The benchmark S&P 500 Index behaved erratically last week, prompting investors to wonder what’s in store for U.S. stocks.
As equities hovered near a record high, two reports at the end of the week — gross domestic product and jobs — suggested the economy is strengthening. But the Federal Reserve is still pouring $85 billion a month into the economy, a stimulus program that many investors say is unneeded.
There’s no way to predict the future with any certainty, but I believe that technical analysis of the weekly S&P 500 chart can allow us to understand the broad trends in the stock market, and perhaps profit from them.
The S&P 500 reached its latest high point at the end of October, when it closed at 1,775. The index held near that level for about a week, until last Thursday, when it dropped dramatically. However, the S&P 500 rebounded Friday with a 23-point jump, closing less than 5 points shy of its October high.
That type of pattern is nothing new. As you can see, the index has been making new highs and pulling back all summer. Furthermore, the pullbacks in June, August and October retraced about 60 percent to 75 percent of the previous legs up. If that pattern were to reassert itself this time, the index would fall to the 1,680-1,700 range, right about where the 100-day simple moving average (SMA) now sits.
In fact, the 100-day SMA has acted as a floor several times, stopping the past three pullbacks in their tracks. That’s why many investors are predicting the same thing will happen over the next couple of weeks, and betting on a big drop.
Could This Time Be Different?
However, I believe these stock market bears may be ignoring one important detail about the last leg up, which might not be evident if you’re not paying attention to the technicals, as I do.
If you look closely at the chart above, you’ll see that the recent move extended above the dotted trend resistance connecting the previous market tops. That’s what’s known as a breakout.
|The nature of the stock market now is that you can see in it whatever you want to see.|
When a stock or index breaks out, the resistance line through which it has broken often becomes a support line. And it seems that may be what’s happening now. The S&P 500 is retesting the breakout level, possibly in preparation for a more aggressive move higher.
Of course, stock market bears would argue this is a consolidation phase following the latest advance. They’ll also point to the moving average convergence divergence (MACD) indicator, which appears to be rolling over, perhaps presaging a move south.
But that’s the nature of the equity market these days — you can see in it whatever you want to see. None of us know for sure what stocks will do next, so it’s best to keep an open mind, and react to definitive shifts in trends.