Wednesday, July 6, 2011

Big Week but We Need Bigger

Last week the S&P 500 gained 5.6% en route to the biggest weekly gain in two years, and the 29th biggest weekly gain ever. I think we can now debate this kicking of the European can or the 9.58 second 100 meter dash as the greatest sports feat this decade. The bailout package is in jeopardy and the market refuses to give up those gains. Truly Epic! However, as big a move as last week was, it still has some work to do before we can say that the consolidation is over.

First, momentum has not broken the 2011 downtrend. There are many momentum indicators but the Relative Strength Indicator (RSI) has to be my favorite to analyze. The chart below shows the S&P 500 price chart in the top panel and the RSI in the bottom panel. The RSI is still in a clear downtrend since the beginning of 2011 as marked by the white line. I would like to see this line broken before I become more confident that the market is going to continue higher. Then I would like to see this indicator reach extreme levels above 70 as further bullish evidence.

What provides additional pause is the price chart in addition to the RSI. The price level of the S&P 500 has reached the February high of 1340 but has met resistance at this level at the exact time the momentum has reached resistance. If these two levels hold and the price level starts to fall again we could be setting up a trend reversal. And that trend reversal could take the shape of a head and shoulders reversal (yes, Rick, another head and shoulder pattern. This is an inside the investment committee joke). I thought the saying was summer doldrums!