As I wrote last week in Money and Markets, there is a high degree of uncertainty impacting markets right now as the White House and Congress jockey for position in an effort to hammer out an 11th hour deal to avoid the fiscal cliff.
This means financial markets are likely to remain volatile in the weeks ahead.
If Washington fails to act, we could easily see more downside for stocks, and a flight-to-safety temporarily benefiting the U.S. dollar and Treasury bonds. Meanwhile, a compromise solution could spark a sizeable relief rally for stocks and commodities.
Which path will we follow: A path that leads us over the cliff … or a path leading to renewed upside gains?
The outcome could have a profound impact on your investment portfolio. So this week, I want to brief you on some of the key indicators I’m watching right now for clues to the markets’ near-term direction.
First, when it comes to emotionally charged events like this one, it’s important not to get caught up in the media hype. There will be plenty of prime time sound-bites for cable news to play and replay in the weeks ahead, but it’s often best to tune out the constant media buzz.
In other words, don’t let this background noise distract you from the markets’ action and reaction.
Last week was a difficult one for stock investors, no question. The S&P 500 Index suffered a sharp 3.6 percent post election decline on Wednesday and Thursday alone, before stabilizing on Friday.
The blue chip index has fallen about 7 percent from its mid-September peak. But there’s one sector I’m watching closely that has performed even worse, and could be a harbinger of things to come …
The Tech Sector
The Technology Sector of the S&P 500 has suffered the most so far during this correction. Since the market peaked in mid-September, the tech sector has plunged deeper into correction territory than any other sector, down 10.3 percent.
The Nasdaq 100 Index, which includes many high-profile technology stocks such as Apple (AAPL), Microsoft (MSFT) and Amazon.com (AMZN), has also taken a beating, down 10.5 percent over the same period.
I’m keeping a close eye on this sector because, in the past, technology has been a canary in the coalmine for overall stock market direction.
As you can see in the chart below, the performance of tech shares (thick white line) often leads the S&P 500 Index at both market tops and bottoms. This was the case in March and again in September when tech stocks peaked and rolled over just ahead of the market.
The same was true at this year’s low in May and June, when technology was one of the first sectors to bottom and begin trending higher once again.
In this game of follow the leader, tech stocks are still leading the market to the downside. But I’ll be watching the relative strength of this key sector closely for signs the selloff may be coming to an end.
But, persistent weakness in tech shares could signal more downside ahead for markets.
Stock Market Ceiling and Floor
Next up, I’m watching several key support and resistance price levels in the major market indices, especially the S&P 500.
You can think of support and resistance levels as the floor and ceiling for stock prices. They typically form around key levels where stock prices have spent a lot of time trading in the recent past. Also, moving averages of prices often become popular support and resistance levels that markets can be drawn to like magnets.
In the chart of the S&P 500 below you can see that the 100-day moving average of prices (solid blue line), which was broken to the downside in last week’s sell-off, now becomes a key level of resistance … or a short-term ceiling for stock prices.
Meanwhile, the 200-day moving price average (solid red line) appears to be offering a near term level of support. In recent days, the S&P 500 has traded below this important floor, but has not broken decisively to the downside.
The burden of proof is with the bulls right now.
If stock prices are to regain their footing, we’ll need to witness expanded buying power and the 200-day moving average needs to hold.
But if this floor of support is broken, the bears’ selling pressure could easily push the S&P 500 down into the basement with a deeper correction, perhaps down to the 1,340 to 1,350 level … or down 10 percent from the September peak.
The next objective for the bulls on the other hand is the 100-day moving average price line, which is now acting as a short-term ceiling. The first step is for the bulls to raise the roof, pushing the S&P 500 back above this key resistance level.
Next, the index must overcome additional resistance around 1,430 (the September-early October lows) in order to set the stage for a renewed rally back toward the old high near 1,475.
Of course, the ongoing fiscal cliff-hanger is sure to provide plenty of tricky cross currents and false moves … perhaps in both directions. That’s why perhaps the best move to make right now is no move at all. Keep some dry powder while watching these key indicators until we have more confidence in the market’s next move.
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