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S&P 500 Breaches Key Level, but Will It Break Above It?

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There are two weekly factors looming that give pause to a break above 1425.

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A man may imagine things that are false, but he can only understand things that are true, for if the things be false, the apprehension of them is not understanding.
– Sir Isaac Newton

Today's quote resonates on many levels. I felt it apropos as a lead, sitting battened down inside this weekend anticipating Hurricane Isaac. First and foremost the 'lock-down' provided great time of reflection as the news of Neil Armstrong crossed the wires. Armstrong, "The Rocket Man", passed this weekend at the age of 82. Being the first man to set foot on the moon he was most known for the quote, "This is one small step for man, one giant leap for mankind." But when reflecting back on the Rocket Man's life, there are three other Armstrong quotes that come to mind -- the first of which sits boldly upon my desk:
  1. "I believe every human has a finite number of heartbeats and I don't intend to waste any of mine."
  2. "Research is creating new knowledge."
  3. "Start at the end and work back."
So it's like this: Don't waste time, and focus on the creation of new knowledge by starting at the end and working backward. Newton, not unlike Armstrong, was also continually on a quest for understanding. Sound familiar? Understanding the markets, its moves and its inherent risk, is a quest so many spend their lives trying to get their head around. Just as today's quote says, "… apprehension of [things being false] is not understanding," and we as humans are inherently programmed to seek answers.

Continually, throughout the course of investing, investors ascertain what will most likely transpire based on the weight of evidence of what they believe to be true. This may come in the form of intuition – cognitive thinking developed from our collective experiences – or in the form of empirical evidence gathered. For my firm, this evidence is technical in nature and exemplifies a common quote from Mark Twain: "History does not repeat itself, but it does rhyme." One of Twain's favorite theories was that no occurrence is sole and solitary, but merely a repetition of a thing which has happened before, and perhaps often.

As market technicians, we study the market and evaluate the risk/reward affiliation to current market stance and, as Armstrong suggests, we start at the end and look back. Assuming truth in this modality, we look for the rhymes. My firm defines technical analysis as nothing more than a graphical representation of investor (all investors -- institutional and individual alike) psychology as a whole. Combining this with the simplicity interweaved within the law of supply and demand, technicians can reasonably assess their own stance based on their assumable risk.

On Tuesday of last week the S&P 500 Index (SPX) breached a key level at 1,425 and proceeded to deliver a key reversal day (starting higher and ending lower at an important inflection point). This told us there was not enough demand to push the market into the bull camp. With all eyes -- longs and shorts alike -- on this area, we believe it to be a cornerstone to the coming month's direction. Yet there are two weekly factors looming which give pause to a break above this level.


Click to enlarge

The first point of hesitation is non-correlated momentum, represented in the stochastic. Thus far, since the 2007 market break, there have been two occurrences in which the market has attempted to proceed higher where there was slowing momentum. The second factor is volume. Both stochastic divergences in the last five years have also been accompanied by a substantial drop-off in volume. Based on a weight of evidence yardstick, this triggers some pause. But most technicians do not wait until a weekly chart confirms such a move.


Click to enlarge

The daily it is, then. Outlined above is not only last Tuesday's key reversal day, but what the Street is calling the two-month melt-up channel. For most technicians searching for clarity of direction, they should be calling the last two months the 'Chinese water torture' channel. Nevertheless, since August 7, the first cross back above 1,400 since the March and April top, it looks as if the bears have all but entered hibernation. A close below this level will be our first sign of potential failure for the bulls. Otherwise, as they say, "go with the flow."

I end this quote-immersed piece with the same mantra with which it began. Les Brown says, "If you shoot for the moon and miss, you'll still be among the stars." Godspeed in your final flight, Neil Armstrong; you were a vanguard, a paladin, and a hero to many.

I hope this helps and finds you well.

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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