December 30, 2014
Warning: Watch Out for a Hangover
After This Market Party Ends
By John Kosar
All major U.S. indices posted gains last week, led by the small-cap Russell 2000, which advanced 1.6% and is now up 4.4% for the year. A sustained move above the 1,213 March high would confirm a bullish breakout from a year of sideways indecision and portend more strength into the early to middle part of 2015.
The bad news is that, while small caps appear to be recovering, technology stocks have lagged lately with the Nasdaq 100 gaining just 0.8% last week. Since technology to a large degree has driven the 2014 broad market advance, continued weakness by this index could become problematic, especially in January and February when seasonal factors begin to weigh on stocks.
GE Lights the Way
In last week's Market Outlook, I said that one way to determine whether the previous week's sharp market rebound, ignited by comments from the Federal Reserve, was sustainable was to keep a close eye on market bellwether General Electric (NYSE: GE). At the time, it was testing its 2009 major uptrend line as underlying support.
GE aggressively reversed higher from this support on Dec. 17, the day the Federal Open Market Committee (FOMC) statement was released. It spiked 8.1% to a high of $26 last week before pulling back slightly.
The chart shows that GE began this week situated just below its 200-day moving average at $26.04, a widely watched major trend proxy. A sustained rise above this line would be necessary to confirm that a significant bottom is indeed in place at the mid-December lows and that GE's larger major uptrend has resumed.
Failed Bearish Pattern in Dow Transports is Bullish
Two weeks ago, I pointed out a bearish chart pattern in the Dow Jones Transportation Average that had initially targeted a decline to 8,550, with the caveat that 8,888 must loosely contain as overhead resistance to keep the bearish implications of the pattern intact.
Not only was 8,888 broken to the upside, but the transports have since risen above their 9,220 Dec. 5 high to negate the pattern.
Failed chart patterns are relatively rare, but when they occur they indicate that investors had a sudden and significant change in their collective opinion on market direction. In this case, the market's change of heart was directly attributable to the December Fed statement. The transports turned on a dime from 8,581 on Dec. 17, just 31 points from my downside target.
Failed bearish patterns typically precede a bullish near-term trend change -- in this case a move higher that I expect will soon exceed the 9,310 Nov. 28 all-time high.
The Fed Gives the Market Its Mojo Back
As stated in last week's report, I believe the market misinterpreted the Fed's statement as being much more dovish than it was intended to be. But, regardless of whether it was justified or not, the next chart illustrates how quickly investor apprehension abated.
The CBOE Volatility Index, better known as the VIX or the fear gauge, peaked on Dec. 16 and immediately declined, moving back below its 50-day moving average on Dec. 23.
The green highlight shows that the previous time the VIX spent a sustained period below its 50-day moving average coincided with -- if not fueled -- the early November to early December rise in the S&P 500. Therefore, as long as the VIX remains below 15.39 this week, I expect last week's broad market rally to continue.
Beware of January-February Seasonality
Back in the Sept. 2 Market Outlook, I pointed out that December is the seasonally strongest month of the year in the S&P 500 based on data since 1957. More recently, in the Dec. 8 issue, I said that following a seasonal decline during the second week of December -- which materialized as expected -- the S&P 500 historically finishes the year strong as the well-known Santa Claus Rally emerges.
The next chart shows that seasonality in the S&P 500 isn't quite so rosy come January. The first week of January is the seasonally strongest of the entire first quarter, but that leads into a sharp two-week decline during the middle of January, and then into the weakest week of the quarter at the end of February.
Therefore, even though the near-term environment looks pretty good heading into this holiday-shortened week, keep in mind that things have historically become a little dicey after the New Year's partying is over, which may be when some of the Fed-induced euphoria starts to wear off.
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