S&P 500 Pause or Failure at Resistance?

The 200 day moving average is often viewed as a key technical marker for a bull or bear market. However, it is clear that the price of an asset class simply closing for a day or two above or below this level does not signal an all clear signal. This chart shows the SPY daily price action (the ETF for the S&P 500). One can see that in mid-June we briefly broke above the 200 day moving average (blue line)for about 4 days only to break back down. This week we again have been trading above the 200 day moving average only to see a very bearish price reversal (price started up for the day then went down dramatically suggesting the bears had gained control) today as of early afternoon on some deflationary comments from a member of the Fed. I think it is too soon to conclude that we are now back in the trading range of S&P 1040-1120 of the past few months as many technicians felt we needed to consolidate a bit after a rapid run up last week. If we are to continue higher from here, I would look toward the white lower trend line that I have drawn as a possible level of support where we would have a new higher low to follow the higher high in price three days ago. Uptrends tend to be marked by oscillating prices between higher highs and higher lows. The pattern remains consistent with that possibility unless that trend line is violated.

I quote this portion of a recent post here--"A word of warning, however. I am not a believer in the predictive value of stock market moves to necessarily provide a 6-month guide into our economic future. After the bear market began in early 2008, the S&P 500 went back above the 200 day moving average twice in May 2008, before then descending on a long term downward path. Clearly, early May 2008 was a dangerous time to get back into the market without a risk management plan. Even for long term investors, I would tread similarly here back into the market with a defined risk (i.e. stop loss) such as the ones suggested above."

So here we are in the early spring/summer of 2010 with two failures to hold the 200 day moving average. Continue to use good risk management if you are going to expose yourself to market risk. I have found that lagging a move above a key resistance point or moving average cross by several days or 1-2% (waiting before buying to make sure the price holds above key technical levels) dramatically increases long term returns and reduces volatility in simulated trading models of the S&P 500 and other major markets.

Positive Momentum, A Positive Summation Index, and the Predicted Stress Test Result

It would be hard to fight all the good news and momentum of the past week. The oil leak in the Gulf was slowed. FINREG as a headline risk is now past. Earnings and revenues for the quarter completed have generally been better than expected. Further, as I predicted a few days back, the bank stress tests proclaimed that all was well in European banks. The fact that this seemed to act as a positive catalyst for global stock markets tells one something about the irrational behavior of market participants. While I will admit that I have not read in detail the criteria of the stress tests, I have heard repeated criticism from reliable sources that there was an assumption that there was no risk of sovereign debt defaults (or least an omission of consideration of such risk). Regulators made this assumption despite the fact that Euro banks hold risk of hundreds of billions of dollars in sovereign debt/derivatives related to that debt. As an investor, one should be wary of the conclusion that the ultimate capital shortfall in the European banking system is around $3B....With likely continued good news on the earnings front over the next several weeks, the only headline risks appear to be in employment and GDP reports. Unless, there is a negative surprise on those counts, headline support has helped the bulls regain control of the of the stock market. As John Hussman notes in his weekly report today, the gradually deteriorating fundamentals of the U.S. economy are not likely to get in the way of technical changes in the market short term as the former are not day to day news events.

I would caution that this market has had several apparent breakouts of the trading range and is very tricky. However, on a technical basis, the market is looking stronger. The upper trendline drawn on the S&P 500 ETF in several previous posts has been broken to the upside, as has the 50 day moving average. The next challenge for price is the 200 day moving average just above an S&P level of around 1110. In terms of position, I think the market moves of the next few days will provide an indication of short term further momentum with clear levels to be used as support and resistance. Personally, I would not be short unless we see the 50 day moving average and former trendline violated to the downside. One could take a long position right here with those as your stop points or wait for a hold in price above the 200 day moving average. Of note, I have repeatedly pointed to the NYSE Summation index (a measure of market internal strength by advance and declining issues) as a clue to when the correction might end. This indicator has stayed negative throughout the correction off the April highs. It is now above "0" supporting the breadth of the aggressive recent move upward. Thus price momentum and market internals are now supportive of an end to the correction.

I word of warning, however. I am not a believer in the predictive value of stock market moves to necessarily provide a 6-month guide into our economic future. After the bear market began in early 2008, the S&P 500 went back above the 200 day moving average twice in May 2008, before then descending on a long term downward path. Clearly, early May 2008 was a dangerous time to get back into the market without a risk management plan. Even for long term investors, I would tread similarly here back into the market with a defined risk (i.e. stop loss) such as the ones suggested above.

Downtrend Remains Intact

Initially, I had some concern that the bullish price action yesterday was evidence against my projection of a downward move below 1000 on the S&P 500 (or below 100 on the SPY ETF). However, one can see on the chart above that the 50 day moving average coincides with the upper trendline of the down going channel, and price action has failed to break this area of resistance repeatedly over the past week. Until those lines are held by upside price action, the downtrend remains intact. One potential cause for optimism is that we now see a divergence in the trendline of S&P 500 price movement and the MACD indicator (i.e. the trend in MACD is increasingly positive). Such divergences typically predict a reversal of the current price trend though it can take weeks to months for this to manifest. CLICK ON IMAGE TO ENLARGE CHART

European Bank Stress Test Results Should Not Be A Surprise

Over the course of the past few days, I have heard numerous market commentators note that the forthcoming stress tests in Europe could be a positive or negative catalyst for global markets. I would only agree if one assumes that market participants are silly enough not to predict the results of those test in advance (i.e. the result should already be built into asset prices if the market is forward looking). The results of the US bank stress test served to provide confidence and enable banks to privately raise capital and improve their balance sheets. This was ultimately successful to the tune of tens of billions of dollars. If one thinks for a moment, what central body (e.g. Treasury in the US) would go forward with a stress test designed in such a way that "too big to fail banks" would be defined as doomed to fail and, subsequently, discourage private rather than public capital support to these institutions? One should expect that the results of the European stress tests will provide a similar boost to private support of banks there because they have already seen the ultimate template from Tim Geithner. If European finance leaders are silly enough to release data that further destabilizes European banking sector, then the EU deserves to be too big to fail also.

Summation Index Will Help Define All Clear Signal for the S&P 500

LEFT CLICK TO ENLARGE IMAGE

In some of my recent writings in other forums, I have pointed to the Summation Index as a helpful signal to define an end to the recent correction on the S&P 500. The Summation Index is derived from the advance-decline line and is a measure of market breadth over the medium term. As one can clearly see in looking at the chart above, the Summation Index was negative for most of 2008 even before the stock market actually turned significantly downward in the fall. The rising Summation Index and subsequent move above "0" was also a clue that market internals were improving as the stock market bottomed in March 2009 and then turned rapidly upward. For the remainder of 2009 and most of 2010 the Summation Index has been positive...that is until the past two months. I think any upward move by the S&P 500 should be viewed with caution until we see confirmation of the breadth of the move with a positive reading on the Summation Index. Following this useful indicator in conjunction with price movement would have kept one safe from the recent false moves to the upside.

Convergence of Resistance and Reversal (SPY)

The dramatic upswing in the S&P 500 chart (represented by the SPY ETF chart above) stalled late this week at a predictable point (white ellipse). Daily price action is represented by green and red candle figures. In the area of 108-110 we see a convergence of the 50 day simple moving average (purple), the 200 day moving average (blue), and the upper trend line connecting peaks in a downward channel since the April highs (white). While the market has been quite unpredictable, until these points of resistance are cleared, the most plausible direction/target seems to be the area of 96-97 (green highlight arrow) which corresponds with a long term support level. To see an enlarged version of the chart left click on it.