After taking a little breather last Thursday, stocks again rallied on Friday and in the case of the S&P 500 closed the week at the highest levels in 2.5 months. Last week’s 6% rally of this index has brought it right back to the very top of its 2.5 month trading range. If we measure the move from the May highs down to the August lows we find that the current 1220 area is right at the 50% retracement line. From a momentum point of view various oscillators show that stocks could rise higher in the medium term and a logical first target to look for is near 1260-1270.
It is of great importance however to keep front and center that we remain in a bear market and as such any rally will be marked a bear market rally. Such rallies tend to be viciously sharp and equally volatile. Fake out moves are a staple mark of bear market rallies yet trading on unconfirmed signals is incrementally more dangerous. Yes the S&P 500 closed above the 1220 mark last Friday but a) only moderately so and b) still within the greater trading range. The 12% rally off the early October lows was accomplished in a short amount of time and as such is certainly subject to retrace some before then potentially rallying somewhat higher again.
Large cap technology stocks performed well last week and the Nasdaq 100 index is now only about 2.5% off the 2011 highs. Any short-term pullback here, should we get it, can be played via the large cap stocks among other rally leaders of last week.
Two macro charts I like to focus on for clues are the AUD/USD currency cross and oil. See the two charts below and note that both are at key downtrend lines from their thus far 2011 highs. For equities to further extend this bear market rally these two assets would have to move higher as well. Given the resistance right here right now however that could indicate a pause before a continuation higher.
This week earnings season in the U.S. kicks into full gear and while that certainly will be a contributing factor to market volatility it remains Europe we must focus on for the bigger swings.
Last week the spread between German and French government bonds widened significantly (French bonds fell relative to German bonds). This may be an indication of more weakness to come in the Euro currency when investors smell this as the weakness in French bonds may be in connection to some banking issues in that country.
Watch the euro and the dollar for clues to the U.S. equity market. As of Friday’s close the EUR/USD currency cross has retraced up a little more than 50% of its most recent swing and may find resistance somewhere in this area (see the gray bubble on the chart).