In The Week Ahead: Odds Favor A Continued Rally In Stocks
The major U.S. indices posted their second consecutive positive weekly close last week. They were led by the small-cap Russell 2000 and tech-heavy Nasdaq 100 indices, which gained 2.7% and 1.7%, respectively.
This is a positive near-term sign, as these indices typically lead the broader market higher and lower. Moreover, all sectors of the S&P 500 except for defensive utilities finished in the green last week. The best performers were materials, up 3.2%, and consumer discretionary, up 2.9%.
As I said in last week's Market Outlook, stocks are at a critical decision point from which the market's next near-term move is likely to begin. Heading into this week, that move appears to be higher.
A Near-Term Bottom Emerging?
In last week's report, I said a sustained rise above 1,947 in the S&P 500 would clear the way for a move to the 1,993 to 2,005 area. While the index is still negotiating this overhead resistance, others are starting to signal an emerging breakout.
On Friday, the Dow Jones Industrial Average closed above its 16,511 Feb. 1 high, confirming a double-bottom at the Jan. 20 and Feb. 11 lows. This bullish pattern targets a move to 17,500, which is 5.2% above Friday's close.
The bullish implications of this pattern will remain valid as long as the 16,511 area loosely contains the Dow on the downside as support.
Abating Investor Fear Supports Near-Term Strength
I also said last week that a sustained decline below the 50-day moving average in the Volatility S&P 500 (VIX) at 21.96 would suggest investor fear had abated enough to help fuel a near-term stock market rally. The VIX spent all of last week below its 50-day, which is now situated at 21.88.
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This indicates that, even though the S&P 500 is still negotiating overhead resistance, investor fear is now on the decline, just as it was during the broader market rally between Oct. 2 and Dec. 8.
This also helps confirm the validity of the bullish breakout in the Dow at the end of last week. And, as long as the VIX remains below 21.88, it supports a corroborating breakout in the S&P 500 this week.
Stocks And Interest Rates Joined At The Hip
Two weeks ago, I pointed out that the next key levels for the yield of the benchmark 10-year Treasury note were 1.58% and 1.43% on the downside and 1.85% and 2% on the upside. Yields finished last week at 1.76%.
The next chart shows these yields have maintained a tight and stable positive correlation to the S&P 500 since July. That is precisely when the initial collapse in the Chinese stock market took place. This drove U.S. investors, fearful of a meltdown in global equities, out of stocks and into the relative safety of U.S. Treasuries.
That relationship has remained intact since then as other global markets like Japan and Europe have struggled.
If the U.S. stock market continues to rise, the yield on the 10-year is likely to test the 1.85% to 2% area. Conversely, if stocks reverse lower, look for a decline to the 1.58% to 1.43% area.
[More from StreetAuthority.com: In The Week Ahead: How To Tell If The Market's Rebound Is Sustainable]
Copper Continues To Rally
I recently said both precious and industrial metals were starting to show some upside potential. I told readers that a sustained rise in the iPath Bloomberg Copper Subindex Total Return ETN (NYSE: JJC) above its 50-day moving average would suggest a near-term bottom is in place at the recent lows.
JJC spent all of last week above its 50-day moving average, currently situated at $23.64, and is now challenging the trendline at $24.67 that connects the Dec. 29 and Feb. 4 highs.
Two closes above $24.67 this week would confirm a bullish inverse head-and-shoulders pattern that would target a 10.2% advance to test the 200-day moving average, now at $27.18.
This is particularly interesting because of the current positive correlation between copper prices and the Dow Jones Transportation Average. This relationship exists because copper is used in most industrial applications and then relies on transportation to get the finished product from the manufacturer to the end user.
Per the correlation, a rise in copper prices indirectly supports the near-term advance I'm expecting in the Dow industrials, which have essentially traded in lockstep with the Dow transports for the past 20 years.
[More from StreetAuthority.com: In The Week Ahead: The Number Every Investor Should Be Watching]
Putting It All Together
Last week's move above 16,511 in the bellwether Dow Jones Industrial Average clears the way for a potential rise to 17,500 and is supported by the decline in investor fear, according to the VIX.
Bigger picture, however, the breakdowns that occurred in a number of global stock indices in the fourth quarter continue to warn that this near-term rally will eventually give way to an even deeper intermediate-term decline that could extend into the second quarter.
Current intermarket relationships suggest a near-term stock market rally is likely to coincide with a rebound in the yield of the 10-year Treasury note amid a rise in copper prices as investors at least temporarily position themselves for an economic recovery.
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This article was originally published on Profitable Trading: Odds Favor a Continued Rally in Stocks
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