Two Steps Forward, One Step Back?

April 29, 2009

Nearing a key breakout point, the S&P 500 is setting up to jump another 10%. But failing to find support at that level, a slight pullback is in order.


So far, so good.

But are prospects for more of the same realistic?

Consider that since the current rally started on March 10, smaller stocks have been outperforming their bigger brethren. For example, the prices of the iShares Russell 2000 (NYSE: IWM) and the MidCap SPDRs (NYSE: MDY) have shot up roughly 30% in that period.

By comparison, the S&P 500 SPDRs (NYSE: SPY) is up some 20% since early March. Interestingly enough, prices on the Rydex S&P 500 Equal Weight ETF (NYSE: RSP) have jumped around 30% since early March. That illustrates how an equal-weighted index can capture smaller company outperformance. Normally in a rebounding economy, it's more likely to see a quicker turnaround in fortunes at a small-cap name than a huge goliath.

Markets Giving Mixed Messages

But markets are at an inflection point. From a technical standpoint, the stocks face at least a bit more upward resistance. On the S&P 500, that point would seem most significant at around the 880 level. As of early Wednesday, that benchmark was hovering near 873. In terms of SPY, a key test will be around $88 per share (it's trading at $87.25 early Wednesday).

So we're very close. It's very possible that markets could go up even more. If that scenario happens, the S&P 500 would run into headwinds at 960. That would equate to around $96 per share for SPY. Again, it's tough to figure that sort of scenario out since a lot would depend on how quickly stocks raced to those levels and how involved institutional investors would be in such a second leg up for the broader market.

Right now, the S&P 500 is technically showing an inverted head-and-shoulder formation. That's a strong bullish pattern and indicates that once markets can move above 880 on the S&P 500, then we'll see a jump to 960 fairly quickly.

If SPY goes beyond $88 per share, be sure to watch for decent volume. Trading of around 2 billion shares or more on the New York Stock Exchange that day in which SPY breaks out would be ideal. That would show strong institutional support for the markets.

At the same time, all signals aren't completely favoring such an extended run. A troubling statistic is that 88% of all NYSE stocks are above their 50-day moving average. That's very near an all-time high in terms of stocks trading above their near-term moving averages. Such a high level generally signals an overbought condition. It's also a strong red flag to technical analysts that a short-term pullback in stocks is on the way.

Good & Bad Views

What if stock markets do start to collapse? Technical indicators show that the first floor for such a falloff would be around 825, or about 5% less than current levels. But major support levels really would come into play if the S&P 500 dropped closer to 800. That would demonstrate a much more significant test to the market. And such an 8% fall might be healthier in terms of setting up the broader market for a longer-term run.

The argument that some sort of pullback at this point is overdue does make sense. Consider that starting in the second week of January through early March, the S&P 500 fell eight out of nine weeks. Then, it went up six straight weeks. In fact, the PowerShares QQQ (Nasdaq: QQQQ) is on its eighth straight week of price improvements.


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