The major U.S. indices finished last week mixed, but a closer look reveals some subtle positive signs. The two strongest were the small-cap Russell 2000, which gained 0.5%, and the tech-heavy Nasdaq 100, which was unchanged.  

Since small-cap and technology indices typically lead the broader market higher and lower, last week’s performance could be the early stages of some upcoming market stability. This is especially true as we close in on October, a month that has historically led a strong seasonal rebound into year end.

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From a sector standpoint, however, the market is not showing any signs of life just yet. The only sectors to post gains last week were defensive: utilities, health care and consumer staples. If and when a market bottom emerges, it is likely to be fueled by strength in more offensive sectors like technology and consumer discretionary, perhaps with a little help from cyclical sectors like energy and materials. 

Watch Semis For Clue To Near-Term Direction

In previous Market Outlooks, I discussed signs of an emerging stock market bottom including a bearish extreme in investor sentiment and historically weak market breadth. But I also said that overhead resistance levels needed to be broken in major indices like the Dow industrials first to help confirm that a bottom is in place.  

This week’s first chart identifies another key overhead resistance level, this time in the PHLX Semiconductor (SOX) index. Since semiconductors typically lead the technology sector and technology leads the broader market, directional movement in the SOX is often the first indication that the market is beginning a new trending phase.

After breaking major support at the November 2012 uptrend line in mid-August, the SOX rebounded from the next support level at 559 to 545 to twice retest overhead resistance at 641, but it failed there at the end of last week.  

As long as the index fails to sustain a rally back above 641, it will indicate the current corrective process is still sorting itself out and it is too early to assume a broader market bottom is in place.

Investors Still Too Fearful For A Bottom To Emerge

Another way to determine whether stocks are ready to begin a sustainable advance is by paying close attention to market volatility. I track this via the S&P Volatility Index, better known as the VIX or the fear gauge.  

The VIX finished last week just above its 50-day moving average at 18.79, indicating a fearful/apprehensive investor that has coincided with and likely fueled the current decline in the S&P 500 since Aug. 20. The same can also be said for the decline between June 29 and July 10.

It would take a sustained decline below 18.79 in the VIX this week, ideally accompanied by a rise above 641 in the SOX, to suggest that a meaningful market bottom is in place. As long as the VIX remains above this level, the market is vulnerable to more near-term weakness.

Copper May be on the Move

In last week’s Market Outlook, I pointed out an extremely negative investor sentiment reading — a contrary indicator — on copper. Similar extremes have historically coincided with or led bottoms in the price of the industrial metal. However, I also said bearish sentiment alone was not enough to indicate a buying opportunity and that we needed to see some positive price action first.  

Looking at the chart of iPath Bloomberg Copper Subindex Total Return ETN (NYSE: JJC), we may be seeing the start of that now.

With the exception of Friday, JJC has been trading above its 50-day moving average since Sept. 8. The previous rise above this widely watched minor trend proxy coincided with a 10% advance in JJC between late February and early May.  

What I’m looking for this week is a recovery from Friday’s weak close and a sustained rise back above the 50-day moving average. If it materializes, this would be seen as an emerging and relatively low-risk buying opportunity in copper and related assets.

Putting It All Together 

Unless the U.S. stock market is beginning a 2008-like bear market — which frankly I can’t see due to a number of positive economic factors like a strengthening housing sector and the lowest unemployment rate since 2008 — the market appears to be within weeks of an intermediate-term bottom.  

However, to recap, it would take a sustained rise above 641 in the market-leading PHLX Semiconductor index and a sustained decline below 18.79 in the VIX, ideally combined with rising 10-year Treasury yields, to indicate a bottom may be in place.  

Additionally, what could be an emerging bottom in copper prices would be supportive of a fourth-quarter stock market recovery.

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This article was originally published on ProfitableTrading.com: This Could Be The Biggest Obstacle To A Market Rally