Technicals Suggest Early December Weakness Won’t Extend Into New Year
All major U.S. stock indices finished in positive territory last week, led by the tech-heavy Nasdaq 100, which gained 2% and is up 20.8% so far in 2014. With small-cap stocks lagging all year, the broader market continues to rely heavily on technology to drag it higher.
From a sector standpoint, last week’s advance was led by consumer discretionary and technology, which gained 2.5% and 2%, respectively. The energy sector collapsed 9.8% on fears of global oversupply in crude oil after Saudi Arabia blocked calls for output cuts from poorer OPEC members.
Globally, the recent recovery in European equity prices, particularly in Germany, points to more strength in the U.S. stock market into early next year.
Failed Pattern Bodes Well for U.S. Market
In mid-October, I pointed out a bearish chart pattern in the German DAX Index that targeted an 11% decline to 7,800. This particular chart pattern, a head-and-shoulders, is a common and typically reliable indication of a major bearish change in the price trend of an asset. However, on the rare occasion this pattern fails, it shows that investors have had a sudden and strong collective change of opinion on market direction.
The chart shows this is precisely what happened over the past few weeks. The DAX aggressively moved back above the pattern’s right shoulder at 9,891, set on Sept. 19, which negates the 7,800 downside target and indicates that its larger 2012 advance has resumed.
DAX Market Outlook Chart
Considering the long-term positive correlation between the DAX and S&P 500, the apparent resumption of the 2012 uptrend in Germany’s stock market bodes well for the U.S. market into early-to-mid-2015.
Utilities on Track for More Near-Term Strength
In the Oct. 27 Market Outlook, I highlighted a potential buying opportunity in the Utilities Select Sector SPDR ETF (NYSE: XLU), which was trading near $ 44.50 at the time. A breakout from a triangle pattern targeted a move to $ 47. Through the end of last week, XLU was up 3.3%, and how it got there reconfirms my $ 47 target.
Asset prices typically alternate between periods of investor indecision and conviction. XLU’s late October rise from four months of sideways action — indicating investor indecision — to resume its larger 2014 advance was a textbook example of that.
Since then, the chart shows that another smaller pattern of trend, indecision and resumption of trend played out last week, which confirms that we should see another trending phase to at least $ 47 during December.
XLU Market Outlook Chart
Utilities are defensive, dividend-paying stocks that typically do well when U.S. Treasury yields are declining, because it encourages investors to take on more credit risk in exchange for a higher yield. Accordingly, more upcoming strength in XLU indirectly suggests a near-term decline in long-term U.S. interest rates.
Gold at Another Minor Decision Point
Following a 2.5% rally in SPDR Gold Shares (NYSE: GLD) on Nov. 14, I pointed out that the recent contraction in assets invested in the ETF suggested there wasn’t enough near-term bullish conviction to fuel a sustainable advance. As expected, GLD peaked a few days later before collapsing 2.7% on Friday.
GLD Market Outlook Chart
The lower panel of the chart shows that the total assets in GLD are now negotiating their 21-day moving average from below. This means that they are testing their monthly trend of contraction, just as they did on Oct. 15 and Aug. 11, both of which led to the resumption of GLD’s larger July decline.
This latest test represents another important minor decision point for GLD and gold prices. It would take a sustained move above the 21-day moving average in investor assets to indicate we could see a significant rise in gold prices. Until this occurs, I will view this inflection point as the potential starting point of the next leg lower.
Putting It All Together
The potential for the yield of the 10-year Treasury note to rise into the early part of next year and coincident strength in the defensive utilities sector suggest the potential for a minor stock market decline in early December.
However, this year’s leadership by the technology sector and the recent resurgence in the German DAX Index suggest that, minor corrections aside, favorable conditions exist for the U.S. stock market to extend its 2014 gains into early 2015.
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