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More Upside Likely for Risk Assets, but Key Resistance Levels Are Just Ahead for Bulls


A uniform message is being sent from the fixed income and currency arenas that match up well with those coming from equities: Enjoy the easy ride higher for now, but get ready for the proverbial "fork in the road."

Whether I look at stock charts, bond charts, or currency charts recently, I see the same overall message: We're in for a couple of percent more of relatively uncontested upside in risk assets after which a real dogfight will occur between the bulls and the bears. A breakout in stock prices and/or Treasury yields could spur a major short-covering rally. On the other hand, a failure at resistance for stocks and Treasury yields could lead to a substantial sell-off.

So, how does one play such a binary scenario? Watch the trading action carefully as resistance levels are approached / tested and be on the lookout for bearish divergences across asset classes, bearish reversals on index charts, and/or messages from the market internals that the "tank is empty."

Stock Indices Are Facing Key Long-Term "Correction Resistance" Levels.

The equity markets continue to amaze the general public and irritate the bears on a daily basis. I always find it helpful when things get so seemingly extended in one direction to take a look at the big picture to put things in perspective.

The three major US equity indices are shown below using a monthly basis (with the Nasdaq (INDEXNASDAQ:.IXIC) also using a semi-log chart). The visuals / charts I am presenting here are just the bearish outlook on equities. One can easily put the rose-colored glasses on and label the charts differently to show that equities have much more upside. However, I choose to show these charts so that we can all understand the hurdles facing the markets in the short-term. If those hurdles are cleared, then yes, there will be much more upside ahead for stocks. On the other hand, if they prove to be insurmountable, the decline that could occur shortly after such a failure would be more than most investors would want to endure.

The S&P (INDEXSP:.INX) has to conquer the range of resistance from 1,563.92 (the wave "c & B" correction resistance) to 1,576.09 (the 2007 all-time high). If it does, some technicians are out there saying this is still just some type of "broadening formation" (a topping formation). While I allow that a "broadening formation" is possible, I would tend to believe that the more bullish scenario is the reality – where this is a third wave higher and not wave "B" higher. My minimum upside target for the S&P if it breaks out above the key resistance range is 1,635.02.

On the other hand, if the S&P fails to take out the key resistance range, the bearish scenario becomes the likely reality and wave "C" of the macro "ABC" correction lower may unfold before our eyes. That rather scary scenario would have the S&P tumbling all the way down to a test of the 2009 lows – no fun.

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The Dow Jones Industrial Average (INDEXDJX:.DJI) has virtually the same binary set-up as the S&P. The key, macro "correction resistance" range for the Dow is 14,152.98 (the 100% Fibonacci price projection for wave "c & B") to 14,198.10 (the 2007 all-time high). A monthly close above that level will mean (to me) that this upside is wave 3 higher instead of wave "B of ABC." The upside target on a bullish breakout would be around 15,888.75. On the other hand, a failure to take out resistance (on a monthly closing basis) would put the odds heavily in favor of the bearish ABC formation being the reality. If that is the case, the wave C target would be a test of the 2009 lows for the Dow. Again – no fun.

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No positions in stocks mentioned.

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