The major U.S. equity index has been climbing higher with the S&P 500 hitting new record highs for the nineteenth time this year. After breaking the record of eighteen highs in 1992, the index is slowly approaching the twenty-two highs that were recorded in 1991.
The improvement in the market came from increased merger and acquisition activities, better economic fundamentals, accelerating job markets and low interest rates (read: Deal ETFs in Focus on Flurry of M&A Activity).
The Dow Jones Industrial Average also touched new highs and this trend is likely to continue in the near future. This is especially true if we recall the old Dow Theory that a bullish trend is assured when both Dow Jones Industrial Average and Dow Jones Transportation Average hit new highs at the same time. And currently both the indexes are hitting fresh highs.
However, the market is facing several hurdles raising doubts on whether the large caps can continue their surge in the coming days. Let’s see what major obstacles the market could face.
Signs of Trend Reversal?
First of all, the market rally has consistently been led by weak trading volumes and low volatility as the S&P 500 continued to trade in a narrow range over the past few months. Second, fewer stocks in the index have touched new highs, indicating that the stock market might not be healthy going forward and could see a sharp fall anytime soon (read: Volatility ETFs Crash Signaling Further Volatility?).
Third, the World Bank this week has reduced the global growth forecast for this year, citing slowdown in China, instability in Ukraine, political turmoil in Russia and a harsh U.S. winter.
The global economy is expected to grow 2.8% this year, compared with the previous projection of 3.2%. Growth in the U.S. was also reduced to 2.1% from 2.8% while the outlook for Brazil, Russia, India and China was also lowered.
Further, uneven U.S. economic growth and uncertainty over the Fed policy are also exerting downward pressure on the market. If this wasn’t enough, the FIFA World Cup 2014 starting in Brazil today will keep most investors out of the market, thus hurting the already low trading volumes.
The sporting frenzy will definitely take a toll on trading activity and could cause a trend reversal (read: Can FIFA World Cup Give Brazil ETFs a Kick?). As a result, most analysts warned that the market has been modestly overbought at current levels, and weak trading activity along with low volatility and higher stock prices might signal a slight pullback over the next few days.
The expected trend will be clearer when we look at the technical charts of large cap ETFs – SPDR S&P 500 (SPY - ETF report) and SPDR Dow Jones Industrial Average ETF (DIA - ETF report).
The above chart shows that though the short-term moving average (9-Day EMA) for SPY is still above the long-term average (200-Day EMA) signaling some upward move, it has not broken its near-term range in the past few months. Further, the Relative Strength Index (RSI) is around 69.44, suggesting that the ETF is near to its overbought territory. This chart pattern definitely points toward a correction starting soon.
The ETF added 6.4% in the year-to-date time frame and has a Zacks ETF Rank of 2 or ‘Buy’ rating with Medium risk outlook. Although the long-term outlook appears bright for this fund, a near-term breakout seems imminent (see: all the Large Cap ETFs here).
Similarly, the price chart for DIA, representing the Dow Jones Industrial Average also exhibits somewhat similar characteristics with short-term moving average being higher the long term and RSI of 61.68. The fund is up 3.2% this year and has a Zacks ETF Rank of 3 or ‘Hold’ rating with Medium risk outlook.
Investors should also note that the large cap ETFs are leading the broad market rally while small cap ETFs have not performed particularly well. This is especially true as the two most popular small cap ETFs – iShares Russell 2000 Index Fund (IWM - ETF report) and iShares Core S&P Small-Cap ETF (IJR - ETF report) – have gained less than 2% so far this year (read: 3 Small Cap ETFs Outperforming the Russell 2000 Index).
As a result, the strength of this rally appears to be waning somewhat and investors should take caution while betting on a long position in the market.
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