The major indices were mixed last week, with the Dow industrials and Russell 2000 showing losses, the S&P 500 unchanged, and the recently downtrodden Nasdaq 100 posting a modest gain of 0.9%. The tech-heavy Nasdaq 100 must continue to outperform the S&P 500 from here, ideally accompanied by outperformance by the small-cap Russell 2000, if the current 2013 advance is to remain intact and begin a new leg higher.

#-ad_banner-#From a sector standpoint, my own asset flow-based metric shows that the largest inflow of investor assets over the past week, month and quarter has been into energy, despite the sector’s modest weakness last week. As long as this positive asset flow continues, the recent trend of relative outperformance by energy, which has beaten the S&P 500 by 7% since February, is likely to continue into the third quarter.

Friday’s Rebound in Small Caps May Be a Good Sign
In the April 28 and May 5 Market Outlooks, I discussed minor overhead resistance at 3,617 in the Nasdaq 100, and said that this market leading-technology index needed a sustained rise above this level to help power the broader market to fresh highs. The 3,617 level continues to contain this index on the upside.

One potentially good piece of news, however, is that the Russell 2000, which also tends to lead the overall market higher and lower, tested and held major support at 1,083 to 1,079 last week, which represents the benchmark lows from Feb. 5, 2014, and Nov. 7, 2013, respectively.

Although the financial media focused on the bearish implications of the index breaking its 200-day moving average last week, 1,083 to 1,079 is a much more important level. As long as the Russell remains above it this week, I would view this level as a potential springboard for a new leg higher in the overall market.

In last week’s Market Outlook, I pointed out that the SPDR Dow Jones Industrial Average (NYSE: DIA), commonly known as the “Diamonds,” set an all-time closing high of $165.72 on May 9. I said, “A sustained rise above $165.51 would confirm a breakout from four months of sideways indecision in DIA that would target a 7% advance to $177.”

DIA broke out above $165.51 early last week, but collapsed back inside the pattern by the end of the week. It seems investors were collectively buying into the idea of even higher stock prices until U.S. interest rates collapsed on Thursday and Friday.

For the bullish implications of the pattern to remain valid, the lower boundary at $163 must contain DIA on the downside this week while it rises back above $165.51 — and stays there. Conversely, a meaningful and sustained decline below $163 would clear the way for more near-term weakness.

The two-week period between now and June is a critical one for the market from which the direction throughout much of the third quarter may be decided. If the 2013 advance in stocks is still healthy and intact, the next leg higher should begin during this period via a rebound in the Russell 2000 from support near 1,080 and a sustained move above $166 in DIA.