Since bouncing off the early June lows, the S&P 500 has enjoyed quite a nice run higher, gaining over 7 percent. This week, we asked Mark Arbeter, Chief Technical Strategist for S&P Capital IQ, for his insight on where the market could be heading next as it completes a key chart pattern, and could potentially enter into a “sweet spot” rally. Arbeter also discusses more on extreme sentiments on Wall Street, and why certain asset types may be ready to swing the other way.
EQ: The S&P 500 has been moving higher recently and could be entering a sweet spot rally. What are the levels that the index has to move into for this to happen?
Arbeter: The S&P 500 has completed an inverse head-and-shoulders reversal pattern, which is bullish for equities in the intermediate term. The measuring implications for the completion of this formation equate to a move up to about the 1400 level. We could get to slightly above the 1400 level during this next rally, potentially going up to last year’s high around the 1422 level. From there, we’d look for some kind of pullback or digestion of those gains, but once that pullback is over, I think the S&P 500 could be set up to head up to 1500 or above by the end of the year.
EQ: One obstacle for stocks is the U.S. dollar as it continues to work its way higher. Do you see it approaching a top and why would this help the bullish case for equities?
Arbeter: Yes, I think the dollar may finally be topping out. We’ve seen some negative momentum divergences on a daily and weekly basis, which many times precede a top in a particular asset. We’ve also seen extremely bullish sentiment levels toward the U.S. dollar, as well as extremely bearish sentiment levels toward the euro, which is a major component—about 60 percent, I think—of the U.S. dollar index. So we’ve seen some negative divergences.
We’ve also seen some interesting data from the Commitment of Traders report where commercial hedgers–which is considered the “smart money”–have been reducing their net positions in the U.S. dollar while the supposed “dumb money,” or the large speculators, have continued to increase their net positions toward the dollar. I think the combination with the technicals and the sentiment points to a top, or at least an intermediate-term top, in the dollar. Over the past couple years when the dollar has gone to an intermediate-term decline, our stock market has done very well.
EQ: There was a lot of expectation a few weeks ago that gold could experience a run higher—mostly because of QE3 speculation–but it has not been able to take off just yet. Are you still bullish on gold’s prospect here, with or without another round of easing?
Arbeter: Certainly, if there’s no more easing, I think the bullish prospects for gold will probably go out the window. However, I am expecting more QE programs here and around the world, which hurt countries’ currencies and that would eventually be bullish for gold. We have a similar situation in gold as we do with the U.S. dollar, except it is just the opposite. Sentiment is very bearish toward gold and it was very oversold in May. Also, the Commitment of Traders report shows increases in positions from smart money and decreases in positions by the dumb money. It certainly has been disappointing, however, because gold started to rally before everything else in May, and that looked like a great market tell that there was going to be more easing and a weakening dollar trend, but we just haven’t seen that yet.
EQ: Last time we spoke, sentiment regarding specific asset types had swung so far to their respective extremes, do you still believe that they’re likely to swing back the other way or will the current trend continue?
Arbeter: I think one of the great sentiment reads at this time comes from a poll of Wall Street strategists. They are recommending the lowest equities exposure since 1998 while they have an extremely high exposure to the bond market. I think this will start to unwind as we move into the rest of the year, which could be very bullish for our U.S. stock market.
EQ: Are there any particular areas of the market or asset types that you think could be worth additional attention right now?
Arbeter: Since the early June lows, we’ve seen real nice leadership from the small-cap sector, especially the S&P SmallCap 600 and Russell 2000. We had breakouts from real nice inverse head-and-shoulders before the rest of the major indices broke out. In addition, the recent pullback was right back to the top of that reversal formation, whereas many of the other indices came way back into their bases on that pullback. So the small caps, from a leadership standpoint, look very good going forward and could be one of the stronger areas to be in for the rest of the year. Historically, leadership by small caps have been very bullish for the overall market.