I'm always looking for inter-market, inter-sector, inter-whatever relationships to help shed light on where we are and where we might be going. Very often this type of analysis reveals indications of investor risk appetite (risk-on vs. risk-off mode), whether it's on the rise, plateauing or waning. By picking up on clues about underlying sentiment, one can frequently gain a bit of a jump on timely inflection points or if the market is likely to continue in the current direction.
Viewing the hourly S&P 500 Index chart, the market has steadily climbed over the last several days, successfully getting through resistance levels along the way.
As shown above, recently the Index was able to breach resistance at about 1680, pulling back yesterday. Granted, it has yet to be considered what I would call a significant breakout since price hasn't risen above resistance with room to spare, but nonetheless a breakout it is. Or more specifically a breakout with a pullback, with a price retreat being a very common occurrence post-breakout and such a retrace can be considered healthy, re-energizing momentum as evidenced by the now oversold stochastic (red circle in chart above). Also note the blue circles in chart highlighting a bullish inverse head-and-shoulders formation.
The question now is will the market (Index) continue to ascend or will at this current level a double-top begin to form? Based on what I'm seeing (already mentioned a few above), the former is more likely.
It's always good to check how the Russell 2000 Index is performing versus a larger index like the S&P 500.
The hourly chart above shows the S&P 500 recently making a new high, yet the Russell 2000 had successfully made a new high several days ago -- a bullish confirmation. The smaller-cap Russell 2000 Index is a much flatter representation of the market than the S&P 500 and in effect serves as more of an A/D line. Also, small-cap stocks have a higher sensitivity to the economy compared to their larger-cap brethren and give a better indication of economic conditions.
I've discussed here many times the implication of inter-sector relative returns. The chart below shows the XLY (Consumer Discretionary) versus the XLU (Utilities).
When the XLY:XLU line (lower inset) is rising, it means the XLY is outperforming the XLU, and vice versa. XLY outperforming XLU is generally indication of risk-on mode, bullish for the market, and a declining relative return line with XLU outperforming XLY generally infers risk-off mode is taking hold, bearish for the market. As I say many times, no indicator is perfect (which is why one needs to follow many), but I show periods (blue lines) where the XLY:XLU line has diverged from the market (S&P 500, upper inset), giving ample warning for turning points. More recently, the XLY:XLU line made a new high in May and has continued to rise -- a bullish confirmation.
Another near-term bullish occurrence has been momentum. I've discussed here once before the concept of "good overbought" and "bad oversold," which in a nutshell refers to extreme, longer-duration momentum. When momentum is extreme and has been consistently so over a period of time, it suggests the trend will continue in that direction, even after a correction. We observed good or bullish overbought momentum for the market (S&P 500) in May and here we are at a new high.
Note the S&P 500 hourly chart below:
It shows the July rally with consistently extreme-positive momentum, with the stochastic and RSI indicators highly elevated over several days (red boxes). In my experience, such powerful momentum represents significant thrust which tends to have a carry-over effect. The S&P 500 has retreated from its breakout, but given the observed "good overbought" condition I would expect another run at new highs to follow.
Speaking of momentum and thrust, I would finally mention that the venerable Ned Davis of Ned Davis Research (NDR) released a report on Monday discussing this subject. According to NDR, the S&P 500 registered a BUY thrust signal in early January (1/4/13 to be exact). Since 1970, the S&P 500 has registered 16 BUY thrust signals (not counting the current one) and in every instance the market was higher a year (253 trading days) later. We'll wait and see if the record improves to 17 out of 17....
It's nice to see the market stands a good chance of finishing the year higher, but my focus above is more near-term, covering the next few weeks. I have found the best one can do in hopes of making fairly accurate market calls is to function within a rolling 3-4 week window, making adjustments as needed. Within such a time frame, things continue to look bullish to me.