Russell 2000 charts still bearish despite slight gains

Kevin Pendley | Sep 13, 2008 10:44am EDT | Comment

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It would be easy to take a look at this week’s price action in small-cap stocks, shake your head in disbelief, then come to the conclusion that it was much ado about nothing. How about the largest one-day decline of the year on Tuesday, sandwiched between two above-norm daily gains? Or how about the fact that Tuesday’s epic collapse came on the heels of the previous largest one-day drop just three sessions earlier? But when all was said and done, what was the end result? The Russell 2000 (NYSE:IWM) was up all of 0.18% for the entire week’s worth of aggravation. As I’ve noted, it was the kind of week that only a day trader with great entry and exit points could love.

Despite the relatively tame finish to a manic week, there are some interesting themes to investigate. Let’s start with the good news: first off, the market was able to grind out a mild advance even though most of the news had a decidedly bearish tilt. For instance, the fourth-largest investment bank in America -- Lehman Brothers Holdings Inc. (NYSE:LEH) -- was basically relegated to the scrap heap, apparently another potential casualty of the long-running credit crisis that has been gripping financial stocks for over a year now. What’s more, the world’s largest insurer – American International Group Inc. (NYSE:AIG) collapsed 47% this week, while LEH unraveled to the tune of 77%. And of course, that all took place just a few days after mortgage giants Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) became a government bail-out project. On May 2, 2008, those four stocks had a combined share price of $152.65; on Friday, they were worth all of $16.60. And on top of all that, the economic news wasn’t good. Continuing claims for unemployment paychecks approached a five-year peak; retail sales declined when everyone said they would rise and our international trade deficit ballooned to $62.2 billion, the highest in 16 months. Oh wait, this was supposed to be the good news part of the story!

Actually, that is all precisely my point. The news was basically awful this week, yet small-cap stocks were up slightly instead of going into freefall mode. When the market can look past negative headlines it is a sign of underlying strength and should be respected.

And now for the bad news. Remember, this is a technical analysis column. The chart patterns were dominated by bearish formations before this week began. The most dynamic patterns in play right now are still bearish after the dust cleared on this wacky week.

There is a double top on weekly charts at the June and August peak. There is a huge bearish reversal on weekly charts from the action two weeks ago. This week’s price action reflected lower lows and lower highs. The big recovery rally off the lows Thursday took place on soft market internals (more stocks made new lows than made new highs) and the volume has been noticeably better on down days. Even though the Russell closed out the week with a modest gain, it still left a red candle on weekly charts, indicating a lower close than open; and when we get two consecutive red candles off a topping pattern we often get them in bunches.

Looking ahead to the coming week’s price action, I am focused on these key levels:

• 720.50 – as you see on daily studies, the market continues to bounce around that price point and we have a chance to establish that area as the new upside range. If that happens, “figure” support at 700 will have tire treads across its back.

• 692.08 – this represents a 61.8% Fibonacci retracement of the July-August rally. A breach of that point would suggest that the rally was corrective, not bottom-forming, and would support a slide down to retest those summer lows.

If you are a short-term trader, there will be other short-term key points to keep in mind this week. For instance, 726 has been an important upside swingline for the Russell. A breach of that line could spark a run to 739 or so. Before we get to the key 692 point, there is logical support at 704.50, 701 and 694.

If the Russell retreats Monday or Tuesday (we’ve got FOMC Tuesday afternoon), then the most likely course of action would be a downside press. A weekly range between 725 on the upside and 680 on the downside would not surprise. If we can pop through 726 without any significant downside probing, then a range from 714.50 to 750 is reasonable. Keep in mind that the first scenario would basically break the back of the recent consolidation and would clearly empower the dominant bearish chart patterns already visible.

The table below contains support and resistance points for the Russell 2000 to keep in mind heading into this week’s trading. For long-term traders, some of these key levels may remain in place for weeks...even months at a time. Those with a short-term horizon will lean toward levels that are more immediately in play. As time passes, we will build upon this table with levels that come into focus as important testing zones for trend analysis, and to act as road mark indicators for key reversal patterns.

From a trading perspective, I always keep a printout handy each day of my key support and resistance points for any stock or market I’m trading. It helps remind me of key areas to watch for signs of trend exhaustion, and also for potential entry/exit points for trades.

TECHNICAL ANALYSIS SUPPORT/RESISTANCE POINTS FOR RUSSELL 2000

- 890.16   upward channel resistance on monthly charts off 5-year run;
            also fits with potential upside breakout of congestion zone
- 860.00   projected “figure” resistance off 15-handle testing zones on the ’06 rally
- 856.48   record intraday high set July 13
- 855.77   July 13 close; record high daily and weekly close
- 852.06   Oct. 11 high; bearish reversal peak on daily charts
- 830.01   previous high from the February 2007 peak; key swing line of note
- 815.00   key swing line
- 801.00   congestion resistance zone from November-December 2006
- 775.03   61.8% Fibonacci retracement of the Aug. 2007 peak-Mar. 2008 collapse
- 764.38   new move high set August 15, 2008; approximate double top with June ‘08
- 762.89   previous move high set June 5, 2008
- 760.06   March correction low; key approximate double bottom formation support;
            Near 50% Fibonacci of July ’06-’07 bull run; violated in November ’07;
            Key swingline to watch
- 743.49   previous Aug. ‘07 collapse low; short-term support violated, now resistance;
            Also near chart gap left by Jan. 2008 employment report news
- 729.93   20-day moving average
- 726.19   previous double top in June/July 2008
- 720.73   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 720.50   recent trading range swing point
> 720.26   September 12 close
- 700.00   “figure” swing line; no monthly close below here since Dec ’05 until Feb ‘08
- 692.08   61.8% Fibonacci retracement of the July-August rally
- 685.00   20% decline off 2007 record highs; breached Jan. 2008 and July 2008
- 680.94   mild reversal low on daily charts Jan. 28; near 50% of the March ’08 bounce
- 668.58   July 2006 low; important bottom for summer correction
- 660.00   short-term downside target on wedge breakout; support zone
- 650.00   previous bear market move low set Jan. 22, 2008, critical support zone
- 647.37   July 15 2008 low; approximate triple bottom with Jan ’08; Mar ‘08
- 643.28   recent move low set Mar. 10, 2008
- 614.76   October 2005 bottom; next major chart related downside point
- 591.00   50% Fibonacci retracement of the 2002-2007 bull market run

In addition to the printout of support and resistance points to watch, I also like to keep in mind where sudden volatility can spring into the trading mix from the typical release of economic data and Federal Reserve activity.

There are plenty of economic events this week that could get the heart pumping, but all the macro numbers will likely take a back seat to Tuesday afternoon’s FOMC meeting, especially now that the market is starting to talk about potential rate cuts once again. Outside of FOMC, look for Tuesday’s CPI report and Wednesday’s housing starts data to be the big events. Also, keep in mind that options expirations activity could be a theme in play.

The table below highlights calendar event risk, with the emphasis on various economic reports. Our table below has a special “Risk Factor” designation, which is simply my assignment of risk to that event, ranging from 0 to 5, with 5 marking the highest risk for volatile market swings.

CALENDAR EVENT RISK ASSESSMENT

RISK FACTOR REPORT/ITEM (all times Eastern) Consensus

2           NY Manufacturing Survey (Mon., 8:30 a.m.)          1.0%
3           Industrial Production (Mon., 9:15 a.m.)               -0.3%
4           CPI (Tues., 8:30 a.m.)                                     0.0%
5           FOMC (Tues., 2:15 p.m.)                                 2.00% (unch)
4           Housing Starts (Wed., 8:30 a.m.)                        950,000
0           Current Account (Wed., 8:30 a.m.)                   -$179.4 bln
3           Weekly Claims (Thurs., 8:30 a.m.)                        440,000
1           Leading Indicators (Thurs., 10:00 a.m.)               -0.2%
3           Philly Fed Survey (Thurs., 10:00 a.m.)                 -10.0