There is no outperformance here. 

4. Using the MACD to help identify trend and momentum health we can see a steadily deteriorating situation unfolding. How I like to use MACD is to focus on whether the indicator line is above or below the Zero line. Above the line suggests an uptrending environment. Being below the line suggests a downtrending environment. Since making lower lows in mid-2012 the stock has had a very difficult time sustaining any sort of rally. With this week's breakdown, it appears that the trend lower will persist and is potentially just getting started.  

AMZN weekly bars

Amazon is in a similar situation as IBM right here. Price is breaking below support of a Descending Triangle pattern, RS is breaking to new 3-year lows, and the MACD is rolling back through its signal line below the Zero line. This looks like a downtrend to me. 

While it can be very confusing and distracting with all of this conflicting information, the real clarity comes from simply owning stocks moving higher and avoiding the ones moving lower. This way we never get caught in a situation where a loss grows to damaging levels and we always give ourselves the best odds of success by backing only the winners. By always keeping an open mind about the market and focusing on the action of individual stocks, we are able to always know with certainty which stocks we want to be in and which ones we don't. 

The market is often similar to "A Tale of Two Cities". There is always uncertainty around the corner, there are always good stocks to own, there are always risks and rewards that need to be balanced. But by focusing our attention on the best performing stocks and then moving out of them when they begin to signal vulnerability, we are usually able to stay on the correct side of the market the majority of the time.