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There will be a number of earnings reports this week, and traders should start focusing on the trend in earnings. That could be bearish for the stock market.
Weak Start to Earnings Season Puts Bull Market at Risk
SPDR S&P 500 (NYSE: SPY) closed down 0.27% last week. Technical indicators are mostly bullish although bearish divergences are forming.
The chart below shows Moving Average Convergence/Divergence (MACD) on a weekly chart of SPY, although a similar pattern can be seen with other indicators such as stochastics or the Relative Strength Index (RSI). Bearish divergences are also visible on daily charts.
A bearish divergence forms when prices move to new highs while an indicator fails to confirm the highs. Many technical analysts believe that divergences are eventually resolved with a decline in prices, but this belief is not confirmed by backtesting. Divergences lead to lower prices only about a third of the time in testing.
In testing divergences, I looked at various indicators and different time frames. Divergences that formed over eight weeks or more, like the current one shown in the chart, were followed by declines about 30% of the time with holding periods varying from 1 to 12 weeks. My conclusion is that while divergences are widely cited, they are rarely useful.
Whether or not the bull market continues will depend on earnings. There will be about 50 earnings reports from companies in the S&P 500 this week, nearly doubling the number of fourth quarter reports.
So far, earnings season is off to a lackluster start. Of the 52 companies that have reported, only 27 (52%) have beaten expectations. In the most recent quarter, about 66% of companies have exceeded analysts' estimates. Unless the current trend in earnings reverses, the bull market could finally be at an end.
However, for now, the bull market is intact and traders should remain long.
Ichimoku Cloud Points to Higher Gold Prices
SPDR Gold Shares (NYSE: GLD) closed higher for the fourth week in a row after a gain of 0.56% last week.
Gold is looking more and more bullish, and the Ichimoku Cloud chart below shows that GLD gave one buy signal last week and will give a second buy signal if it moves into the cloud.
Cloud charts are interesting and provide a forecast of the future. They are basically constructed with moving averages. Trade signals occur when lines cross. Last week, the Tenkan Line crossed the Kijun Line. The Tenkan Line is a 9-day moving average of the difference between the highest high and the lowest low while the Kijun Line is a 26-day moving average of that difference.
It is also bullish when prices move above either line (GLD is now above both) or when prices move into the cloud from below, which could happen this week.
Testing shows a high probability of a gain after the Tenkan Line crosses the Kijun Line. In testing, using a simple time exit by selling at a predetermined time after the buy signal, GLD has been higher more than 50% of the time over all time periods from one week to six months. Intermediate-term traders should consider that GLD has been up 70% of the time three months after the signal.
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