Major U.S. indices were essentially unchanged in a week that featured a lot of day-to-day volatility but not much directional movement. When markets move in a sideways range, as the U.S. stock market has been doing since February, it indicates temporary investor indecision. 

#-ad_banner-#These periods of indecision almost always lead to the next meaningful directional move, which is precisely where the market finds itself heading into this week. The big question is: “Which way from here?” That is the focus of this week’s report.

At the sector level, financials and consumer staples were last week’s best performers. The recent strength in financials, which are up 1.9% in the past month, has been driven by the spike in long-term U.S. interest rates amid a steepening yield curve. Both of these factors will help make banks more profitable.  

The weakest sector last week was energy, which lost 0.9% and is down 4.5% over the past month. This has been driven by a strong outflow of investor assets, according to Asbury Research’s own metric, as shown in the table below.

The biggest inflow of investor assets over the past one-week and one-month periods went into the financial sector.

Stocks Need a Rally to Prove They’re Still Healthy

For months, and most recently in the May 18 Market Outlook, I have been discussing chart patterns in the Nasdaq 100 and Russell 2000, which represent market-leading technology and small-cap stocks. The targets of these patterns are Nasdaq 100 4,347 and Russell 2000 1,213. They remain valid this week, but we need to see some strength in the broader market to get there.

The chart below plots the S&P 500 daily since January with its 200-day moving average, a widely watched major trend proxy. It also includes a monthly overbought/oversold metric plotted in the lower panel. The green highlights show that monthly oversold extremes have coincided with every near-term bottom in the S&P 500 since the beginning of the year.

The April 17 low at 2,072 has contained the index on the downside for the past two months. This combination of monthly oversold conditions and underlying support should be the springboard for the broader market’s next leg higher. If the market can’t rally from here, it will put the viability of my upside targets in the Nasdaq 100 and Russell 2000 into question.

What’s Standing in the Market’s Way?

In the May 18 report, I also mentioned a bearish chart pattern in the German DAX index, which is positively correlated to the S&P 500, that targeted a 4% decline to 11,000. This target was met last week.  

In last week’s Market Outlook, I pointed out a second bearish pattern, this time in the positively correlated London FTSE 100, which targeted a 4% decline to 6,550. Per the correlation, more upcoming weakness in Europe should indirectly put downside pressure on U.S. markets.

In addition, formidable overhead resistance at the Nasdaq Composite’s March 2000 high at 5,133, first discussed in the April 27 Market Outlook, still looms just above the market and is unlikely to be broken without at least a corrective decline first.  

Bottom line: The S&P 500 must resume its 2015 advance from 2,072 this week if it is still healthy and intact. A decline below 2,072 would indicate that at least a minor corrective pullback is beginning, which I believe is the more likely scenario.

Crude Oil Rising From Secular Support

Even though investor assets have been aggressively leaving the energy sector over the past month, which is illustrated by the sector table above, crude oil prices are showing some longer term upside potential.  

The chart below, which I discussed last week on CNBC’s “Street Signs,” shows that West Texas Intermediate (WTI) oil tested and held its $43.90 per barrel 1994 low in late March. It has since rebounded by 37% in just 10 weeks to finish last week at $59.96 per barrel.

While the energy sector has recently fallen out of favor with investors, oil prices have responded very favorably to a previous major support level. The next significant level is almost 15% above the current market price at $68.84, which is where prices appear to be headed next.

The S&P 500 begins this week situated just above key support at 2,072, a level from which the advance must resume if my upside targets in the Nasdaq 100 and Russell 2000 are to be met. However, a sustained decline below 2,072, which seems to be the more likely outcome, would set up at least a test of major support at 2,048 and would warn that a significant top may be in place at the recent highs.

My expectation for an eventual rise to 2.82% in 10-year yields not only supports an initial stock market decline as investors recognize that the Federal Reserve no longer has their backs, but also rising crude oil prices as the U.S. economy starts to stand on its own following years of quantitative easing.

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This article was originally published on ProfitableTrading.com: A Rally This Week Could be Critical​