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As Government Shutdown Looms, S&P 100 Trend Indicates Elusive Market Risk


With the market near all-time highs, it can still be hard to tell where the risk lies.

Let's go, time's a-wastin'...
--Johnny Cash

Tick-tock, tick-tock. Less than 24 hours from now, if no resolution is met in Congress, all non-essential spending will be halted, and many public sector workers will be forced to take a temporary unpaid leave of absence. In other words, the United States maxed out its credit. But wait -- weren't we here almost a year ago? Welcome to round two of the fiscal cliff. But this time, the sequestration has already begun, Obamacare is knocking on the door, and we have another debt ceiling to raise.

Oddly enough, other than this morning's open, the markets don't seem to be panicking as much as they did back in November of last year. After all, it's not as if a government shutdown -- especially when the stakes are higher than ever before -- is that big of a deal.

With the market near all-time highs, it can still be hard to tell where the risk lies. From a technical perspective, as prices continue moving higher, there are certain momentum indicators that have begun signaling a slowdown. Last week, my firm discussed a "stochastic divergence" forming on the weekly chart of the Dow Jones Industrial Average (INDEXDJX:.DJI). This time, we wanted to discuss a more transparent trend that pulls back the curtain on the elusive risk throughout the markets.

There are numerous ways to gauge underlying strength of the market as it moves into "new high" territory. One way is assessing how many underlying companies within the index are also making new highs. For this example, we use the S&P 100 Index (INDEXCBOE:OEX), as it represents the top 100 market capitalization companies of the S&P 500 (INDEXSP:.INX). The OEX has made three new distinct highs since the beginning of summer: May 22, August 2, and September 18. If we calculate the number of companies making new highs on these dates, we can see if broad-based support exists each time, or if momentum is waning.

We found that 66 companies made a new high at or near the May 22 OEX high, 46 companies made a new high near the August 2 high, and 37 companies made a new high near the September 18 high. In other words, as the market's gone higher, fewer companies have been contributing. It is entirely possible that this trend could change, and a new surge of constituents may begin making new highs. However, in a game of odds, why not stack as many as you can in your favor?

Click to enlarge

Generally the market still has pockets of strength that are appearing among the apparent weaknesses. Two weeks ago, we discussed the Internet and social media companies, and software in general, as having the potential to be the leaders of the next bull run, assuming it were to happen. Following behind in close second are the semiconductor companies (PHLX Semiconductor (INDEXNASDAQ:SOX)). The question now becomes, "Is the recent surge in this sector since the August 27 low akin to showing up to a party at midnight?" The 11% four-week move doesn't sound so bad, but taken within the context of a potentially weakening market, it may just be a tease.

Click to enlarge

The 500 level in the SOX corresponds to the 2007 resistance point just before the wheels "flew off" the market just under a year later. It's hard to believe that this sector is already back to that point, considering how far it had to move up from the 2008 bottom. In the same fashion, it makes this resistance level all the more important.

The next 24 hours will most likely be pivotal for the country and the markets. In the eleventh hour on January 2, Congress passed the American Taxpayer Relief Act of 2012, thus averting the fiscal cliff temporarily. On that news, the SPX gained 2.5%. If there's anything to glean from history, Tuesday could be a game changer.

We 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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