Lazy August rally now faces September test

Kevin Pendley | Aug 30, 2008 9:04am EDT | Comment

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Small-cap stocks finished the official “summer doldrums” of August on an upswing. The Russell 2000 (NYSE:IWM) gained 3.5% for the month to climb back into the upper portion of the recent range. It should be noted however, that volume was dreadful the last couple of weeks as investors took off ahead of the final holiday weekend of the summer. We’re lurching into a short trading affair next week, but there won’t be much time to catch up, as the market will have to navigate through quite a few key economic reports, including the monthly employment release Friday.

Even though August was a kind month to small-cap stocks, the chart structure is still dominated by bearish patterns. For instance, monthly studies show a potential head-and-shoulders top, while weekly and daily charts still sport the dynamic double top pattern off the June and August highs. If the market does not push through to new move highs relatively quickly, then these patterns form the perfect quicksand that could spell a gloomy entry to autumn.

Now that we’ve closed the door on August, we’re moving into a more difficult seasonal pattern. Those of you who have just started trading in the past few years might wonder “hey, what’s so bad about September?” While it’s true that the Russell 2000 has worked higher every September for the last four years, it’s also true that the market was down every September the four years before that! What’s more, those down years were far more dramatic than the recent rally years. Those last four September time frames saw an average gain of 1.7%--during a dramatic 5-year-plus bull market charge. However, the down years before saw an average decline of 6.4%. When September is ugly, it is often very ugly. In addition, those down years came into the teeth and then the shadow of the 2001 economic recession and the bear run in stocks. Although we are not in an official bear market in small-cap stocks at this juncture of 2008, at the lows we were below on the official 20% bear market declaration, and our large-cap brethren in the Dow and S&P 500 are still within easy breathing distance of that bear market designation.

It’s no surprise to see low volume in late August, but it does cast a cloud of doubt on the price action that took place on diminished trading activity. How we trade from here on increased volume will be vital to either bursting free of the range, or reversing back down to test the lows.

Looking ahead to the coming week’s action, there is critical resistance in the Russell 2000 at 762, which roughly translates to the double top. Before we get there, resistance also comes into play at 750 and 756. On the downside, support is at 734, then at 726 and the key zone for me is at 720.50. If we see a slide back below 720.50, then I think 690 becomes a real possibility.

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
> 739.50   August 29 close
- 734.05   20-day moving average
- 726.19   previous double top in June/July 2008; now support
- 722.60   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 720.50   recent trading range swing point
- 700.00   “figure” swing line; no monthly close below here since Dec ’05 until Feb ‘08
- 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 print-out 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.

Even though it’s a short work week, it’s still very busy on the risk front, with critical economic data on manufacturing and labor scheduled for release. The “Big Event” will be Friday morning’s employment report. After several upside surprises last week, it will be interesting to see if the economic data can provide the push needed to burst through the trading range highs, or send the market back down toward the lows.

The table below highlights calendar event risk for the coming week, 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

4           ISM Manufacturing Survey (Tues., 10:00 a.m.)           49.6%
1           Construction Spending (Tues., 10:00 a.m.)               -0.5%
2           Factory Orders (Wed., 10:00 a.m.)                           1.0%
2           Fed’s Rosengren on the economy (Wed., 12:15 p.m.)
2           Beige Book (Wed., 2:00 p.m.)
2           Vehicle Sales (Wed., all day)                                   13.0 mln
2           Productivity (Thurs., 8:30 a.m.)                                3.0%
4           Weekly Claims (Thurs., 8:30 a.m.)                            423,000
3           ISM Non-Manufacturing Survey (Thurs., 10:00 a.m.)    49.5%
2           Fed’s Fisher on econ challenges (Thurs., 1:40 p.m.)
3           Fed’s Yellen on econ outlook (Thurs., 2:30 p.m.)
1           Fed’s Yellen on econ outlook (Thurs., 2:30 p.m.)
5           Employment (Fri., 8:30 a.m.)                                  -71,000
                -- unemployment rate                                           5.7%