In The Week Ahead: Charts Point To An Overdue Correction

Evaluating market performance charts

All major U.S. stock indices finished slightly higher last week except for the tech-heavy Nasdaq 100, which lost 0.4%, posting its second consecutive negative weekly close. As I have been stating for the past month, relative outperformance by technology is necessary to drive the broader market higher. If this recent weakness continues, it is likely to trigger a correction.

From a sector standpoint, last week's modest advance was led by defensive utilities and consumer staples, which gained 2.1% and 1.5%, respectively. However, my own ETF-based metric shows that the biggest contraction in sector bet-related assets over the past one-week and one-month periods actually came from consumer staples. This suggests that last week's strength in the sector is likely to be short lived and may lead to some outright weakness and relative underperformance versus the S&P 500 later this quarter.

Technology: Contracting Investor Assets a Red Flag

In last week's Market Outlook , I pointed out that the Nasdaq 100 was testing underlying support at its October uptrend line, which I identified as a critical inflection point from which the index's current advance must resume if still valid.

The index traded around that trendline on Thursday and Friday, but it failed to post a decisive close on either side of it. This indicates investors were undecided about the outcome headed into this week. My first chart, however, gives us a good indication of what to expect.

The upper panel plots the Nasdaq100 daily, with the corresponding total net assets invested in the PowerShares QQQ Trust (NASDAQ: QQQ ), which emulates the NASDAQ 100, in the lower panel.

Nasdaq 100 Market Outlook Chart

The assets invested in QQQ started shrinking at the end of March and are now below their 21-day moving average. This indicates a new monthly trend as investors are liquidating long positions.

Similar periods of contraction triggered the September-to-October and November-to-January declines in the Nasdaq 100. The recent contraction suggests a negative directional bias for the index headed into this week. This would be confirmed by a sustained decline below the October 2014 uptrend line, which is currently situated at 4,321.

Weak Transports Another Warning Sign

Last week, I also pointed out how recent relative weakness in the Dow Jones Transportation Average versus the Dow industrials led to the current broader market decline from the late-February highs. The tranports are a particularly good barometer of economic strength because they indicate the volume of goods being shipped across the country and around the world.

The next chart shows that, unlike the Nasdaq 100, this key average has already decisively broken its October uptrend line and is starting to edge below its 200-day moving average, a widely watched major trend proxy, at 8,664.

Dow Jones Transportation Average Market Outlook Chart

A sustained move below 8,664 would suggest that a major bearish trend change is emerging in the transports and, especially if accompanied by a decline below 4,321 in the Nasdaq 100, would indicate that a correction is emerging in the overall market.

Watch the VIX for Confirmation

I have been especially focused on market volatility, as measured by the Volatility S&P 500 Index (VIX), over the past two weeks. While the market is flirting with a correction, it needs an increase in investor fear to facilitate it.

The VIX has been below its 50-day moving average since mid-February, indicating a level of investor complacency that has historically fueled stock market advances. The green highlights show that three negative reversals in the VIX from its 50-day moving average coincided with the past three near-term bottoms in the S&P 500.

S&P 500 and VIX Market Outlook Chart

It would take a sustained move above the VIX's 50-day moving average at 15.68, similar to what took place in mid-December and again in late December through early February, to confirm that there is enough fear to trigger the correction that the first two charts warn of.

Contracting investor asset flows amid relative weakness in economically sensitive transportation stocks warn that an overdue stock market correction is emerging. This would be confirmed this week by a deeper decline in the market-leading Nasdaq 100 accompanied by a rise in the VIX.

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This article originally appeared on Charts Warn Market Is Headed For An Overdue Correction

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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