Weekly Market Summary

After a 26% uncorrected rise over the past 6 months, SPX finally experienced a 5% correction this Thursday. It rejoins every year, except for 1995, in that regard.

On Wednesday, the day before the low, we published a detailed note summarizing the low-risk, high-reward long set up, as well as what to expect next (please read it here).

The two week down-move in SPX retraced all the gains from May 2 onwards. The 2000-07 resistance zone that we had expected to hold in April was back-tested as well (chart). In essence, risk was removed as was any opportunity-loss in May.

What to expect next:

Upside: it would be 'normal' for SPX to at least attempt a retest of the recent highs in the coming weeks. That is a pattern that has played out in almost every strong uptrend over the past several years (yellow shading in chart).

Downside: SPX 1600 obviously becomes key to hold. A quick return to that level, and a 38% retrace of the rally from November would be likely, bringing SPX back to 1550, also the key support during March and April lows (chart). Incidentally, the powerful 2006-07 advance (that this rally has been compared to) retraced by 38%. And, 1550 also represents an 8% drawdown off the YTD highs; since 1980, SPX has declined by at least 8% intra-year in 80% of instances.

On Wednesday, we mentioned that the brief retrace so far had not 'reset' the market, as shown by both the bullish percent index (chart) and the percent of companies over their 50-dma (chart). These moves take time; think 6-8 weeks as opposed to the two weeks since the highs were made. 

One immediate indicator to watch is breadth. The washout this week should be followed by an expansion in breadth as a sign investors want back in. That hasn't happened yet. In the past, a 9:1 up day has followed solid bottoms. When that hasn't happened, SPX has moved lower (chart).

SPX Is On Major Support With An Extreme Negative Breadth Reading

Today, $SPX returned to the bottom of its channel from December 2012. We noted at the close the defined risk in going long here as (1) the channel bottom, (2) the 50-dma, (3) the April high pivot and the May opening gap were all within 1%. Note also the positive RSI divergence. The clear support close by makes the risk-reward attractive.

The rise into mid May was driven by cyclicals. The cyclical index has also returned to its May break out level today. No harm, yet.

One indicator mentioned today that supports a near-term long is the McClellan, a breadth oscillator. It closed at an unusual low that has consistently been near a profitable bounce. The bounce may eventually fail, but there is normally upside within the week.

Weekly Market Summary

The story so far is this: by April, SPX had run into the resistance zone from the 2000-07 tops and stalled. Dividend and defensive stocks were leading with cyclicals and small caps lagging badly. European and emerging markets were in retreat and commodities were plummeting. In short, it looked as though economic growth prospects were dire, an assumption seemingly confirmed by treasuries which were outperforming equities by more than 3 times (chart).

Add in a declining number of stocks over their 50-dma and the fact that fund managers were at near record equity exposure and it looked as though SPX would shortly suffer a regular counter cycle drawdown. Recall that since 1980, SPX has declined by at least 5% every year by May in 90% of cases. 

Within this context, May's turnaround was remarkable. Cyclicals and small caps have been leading. Europe, too, has seen new uptrend highs. Commodities rebounded somewhat. The summation index (breadth) cracked a YTD high.  Perhaps most significantly, treasuries have sold off, with rising yields confirming, it seems, better economic growth prospects. Overall, the set-up appears constructive (chart). 

It would be, therefore, no small irony if the SPX were to now suffer its regular counter cycle after having successfully diverted a far weaker construct in April.

US cyclicals sectors are all trending higher (chart), as are all 4 US indices and many ex-US indices (chart). SPX is firmly in its 2013 channel. All eyes are on 1600: it would represent a 5% correction, its the channel bottom, the April pivot high and the 50-dma (chart). 

In the three instances since 1980 that SPX corrected 5% after May, one occurred in June (1985), one in September (1989) and one not at all (1995). The first two of these corrected 8%. Recall that since 1980, a drawdown of 8% or more has occurred 80% of the time; the median drawdown is 11%. Coincidentally, the March/April key support level (chart above) at 1540 represents a 9% drawdown. Any decline to 1540-1600 would be normal for a counter cycle. 

Short term, SPX ended the week very oversold. McClellan closed the week at the lowest level since mid-November. In most cases, within a day or two, a profitable bounce has occurred. The big exception was August 2011 (chart). We noted the similarity in the tick pattern between then and now (a very high number of ticks below -1000), which continued into this week. 

This market has stared down far greater obstacles over the past two months. It's now oversold and has a lay up opportunity to prove itself once again. Should it fail to do so, it would be a noteworthy change in character.

The macro backdrop remains weaker than expected (chart). The headline focus is on housing, which seems strong, but is running counter to lumber (chart). Inflation expectations are diving (and diverging from equities - chart). While treasury yields have risen, they are still very low and not suggesting significant growth.