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A Pullback Could Be Healthy for the Stock Market


S&P 1153-1157 may be seen as a good sign for the markets in the long term.

Editor's Note: The following was posted in real time on our premium Buzz & Banter (click for a free trial).

The concerns that I shared yesterday sprang to life today. Please see Road Signs from yesterday's Buzz & Banter, reproduced below.

Road Signs

We have a minor argument starting to unfold. The percentage of stocks above the 40-day MA is starting to become divergent. The S&P is at its recent highs, but the percentage of stocks above their respective two-month highs has fallen slightly to 82 (from 86%).

It's certainly not as serious as the April 29 discord, but I pay attention to any such issues. A gush often starts out with a trickle.

Click to enlarge

Over the past 16 years, I've seen numerous "reasons" attributed to such declines, but these aren't necessarily the "causes." I believe that when the internals get weak, the immunity of the market to external shocks weakens.

However, I'd caution against leaning on any one indicator. Remember, it was the quick succession of 90% downside days in April that put us on alert, the euro that jeopardized the rally off of the flash-crash lows (please see "Market Tells" Buzz from May 12), and the media being too "short-sighted" on August 31 (please see "Market Thoughts" Buzz from August 31). Case in point, there are often different things that assume importance at different market junctures.

If I were asked about my ideal market scenario, I would think that a pullback to the 1153-1157 range would be quite healthy for the longer-term picture. Note in the following chart, the S&P has walked along the top Bollinger Band since the rally began in September. A pullback to the mid-point of the Bollinger Bands is often welcome.

Click to enlarge

(Do remember that this important support level is not at a particular number but at the 20-day moving average level. This number will change over the next few days, as it incorporates the recent action. So, I'd calculate it on a daily basis, as a possible support level.)

Also, the 23.6% Fibonacci retracement level of the recent advance from 1049 to 1185 lies around 1153.

Today should be an important day to analyze after close. As I've shared previously, this advance has proceeded with strong accumulation days (8/27, 9/1, 9/3, 9/13, 9/21, 9/24, 10/5; see "Market Thoughts" from October 5 for more) and not a single heavy selling day that closed as a statistically significant distribution day. It will be interesting to determine if the action today can interrupt this long streak.

On another technical note, the dollar rallied stylishly from the support levels that the charts pointed to just a few days ago (Please see Dollar Support, reproduced below). Since that feat was accomplished, now we look ahead at the dollar index.

Dollar Support

The dollar index spotted a bearish head-and-shoulders pattern that was consummated upon the breach of $81. It's coming close to an important support zone, so I'd look for some stability here in the short term.

Purely on the basis of technicals though, it seems that eventually the move could have more on the downside (vicinity of $72).

First things first, any evidence of stability (and kind of reaction) around the previous support zone would be extremely important in determining if the H&S targets are met on the downside.

Click to enlarge

In an idealistic technical set-up, such breakdowns should head all the way back to the levels they broke from (in this case around 81), but the very ferocity of the breakdown sometimes impedes the attainment of that goal! (Sounds strange, but it's an honest deduction of many years of watching price action.)

I only see two technically important resistance areas; one is around 20-day MA, where it's at right now and the other one is 50-day MA, currently at 80.65 (which incidentally satisfies the above predicament).

Click to enlarge

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