The Market Will Head Higher

There. We said it.

For three days in a row into the end of last week the major indices flirted with fresh highs and were beaten back. Friday’s gap up was sold off on such enormous volume that even we were convinced the uptrend would yield to its first significant correction.

But a funny thing happened on the way to the sell off. It was arrested.

The daily charts of the major indices, especially the Dow and the S&P 500, look ready to head lower. But pull up weeklies and read a different story.

Friday closes are important. They allow us to read the true intentions of institutional investors on weekly charts while turning down the “noise” of dailies. Leaving your money invested on a Friday means you have to endure two days of uncertainty before the markets will again allow you to adjust your appetite for risk. A handsome weekly close indicates big money is feeling fairly contented. And that’s just what we have with Friday’s close.

The chart of the S&P 500 shows a pattern familiar to all of O’Neil’s students: Three Weeks Tight (3WT). During an uptrend O’Neil preaches that three tight weekly closes in a row, where the closes are within 1% of each other, are bullish and that breakouts from this pattern are opportunities to add shares. While the index closed below the highs of the 3WT formation the advance on high volume is clear enough. And the index closed in the upper half of its range.

The NASDAQ has completed a corrective pattern that saw it sell off under its 10 MA weekly on volume at the end of October only to right itself, move back over the line, pull back to it in light volume and now break to fresh market closing highs on the highest volume in five weeks.

The catalyst for Friday’s wild action was the employment report, which took the market by considerable surprise with its positive implications. Real growth, not simply stimulus ephemera, appears to be in the making, and the market was ebullient.

Clearly the late morning sell off was due to concerns about The Fed likely ending its easing policies far earlier than anticipated given the change in perception about the economy. We have long said that we are of the opinion that the rally will conclude when the liquidity orgy is over. When investors started to sell the news in the late morning we weren’t surprised.

That they had second thoughts about doing so going into the close did surprise us. It is clearly bullish and an indication of a possible change of paradigm for the rally with liquidity no longer its raison d’etre but rather the certainty of resumed growth.

We witnessed violent sector rotation, which was responsible for the indices ending with gains. The commodity liquidity plays, led by gold and gold stocks, sold off hard. Meantime Small Caps surged over 2% as investors segued into growth oriented stocks that are most likely to benefit from resumed domestic growth and avoid the negative effects a reversing dollar will have on the bottom lines of larger cap companies. And transports and semis, traditional harbingers of growth, surged to new 52 week closing highs.

How these trends play out over the coming week will be crucial. Recently we suggested it was time to take some profits in gold to make sitting through an inevitable correction easier. The trade in gold has been so one sided that when it broke it did so with a large gap down from all time highs. We predicted this is likely to be a volatile correction and the inevitable questions about whether this is a correction or change in trend will emerge should severe selling continue.

Whether the moves in gold and the dollar are corrections or changes in trend will dictate where the opportunities will be in the weeks ahead. We expect a continuation of the rotation we saw on Friday, but as always will follow the market assiduously for clues.