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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.

Click to enlarge

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.

Click to enlarge

The Nasdaq is the last US index I wanted to show you here. Even in the bearish scenario, the Nasdaq is sporting a different macro chart – obviously due to the nature of the 2000 - 2002 decline and the subsequent recovery. In this bearish scenario, the Nasdaq is in wave "c & B" higher of a macro ABC correction lower. The difference between the Nasdaq and the other two indices lies in where the "a's, b's, and c's" are on the chart. The key here is not the labeling, but rather what the Nasdaq needs to do to conquer the resistance. From my perch, the Nasdaq needs to take out the range of resistance from 3,130.86 to 3,196.93 on a monthly closing basis for the bulls to "win." If the month ended yesterday, the bulls would be celebrating. Unfortunately, we've got another week of trading before the month ends. Just as with the S&P and Dow, a breakout means much more upside while a breakdown / failure would likely mean a nasty sell-off will commence.

Click to enlarge

As a responsible technician, I must note that the mid-cap and small-cap sectors of the US market have already easily taken out their previous all-time highs and are sporting very bullish charts. That makes me think that a break to the upside for the large cap indices is entirely possible if not likely. On the other hand, the charts of the iShares MSCI EAFE Index Fund ETF (NYSEARCA:EFA) and iShares MSCI Emerging Markets Index ETF (NYSEARCA:EEM) are nowhere near their all-time highs and are acting as a drag on diversified portfolios around the globe. As usual recently, there's something onto which everyone can grasp.

Now, let's move on to my normal weekly focus: the global currency and bond markets.

Here's a Look at the "Risk-On / Risk-Off" Messages From the Currency and Bond Markets:

As you'll notice below, the messages are mixed in the short-term but leaning more bearish on a macro basis. This fits well with the bears' theory that there's a bit more upside in risk assets in the short-term, but that there could be a correction just around the corner. The good news for the bulls is that nothing here is set in stone and the "neutral" and "risk-off" macro messages from many of the charts here can be flipped over the "risk on" if the global major players decide to change their collective tune. Unless that occurs, though, there is some cause for concern on the part of the risk bulls out there – if they were only looking at these charts.

Click to enlarge

Overall, my message to you all is to enjoy the rest of the upside to resistance for risk assets. Once we get to the key levels outlined in today's report, it will be time to focus on observing the trading action to plan out our next moves appropriately.

Twitter: @seachangereport

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