Following last week’s dovish comments from FOMC Chair Yellen, better than expected nonfarm payrolls and manufacturing PMI reports, US indices continue to advance, breaking out of downtrends and trading at their highest level since December. Technical indicators, however, suggest current advances may be nearing exhaustion and that the risk of a significant correction is growing. With earnings season getting underway in about a week and potentially taking over the spotlight from Fed speculation, we could significant volatility in US stocks and indices over the coming month
Since completing a double bottom near 15,300 back in February, the US 30
has been steadily recovering with rising channels in both the index and the RSI indicating strong underlying accumulation. Recently, the Index broke out of a year-long downtrend through 17,672, confirming the strength of the current advance.
While its underlying uptrend remains intact, bearish short term technical signals have emerged. The index is approaching a potential resistance zone in the 17,900 to 18,000 range where it topped out last fall. RSI getting overbought again and a double top potential forming in the RSI suggests the current rally may be overextended and near exhaustion. This suggests it could struggle with approaching resistance and a correction appears possible perhaps back toward the 17,674 breakout point or the previous low near 17,565.
US economic news last week was fundamentally positive for stocks, setting up a possible Goldilocks scenario that support gains in recent years of a US economy strong enough to support corporate earnings growth but not so strong that it would force the fed to tighten up on liquidity.
Recent advances have been driven by confirmation from FOMC Chair Yellen last week that the US central bank is considering 2 interest rate increases this year rather than the four originally planned. Stronger than expected nonfarm payrolls, and manufacturing PMI climbing back up above 50 into expansion territory, meanwhile, indicate the US economy remains strong.
Expectations heading into earnings season may also influence trading in the coming weeks. Markets on balance reacted negatively to the last earnings season which saw many companies beat the street on Q4 results but then guide downward for Q1 and 2016, which may have exacerbated declines in some markets.
By mid-February, expectations had become really low but have rebounded along with the indices over the last six weeks. Through the quarter, US economic news was pretty good overall and certainly not as bad as the big stock selloff that started the year suggested.
One of the big themes of this earnings season could be the question of whether valuations are getting stretched, or if companies were too pessimistic last quarter?