Stocks have staged an impressive comeback since bottoming at 1343 on the S&P 500
(INDEXSP:.INX) back on November 16. Over the past few weeks, stocks have rallied by +5.6% and managed to reclaim the critical support level at the 200-day moving average (red line on chart below) along the way.
As we move into a new trading week, the stock rally faces a particularly important test. On Friday, stocks as measured by the S&P 500 ended the day at 1418. This closing level is effectively right at the 50-day moving average (blue line on chart above), which represents stiff resistance since stocks first broke decisively below this technical level back in mid October.
On several different occasions over the past two months, stocks have attempted to break out back above the 50-day MA only to retreat back lower. Thus, a decisive break above above this resistance would be a particularly bullish signal for the continuation of the stock rally over the coming months.
Stocks appear poised to break out above this critical resistance in the coming week for the following reasons.
First, the technical setup is strikingly similar to what we saw unfold in the market during the month of June. After breaching support at the 200-day moving average at the beginning of June, stocks exploded higher over the next several weeks. And by the time they arrived at the 50-day moving average resistance in late June, stocks had firmly established its Relative Strength Index in bullish territory with a reading above 50 and momentum readings were just crossing into positive territory after surging off of previous lows. This is almost the exact same setup we are seeing with stocks today, and the last time around they went on to breakout decisively above 50-day MA resistance and rally for the next several months. Thus, it would not be surprising to see the same outcome going forward.
Second, stocks are set to receive a meaningful tailwind from the US Federal Reserve over the next several trading days. Although unprecedentedly aggressive policy actions by the Fed since the beginning of the financial crisis have created massive distortions in financial markets that are likely to end badly at some point down the road, they continue to show the propensity to float markets higher in the meantime.
As for its latest balance sheet expanding QE3 stimulus program announced back in September, much of the liquidity associated with the asset purchases tied to the program has yet to arrive in capital markets. This is due to the fact that the mortgage-backed securities (MBS) associated with the program have settlement dates that only take place on selected days each month. Moreover, it can take several months before these MBS purchases to settle in select cases. So while the Fed's balance sheet has expanded by only $36 billion on net since the beginning of QE3 back in mid September, the Fed is set to settle MBS purchases totaling at least $54 billion next week and at least another $33 billion the following week. This massive upcoming injection represents a considerable liquidity tailwind to help float stocks higher as we move toward the end of the year.
For these reasons, stocks appear poised to pass this latest test in the coming weeks and continue their move higher into the New Year.
No positions in stocks mentioned.