You are here

Market Outlook: 2 Index Funds and This Metal Are on Buy Signals

Federal Reserve Chairman Ben Bernanke ignited another stock market rally and stocks ended last week near all-time highs. Traders will stay focused on Bernanke for at least the next week.

All Eyes Will Stay On the Fed

Last week, SPDR S&P 500 (NYSE: SPY) gained 2.75% as traders once again cheered the Fed's easy money policy. This week, monetary policy should remain in focus as Bernanke makes his semi-annual visit to Capitol Hill. During the past month, the chairman's words have sparked a sell-off (in mid-June) and a recovery (last week) in stock prices. It is unlikely he will add any new information about policy in his testimony, but his words will be scrutinized.

A 30-minute chart of SPY shows the impact Bernanke had on prices last week. A speech after the close on Wednesday, where the chairman said that monetary policy would remain "accommodative" for the "foreseeable future," pushed stocks up by more than 1% the next morning.

SPY Chart

Stepping back to look at the weekly chart, we can see that SPY has become overbought.

SPY Chart

However, an 8% pullback may have set the stage for a new bull run. The 2-period Relative Strength Index (RSI), a very short-term measure of market conditions, is above 90. While traders often expect a pullback after prices become overbought, testing shows that there is a greater-than-average chance of gains over the next six months.

The table below shows how SPY has performed since 2001 on average and how it performs after becoming overbought.

RSI Table

In the past, on average, gains are greater after the market becomes overbought as the price trend accelerates. Whether or not that will happen this time depends on the Fed.

One of the strongest index funds in the market right now is the iShares Russell Midcap Growth Index (NYSE: IWP). The Income Trader Volatility (ITV) indicator signaled a buy in IWP at the end of last week.

IWP Chart

ITV also signaled a buy in SPY last week.

Junior Gold Miners Now 80% Below All-Time Highs

SPDR Gold Shares (NYSE: GLD) gained 5.11% last week. It's too early to tell whether this is the start of a recovery in gold prices. After large price declines, prices often spend weeks forming a consolidation pattern that serves as a bottom.

In the precious metals sector, junior mining companies have suffered the most. Junior miners are generally exploration companies working to find gold rather than operating mines. Many junior miners have little, if any, revenue. In a bull market they can be among the biggest winners, but in bear markets they are likely to lose more than companies that have revenue.

Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) is now more than 80% off its 2010 highs.

GDXJ Chart

An 80% decline is rarely seen. Homebuilder stocks offer a recent example of this kind of decline, and they remain significantly below their highs more than four years after bottoming.

XHB Chart

Junior gold miners are unlikely to recover quickly. They also may not be done falling. Bank of America (NYSE: BAC) is an example of a stock that fell more than 80% after topping in 2006. After falling 80%, BAC fell an additional 75% before finding a bottom. In all, BAC lost 95% of its value in the bear market. BAC is still 75% below its all-time high even after rallying more than 440% in the past four and a half years. 

I say all of this to illustrate the fact that miners are not a buy simply because they have fallen and are oversold. Many individual companies are likely to fail at this point. Company financials will have a greater impact on their survival than gold prices will.

Gold does look set to rally, at least briefly, and iShares Silver Trust (NYSE: SLV) appears to be the most interesting trade in the metals sector.

SLV Chart

SLV could rally significantly as it has done in the past when a bullish divergence in the Bollinger Percent B indictor develops. This divergence forms when prices make a lower low but the indicator does not.

This Week's News

Bernanke's testimony before Congress should be the focus this week.

Market Outlook News