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These signals will tell you that stocks are heading higher

Matt Maley

With stocks rising on Monday for the third straight session, is the stock market rally still intact after last week's hiccup? To find out, let's take a proverbial look under the hood, and check on the performances of some key market groups.

Last week, we finally got some volatility back in the stock market. Wednesday's big sell-off took the S&P 500 (INDEX: .SPX) below its very tight three-week range — but the bounce on Thursday and Friday took it right back up to the underbelly of that range. This week, it will be interesting to see whether the S&P can fully regain that range (or better).

For the bulls, it was unfortunate to see the late-week bounce come on less volume than did Wednesday's sell-off. That was all the more disappointing given that Friday saw May monthly options expire, and volume tends to pick up on expiration days. On the other hand, breadth was quite good, with more than five stocks in the S&P 500 rising on Friday for every one that fell.

The rebound in the S&P and in the Dow Jones industrial average (Dow Jones Global Indexes: .DJI) led both indexes to retrace about 60 percent of their Wednesday declines. It is interesting to note that both the Nasdaq and the XLK (NYSE Arca: XLK) tech ETF did not retrace as much of their losses (about 40 percent each). The small-cap Russell 2000 (Exchange: .RUT) fared even worse, retracing only 30 percent. And the Dow Jones transportation average (Dow Jones Global Indexes: .DJT) retraced about 35 percent of it Wednesday losses.

That's not to say that these indexes and groups cannot bounce back this week; just because they have lagged the S&P for two days, does not mean they will continue to lag. However, if they do not play catch-up as we move through the week, it will raise the odds that we'll see more weakness in the stock market before long.

We saw even less movement in the Treasury market. The yield on the 10-year note (U.S.: US10Y) only retraced about 25 percent of its decline — and the spread between two-year and 10-year notes didn't change at all! So the yield curve continues to flatten, and now stands at its flattest level since October. In other words, the Treasury market is telling us a very different story about the big pick-up in growth that the consensus is looking for in the second half of the year. When you combine this with the paltry bounce in the Japanese yen (Exchange: JPY=) against the U.S. dollar, there are still reasons to be concerned about last Wednesday's big decline in the stock market.

One of the key focuses for investors this week will have to continue to be the tech stocks. Their underperformance during the bounce on Thursday and Friday is not a big deal, given how much they've outperformed all year. However, if we see any signs that this group is going to see some further weakness, it will certainly be negative for the broader market. Conversely, if it can get back on track, it will be quite positive, of course.




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