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Market Outlook: There's a 78.6% Chance Stocks Will Move in This Direction in the Next 3 Months

Michael J. Carr

The Dow Jones Industrial Average closed up for 10 days in a row before the winning streak was broken on Friday. Looking back at history, that is bullish.

The Trend Is Your Friend

When a stock or a market average is moving higher, prices are in an uptrend. I understand there is much more to market analysis than that, but the direction of the trend should be the starting point for any analysis. For now, the trend in the stock market is up.

SPDR S&P 500 (SPY) gained 0.25% last week after moving within 1% of a new all-time high. Each day brings out more analysts highlighting potential indicator divergences. In order to call for a top in stock prices, they have to ignore the reality that the Dow Jones Industrial Average (DJIA) closed higher for 10 consecutive days and the S&P 500 has now gone 40 weeks without a 10% correction. Looking only at prices, the stock market is clearly in an uptrend.

In the past, strength has led to more strength in the stock market. Three months after a winning streak like this, the DJIA was up 78.6% of the time.

The chart below looks at SPY in the monthly and daily time frames and offers visual evidence that markets can remain overbought far longer than we'd expect them to. Monthly data shows that prices can move along the upper Bollinger Band for months, and even years, before a significant decline. On the daily chart, we can see that the stochastics indicator has only been overbought for 10 days. This indicator remained overbought for 31 days at the beginning of the year.

SPY Market Outlook Chart

None of the traditional indicators I follow show any cause for alarm. As I pointed out last week, fundamentals support a price level of 1,669 for the S&P 500, or $167 a share for SPY.
Prices will fall from time to time, but we should react to declines when they occur rather than anticipate a drop and miss out on the possibility of more gains.

Recommended Trade Setup:

-- Long SPY
-- Use a stop-loss of $145
-- Maintain price target at $158.20 but expect further gains from there

Gold Gives a Short-Term 'Buy' Signal

SPDR Gold Trust (GLD) continues recovering from a deeply oversold condition. Last week, the ETF gained 0.84%. GLD has now moved up two weeks in a row, but that is not necessarily the start of a strong uptrend.

GLD has been in a downtrend for the past six months and bounced off support near $150, a level that has held since the beginning of 2012 and is very significant. The trendline in the chart below shows that a break above $159 would signal a trend reversal. A buy signal given last week also has a target of $159.

GLD Market Outlook Chart

Below prices, the Traders Dynamic Index (TDI) is shown. This indicator uses moving averages of the Relative Strength Index (RSI) to provide short-term trading signals. On Thursday, TDI signaled a buy. In the past, GLD has moved up an average of 3.2% in the two weeks following a buy signal and 62.7% of the trades have been winners.

This signal offers only a slight trading edge. Buying GLD randomly since it began trading and holding it for two weeks would be profitable 57.9% of the time. I have been bearish on gold for some time and this signal does not change my longer-term outlook. Although we may see small gains in gold for a few weeks, I expect more on the downside.

For now, the chart shows that we should expect only a small up move in GLD. Until the downtrend line is broken or evidence points to a trend reversal, PowerShares DB Gold Short ETN (DGZ), an inverse fund that goes up when gold prices fall, remains my favorite gold trade despite a 0.72% gain last week.

Recommended Trade Setup:

-- Buy DGZ on dips below $12.25
-- Maintain stop-loss at $11.75
-- Maintain price target at $14

This Week's News

Inflation was in line with expectations last week, and this week, economists will focus on the housing market. Housing starts and building permits for February will be reported on Tuesday, and the number of existing home sales is scheduled for release on Wednesday. Analysts expect to see confirmation of a recovery in real estate.