Investors and Traders Eye Market Correction, But Can DJIA and S&P Breakout?

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Caution lights flash as major U.S. stock indexes and ETFs encounter technical resistance and fundamental headwinds.

After a good start to 2012, major U.S. stock indexes and exchange traded funds have run into serious resistance on a technical basis and mixed fundamental indicators with the U.S. economy improving and Europe still offering headline risk.  Markets are overbought and overextended and storm clouds still hang over Europe.  Caution lights flash.

On My Wall Street Radar

NYSEARCA:SPY

The S&P 500 (NYSEARCA:SPY) has stalled at the 1370 level for the last ten days, unable to break higher and continue the up trend started in December.

A glance at the chart of the S&P 500 (NYSEARCA:SPY) is instructive as, in addition to the stall at resistance, we see confirming indicators of overbought conditions and the onset of further weakness.

In the top red box we see RSI in overbought territory and turning down.  Next level down we see MACD rolling over to a “sell” signal.  Below that we see Stochastic also rolling over to a “sell” signal from overbought levels.

Charts of the Dow Jones Industrial Average (NYSEARCA:DIA) show similar readings while the Russell 2000 (NYSEARCA:IWM) has diverged sharply from the other indexes, declining approximately 3% from February’s high and now approaching its 50 day moving average.  Small cap stocks represented by the Russell 2000 (NYSEARCA:IWM) are oftentimes leading indicators for the major indexes and so we have to ask, “if things are to turn lower, how low can it go?”

In the S&P 500 (NYSEARCA:SPY) we can see support levels at the horizontal lines near 1340 and then 1300, along with the 50 day moving average at 1317.  So there’s plenty of support not too far away, with the bottom end of major support some 70 points or 5% away from current levels.  However, a drop below 1300 would set up a scenario for a quick drop to 1260 or 110 points from today, a more significant drop of approximately 8%.

The S&P 500 (NYSEARCA:SPY) and the Dow Jones Industrial Average (NYSEARCA:DIA) and the Russell 2000 (NYSEARCA:IWM) are flashing strong caution signals of a sell off just ahead.  Over the next few days and weeks, we’ll see just how deep such a sell off might be.

The Economic View From 35,000 Feet

Last week’s economic news was mostly positive with initial jobless claims staying below 400,000 and reaching low levels not seen since spring, 2008.  Pending home sales were up, consumer confidence climbed and Dr. Bernanke told Congress that the recovery was continuing and that rates would stay low for the foreseeable future.

In Europe the news was mixed as the Long Term Refinancing Operation entered its second phase with 530 billion Euros going to European banks virtually for free which adds enormous liquidity to their financial system.  They might need it as after the close on Friday Moody’s downgraded Greece to “C,” its lowest level as bond holders are going to get a 70% haircut this week that Moody’s calls “a distressed exchange, and hence a default.” Bloomberg

This will be a major week for Greece and Europe as they progress with their bond swap for “voluntary” participants and collective action clauses for “non-volunteers” which could set off the chain of credit default swap claims that we’ve read so much about over the last couple of years.  Nobody knows quite what will happen should that occur, but we might find out this week.

On the downside this week, Europe is forecast to be entering recession, the U.S. Durable Goods order was a huge miss and Case/Shiller reported home prices at the lowest level since February, 2003.  Also, more than 11 million homes in the United States are “underwater.”  This accounts for 23% of all U.S. homes with a mortgage, according to CoreLogic.  Leading states with  underwater homes were Nevada with 61% underwater, Arizona with 48% and Florida with 44%.  Since home equity is a major portion of most peoples’ net worth, these are disquieting figures, to say the least.

Spending and Income stayed flat in January with income declining from last month’s levels and spending increasing less than expected. January Construction Spending declined 0.1% compared to last month’s 1.5% increase and 0.7% expected, another huge miss and troubling news for the all important housing sector.

The most important report of the week, February ISM, came in at 52.4%, down from the previous month’s 54.1% and 55% expected.

This week brings a slew of important economic reports with ISM Non Manufacturing on Monday, ADP Employment, Productivity on Wednesday, weekly jobs reports on Thursday and the Big Kahuna is the February Non Farm Payrolls and Unemployment Reports on Friday.

What It All Means For ETF Investors: The U.S. economy continues to gradually improve, albeit in fits and starts, while Europe continues to falter and presents ongoing headline risk with Greece.  On a technical level, indexes are overbought and overextended and subject to correction.  Caution is the watchword of the day.

John Nyaradi is the author of The ETF Investing Premium Newsletter.

To contact the reporter on this story: John Nyaradi at staff.writers@wallstcheatsheet.com

To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com

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