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Where Is the Market Headed During Next Two Months?


There is now, for the first time since the Greece debacle in the summer of 2011, a divergence in momentum and price.

You got to be careful if you don't know where you are going, because you might not get there.
Yogi Berra

It's official: There are two weeks left of summer time. After Labor Day and the traditional Hampton vacations, it simply becomes a race to the holidays. Considering that the following two months are traditionally the most tumultuous time of the year for the markets, this race is more like a "mud run" than a leisurely jog. In last week's piece, in an attempt to poke a little fun and deliver some humor, I overlaid, date for date, the past four years of the S&P 500 (INDEXSP:.INX) over the same dates in 1987. To a certain degree, my efforts backfired as the referred correlation was somewhat eerie. Once last Thursday's sell-off hit the tape, the humor all but disappeared as investors began bandaging their wounds.

Intriguingly, Thursday's sell-off began at the exact same level as the May 22 Fed "taper" meeting in which the market posted a considerable reversal day. This is important for many technical reasons. Analyzing the supply and demand of market participants becomes extremely important when a market surpasses past resistance. This is where a continuation of trend is paramount. Simply put, as the market superseded the Fed's reversal day highs (~1,675), this should have become an area of support where the buyers were prevalent. Conversely, when the area cannot sustain, due to lack of buyers, it becomes a key indication of a market top, whether short, intermediate, or long-term.

This, for all intents and purposes, is only one of the issues that the latest sell-off has created. The above chart outlines the S&P 500 on a weekly basis going back to the summer of 2010. Analyzed within is the second major issue facing the broader market: the momentum indicators (RSI & Stochastic). This factor affects continuation. As the market hits higher highs within a trend, one would want to see increasing momentum. Today, this is just simply not the case. Over the last few months, the market has not only increased its volatility, but it has also fallen short on momentum. There is now, for the first time since the Greece debacle in the summer of 2011, a divergence in momentum and price.

Imagine it this way: It's impossible for a basketball, after being dropped, to bounce higher unless there is another force pushing it. Physics states that it must bounce lower and lower until finally coming to rest. With the 1,675 breach, the most logical place for this ball to come to rest is ~1,550 – 1,560, about 6% from these levels. This would bring the market down to the intermediate-term trend, which has been in place since November 2012. But the unsettling news doesn't stop there. If a test of trend at 1,550 were to occur, it would form a longer-term issue in the shape of a double top with a neckline at 1,550 and height of ~1,710, approximately 160 pts.

These technical formations, on a weekly basis, are not very common and suggest further deterioration. If, or when, the neckline is breached, the traditional "best guesstimate" of drawdown is the prior distance drop from height to neckline. In this case, it would be ~150 – 160 points (a measured move). This action would not only send the market down to ~1,400 (15% from here), but it would also constitute a break of the one-year trend, which in turn and at minimum, suggests a serious consolidation (over 12%).

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

Twitter: @TAM_News
No positions in stocks mentioned.

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