In the Week Ahead: Is A Market Bottom Finally In Place?

By: John Kosar of Street Authority

All major U.S. stock indices finished in positive territory last week, for only the second time since Aug. 29, led by the Russell 2000, which gained 4.9%. This is good news for the market as small-cap stocks have lagged in a big way all year. The Russell 2000 is up just 0.9% year to date compared with 15.8% for the tech-heavy Nasdaq 100 and 9.2% for the broad market SP 500.

Another good sign is that, despite the Federal Open Market Committee (FOMC) announcing the end of its bond-buying program on Wednesday, the SP 500 rose by an additional 1.7% into Friday's close. This suggests that, despite a lot of investor apprehension beforehand, the market ultimately interpreted the Federal Reserve's action as evidence that it believes the U.S. economy is finally strong enough to stand on its own two feet.

From a sector standpoint, last week's rally was led by technology, up 3.3%, and financials, up 3.2%. This is another good sign for the overall market between now and year end as these sectors typically outperform amid expectations for a strengthening U.S. economy.

Technology Stocks at a Key Inflection Point

In the Aug. 25 Market Outlook, I discussed an important overhead resistance level at 4,147 in the Nasdaq 100. I said, "Major benchmark highs like this one are seldom meaningfully and sustainably broken without at least a multi-week corrective decline first."

The index peaked three and a half weeks later, at 4,119 on Sept. 19, and then subsequently declined by 10.2% into the Oct. 15 low. The SP 500 declined by 9.8% during the same period.

The Nasdaq 100 managed to edge slightly above 4,147 last week, which represents the September 2000 benchmark high, closing at 4,158 on Friday.

The more time this market-leading index spends above 4,147, the more likely that a major breakout is emerging that would clear the way for a continued rise into year end.

Investors Breathing a Sigh of Relief

Declining market volatility also suggests the potential for more stock market strength this quarter. The next chart shows that the CBOE Volatility Index (VIX) declined below its 50-day moving average on Friday for the first time since mid-September.

This suggests investors are getting over their fear of a deeper decline and are now becoming complacent or fearless enough to help drive equity prices to fresh highs.

As long as the VIX remains below its 50-day moving average this week, currently situated at 15.37, I expect last week's rally to continue.

Utilities Posts Quick Gains, What Now?

I pointed out a buying opportunity in the Utilities Select Sector SPDR ETF (NYSE:XLU) last week, targeting a 5.6% gain to $47. It rose as expected, gaining 2.5% to a high of $45.63 on Friday.

My $47 upside target remains valid above $43.10, which is the upper boundary of the sideways action of investor indecision that XLU initially broke higher from in late October.

There is one note of caution: Utilities historically have done particularly well when interest rates are declining because investors become increasingly willing to take on more credit risk to get a better yield than Treasuries offer. However, my work suggests long-term interest rates appear to be in the process of bottoming.

Assuming this is the case, readers should consider taking profits in XLU if it reaches $47 rather than waiting for an even bigger return to materialize.

Getting Back to Base Metals

In the Oct. 6 Market Outlook, I discussed what appeared to be an emerging buying opportunity in the PowerShares DB Base Metals ETF (NYSE:DBB).

After declining slightly below the $16.60 Oct. 2 low on Oct. 16, DBB rose by 5.4% to Friday's $17.32 high before finishing the week at $17.23.

I would view a sustained rise above minor overhead resistance at the 50-day moving average at $17.22 as evidence that a more sustainable bottom is in place at the October lows. It would also be a potential precursor to a retest of the $18.14 Sept. 8 high.

Putting It All Together

In the Oct. 13 Market Outlook, I suggested the likelihood of at least a near-term rebound over the following week or two. And last week, I said, "If the market is indeed resuming its larger bullish trend, this is a likely place for it to begin." The SP 500 bottomed on Oct. 15, and is since up 10.8% -- rising 2.7% last week alone -- to retest its 2,019 Sept. 19 high at the end of the session on Friday.

A number of favorable market factors collectively suggest that a sustainable market bottom is in place at the mid-October lows and set the stage for a potential rally into year end. These include a significant decline in market volatility, the recent recovery in European equities, bullish fourth-quarter seasonality, and recent breakouts in individual sectors, such as utilities and health care.

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