With the recent rise in stocks the major averages have begun digging their way out of being in the red by double digits. From the September low, the S&P 500 ($SPX) has bounced roughly 8% with another 5% to go before getting back to its prior high. While its made significant improvement from what many believed to have been the ‘edge of a cliff’ we are not quite out of the woods yet. On August 24th, when markets were “in turmoil” and traders were beginning to pull their hair out from stress I wrote a post, That Was Unlikely The Market Top & Where I See Things Going From Here. In which I laid out my thinking that I expected the market to whipsaw for a bit before potentially testing the low and bouncing higher. It seems that’s the scenario we’ve seen play out thus far. However, we can’t ignore the warnings that preceded the decline and the possible impact they can still have on financial markets.
So with all that, I thought it’s time to show a few charts for the broad market and explain my view on equities based on where we are and the environment we’re in. From a seasonal standpoint, we are exiting the historically bearish six month portion of the year, giving equities a bit of a tailwind but the major indices are also approaching critical levels of potential resistance. Can seasonally give enough of a boost to push past and move back to new highs?
Below is a monthly chart of the S&P 500 along with two Moving Averages and a momentum indicator, going back to 2005. Looking at the far right portion, the latest set of data the market’s provided us, we can see that in August the S&P broke through the 20-month and 10-month Moving Averages after a small divergence appeared in the Relative Strength Index (RSI) indicator. I show the 10- and 20-month MA’s because they have acted as support during the up trend and are commonly referenced when traders define a trend, either up or down.
In 2007, the monthly RSI went from being over 70 to having price break through these two Moving Averages price bounced back up and tested what had been support. Except support that had been provided by these MAs had become resistance and the RSI failed to get back above 50 before price continued into a bear market. Looking at present day, we had the RSI bounce on its mid-point, a bullish sign that momentum may still be in a bullish range. Price has been able to re-take the 20-month Moving Average but still remains slightly below the 10-month. I’ll be watching to see if we get a close above these two important levels.
Another example of this occurred at the 2000 top…. Price broke below these two Moving Averages in late 2000 while the Relative Strength Index dropped under 50. An attempt to regain the 20- and 10-month MAs was made but failed and momentum was unable to get back above its mid-point. A bear market then followed as the 10-month Moving Average that had been support during the up trend switched to act as resistance during the multi-year down trend.
Zooming in a bit, below is a weekly chart of the S&P 500 since late 2012. We can see a similar setup with the 50-week and 20-week Moving Average. Where they had once been support but are now is being tested as possible resistance. These shifts in being support and becoming resistance help show a change in psychology and market sentiment. It doesn’t require an understanding of what’s going on in China, Washing DC, or individual corporate board rooms – just price.
I call these next few weeks ‘the make or break’ moments for stocks because how they act around these moving averages, in my opinion, will help give traders a better idea about if the market is in the process of shifting from a bull to a bear market. I don’t believe that decision has been made, not when we are this close to a prior high, at this very moment. A fail at these levels of potential resistance, following declines in breadth and momentum, would check quite a few boxes that have led to prior bear markets – while they aren’t requirements they do act as a fairly consistent road map. If price can move above these levels then it’s likely we see the prior high tested and taken out as the bulls remain in control. Price is what matters so that’s what I focus on.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.