January 6, 2015
Caution: These 2 Charts
Warn of a January Correction
By John Kosar
In last week's Market Outlook, I warned that continued weakness in the technology sector, which to a large degree drove the 2014 broad market advance, could become problematic, especially in January and February when seasonal factors begin to weigh on stocks. My fears may be materializing as all major U.S. indices closed lower last week, led by the tech bellwether Nasdaq 100, which lost 1.9%.
As long as technology is weak, and the small-cap Russell 2000 -- the other traditional market leader -- remains below its 1,213 March 2014, the stock market could be in for a tough January.
All of the S&P 500's sectors were negative for the week, led lower by technology, which fell 2.5%. One of the "least weak" sectors was consumer discretionary, which lost just 0.8%. My own ETF-based metric shows that the largest inflow of sector bet-related investor assets during the past one-week, one-month and three-month periods went to consumer discretionary, which was mentioned as a potential buying opportunity in the Dec. 8 Market Outlook.
In last week's report, I suggested readers view the mid-December rebound as more of a gift from the Federal Reserve than a precursor to a terrific first quarter considering 57 years of seasonality data warned the market could start to lose upward momentum by the middle of January. The first two charts this week provide two more reasons for investors to be cautious this month.
Momentum Divergence Predicts More Weakness
The first chart shows the S&P 500 with the Moving Average Convergence/Divergence (MACD) indicator. MACD plots the difference between a 12-day and 26-day exponential moving average to measure price momentum.
The diverging arrows in the upper and lower panels highlight periods that the S&P 500 was rising while MACD was declining. These momentum divergences preceded near-term market peaks in December 2013 and July and September 2014.
A similar divergence is now emerging. Barring a strong upward reversal in MACD this month, this indicator warns of an upcoming stock market correction.
Stalling Semiconductors are Another Red Flag
The second chart shows the PHLX Semiconductor (SOX) index is currently testing and reversing down from its May 2001 high at 711.
Since semiconductor stocks tend to lead the technology sector and technology tends to lead the S&P 500, as long as 711 continues to contain this index on the upside, I view it as an indirect indication of an upcoming broad market pullback.
The VIX: From Mojo to Uh-Oh
In the Dec. 22 Market Outlook, I said Fed Chair Janet Yellen had at least temporarily given the market its mojo back. This could be seen in a declining CBOE Volatility Index (VIX), which indicated that investors had again become complacent enough to facilitate more market strength.
Less than three weeks later, however, the market appears to be getting nervous again.
The VIX rose back above its 50-day moving average last week, indicating a significant increase in near-term investor fear. A move above the 50-day helped fuel declines in the S&P 500 in mid-September to mid-October and in mid-December.
As long as the VIX remains above 15.11 this week, I expect near-term weakness to materialize in the marketplace.
Putting It All Together
The stock market euphoria immediately following the release of the December Fed statement appears to be wearing off. The late December new all-time highs in the S&P 500 were not confirmed by momentum metrics, which is often a precursor to a minor pullback.
Meanwhile, the market-leading semiconductor sector is failing at overhead resistance while volatility is starting to tick up. The latter indicates that rally-killing investor apprehension is starting to creep back into the marketplace.
Add to all of this the seasonal tendency for the first week of January to be the strongest of the entire first quarter, and we have the makings of a potential market pullback into February. Bigger picture, however, I continue to look for overall economic improvement through the second quarter, which is supported by what appears to be an emerging bottom in long-term U.S. interest rates.
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