By: John Kosar of Street Authority
Major U.S. indices closed mixed last week, with the broad-market SP 500 and tech-heavy Nasdaq 100 closing higher and the blue-chip Dow industrials and small-cap Russell 2000 closing lower. The bigger takeaway to last week's lack of direction is that the bellwether SP 500 has been moving sideways for the past month and is essentially unchanged since July 1.
This recent loss of upward momentum suggests some distribution/profit-taking has been occurring and defines a near-term decision point in the index, bordered by 1,986 on the upside and 1,953 on the downside, from which its 2014 advance must resume if still healthy and intact.
Small Caps, Volatility Will Be Key Again This Week
In the July 14 and July 21 Market Outlooks, I pointed out that the Russell 2000 and the Vanguard Small Cap Growth ETF (NYSE: VBK) were situated right on top of major support levels and amid favorable conditions to resume their 2014 advances -- if they were still valid. Following initial rebounds, Friday's sharp decline positioned both back on top of these levels -- 1,143 on the Russell 2000 and $121.53 on VBK.
A key determining factor of whether these support levels hold is investor fear, and one way to measure it on a daily basis is via the CBOE Volatility Index (VIX). The VIX has been hovering on both sides of its 50-day moving average, which I use as a baseline to determine investor fear and complacency, since early July.
This means investors have been alternating between fear and complacency for the past month, which is precisely the indecision that has kept the SP 500 in a tight sideways range. In the June 9 Market Outlook, I noted that sustained rises in the VIX above its 50-day moving average, from an extreme low of below 12, have historically coincided with meaningful declines in the SP 500.
Therefore, I would view a sustained rise this week above the VIX's 50-day moving average, currently situated at 11.78, accompanied by a decline below the aforementioned major support levels in the Russell 2000 and VBK, as an indication that an overdue corrective decline is emerging in the broader U.S. market.
Gold Still Has Second-Half Potential
In the July 7 report, I highlighted the rise in SPDR Gold Shares (NYSE: GLD) on expanding investor assets, saying: "Think of these assets as 'trend fuel' -- as long as they continue to expand, gold prices and GLD are likely to continue rising."
The chart shows daily assets in GLD contracted at the end of last week, back below their one-month moving average, which warns of their vulnerability to a near-term decline similar to those that took place in October 2013 and in mid-March of this year.
However, I am currently viewing the recent weakness in gold as just a temporary decline within what appears to be a larger basing process.
The next chart plots the Market Vectors Gold Miners ETF (NYSE: GDX), which is positively correlated to GLD. An inverse head-and-shoulders pattern was confirmed by the July 9 breakout above the declining trendline from the August 2013 high.
The pattern targets a 31% rise to $35 that will remain valid as long as the ETF's 200-day moving average, currently situated at $24.10, loosely contains as underlying support. Therefore, I would view a rising GDX, on expanding daily assets in GLD, as a new buying opportunity in either ETF.
the 2014 advance in the bellwether SP 500 has stalled over the past month while the small-cap Russell 2000, which tends to lead the market both higher and lower, is struggling to remain above major support. I would view a meaningful decline below 1,143 this week, on a sustained rise above 11.78 in the VIX, as evidence that an overdue stock market correction may be emerging. Should this occur, it is likely to trigger a shift into more defensive assets like gold.
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