The Week Ahead: Does the Rally Continue?

Last week the markets continued the rise that began on February 8th. Most of the major indexes followed in the Russell 2000’s lead and established new recovery highs. As positive as these moves have been, to me it certainly appears that the markets are clearly overbought. Rather than reviewing charts of the DOW, S&P 500, NASDAQ and the Russell 3000 I have used the charts of their respective tradable indexes. For those of you unfamiliar with these I have included a short description of each.

* Started in 1984, the Russell 2000 Index is a subset of the larger Russell 3000. It is one of the most widely used indexes and is generally accepted as the benchmark for small-cap firms.

The Russell 2000 has recently been the clear market leader and as the chart of the iShares Russell 2000 Index (NYSE:IWM) ETF shows, it is well past it’s prior high and dramatically higher from the February lows. IWM reads as being extremely overbought at this point so traders need to exercise caution. It is important to note that when a market is trending this strongly, it will correct in a sideways trading range. If it does retrace some of the recent gains the $65 level is an area to watch as this was the prior high in January and now may well represent a strong level of support..

* The S&P 500 SPDRS [NYSE:SPY] is essentially a passively-managed, closed end mutual fund that allows you to buy and sell the stocks that make up the S&P 500 Index in one fell swoop. Basically it reflects the fluctuations in the value of the largest stocks traded in the United States.

The S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF caught up to the small cap stocks last week. While Friday’s close was weak, it did manage to close less than half a point below the prior day’s close. Much like IWM, SPY is overbought. With an expected retracing of the recent gains the first level of support sits at the $115 with $112 as another area to watch in the case of a deeper pullback. This is about where the 20 and 50-day moving averages [see chart] are currently, as well as a horizontal trendline [RED] dotted line, marking prior support and resistance.

* The Diamonds Trust, Series 1 (NYSE:DIA) ETF is a unit investment trust that tracks the 30 publicly-traded companies listed on the Dow Jones Industrial Average [DJIA]. Traders/investors can buy, sell or short units in the Diamond Trust just as they would any stock.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF continues to lag the other indexes. As the Dow is composed of mostly slower moving large caps, it generally under-performs in strong up trending markets. DIA failed to set new highs along with the other indexes this week, but is on track to test the $107 level.

The Powershares QQQ ETF (Nasdaq:QQQQ] tracks the performance of NASDAQ’s largest 100 non-financial companies.

The Powershares QQQ ETF (Nasdaq:QQQQ) also rallied to new recovery highs and performed very well for the week. QQQQ cleared through resistance at the $46.50 level quite easily and followed through by trading up another full point. As with the other indexes, QQQQ is extended and overbought. The $46.50 level is the first level of support on a pullback, and a further retracing of recent gains could take the QQQQ all the way to $45.

As the above charts show, the markets were able to clear their prior highs effortlessly, except for the Dow. As mentioned above, it is my opinion that the major indexes are overbought and extended. Traders should be very cautious and while it’s likely that the markets will retrace some of their recent gains it is also vital to recognize that they have also clearly demonstrated strength. The singular area of concern continues to be the lackluster volume. Traders should watch intently to see if the first real sign of weakness is accompanied by an increase in trading volume. That may well prove to be an indicator of a more serious sell-off.