Have Stocks Formed a Major Top?

The increasingly contentious tone regarding the debate over the fiscal cliff along with new tensions in the Middle East battered an already weak stock market on Wednesday. MoneyShow’s Tom Aspray takes a look at key market levels investors should watch.

The stock market’s attempt to stabilize failed Wednesday afternoon as investors apparently felt that after President Obama’s press conference it will be more difficult to avoid the fiscal cliff.

The news that the Hamas military leader was killed in an air strike also likely pressured stocks in the last two hours of trading. The threat of a broadening conflict will continue to worry the market and add to pressures to the fiscal cliff.

In addition, we have a host of economic reports Thursday, as in addition to the jobless claims we get the Consumer Price Index, Empire State Manufacturing Survey, and the Philadelphia Fed Survey. It is unlikely that any of the reports will have enough of an impact to turn the market around, but if they are better than expected they could stem the selling.

The more important question for investors and traders is how much lower the major averages are likely to go before they can bottom out. Many would be surprised to learn that in percentage terms the current decline has not yet been as severe as last spring’s correction.

The technical evidence does not yet suggest that a major top is in place but a significant drop below last spring’s lows will weaken the outlook. Therefore the current market decline should present some good buying opportunities, but I would not be aggressive until there are signs that the market is stabilizing.

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Chart Analysis: The weekly chart of the Spyder Trust (SPY) is currently trading below the 40 week moving average (MA), which is at $138.06. This measure of support was just slightly violated in May but in October 2011 SPY dropped over 9% below the 40 week MA.

• The next band of support is in the $132-$133 area and then at $130.


• The market correction last spring resulted in a 10.6% drop in the SPY.


• The May low at $127 is 6.5% below current levels and is the key level of support to watch.


• The market correction from May to October 2011 resulted in a 21.6% drop in the SPY.


• This met the media’s bear market threshold and sentiment before the bottom reached negative extremes.


• The market correction in 2010 lasted ten weeks and resulted in a 17.6% drop in SPY.


• The weekly NYSE Advance/Decline line does not reflect the whole week’s trading, but it is still above its WMA and the support at line a.


• The long-term uptrend, line b, is still significantly lower.


• The weekly McClellan oscillator is still well above the oversold levels seen in May 2012 and October 2011.


• There is weekly resistance now in the $140 to $142 area.

The Nasdaq 100 is tracked by the Powershares QQQ Trust (QQQ), and it has dropped 12.1% from the September highs. This is already close to the 12.6% decline that we saw earlier in 2012.

• The May 2012 lows and the highs from the summer of 2011 represent an important level of support in the 2440 area, line c.


• This is 3.6% below Wednesday’s close.


• The correction in 2011 was less severe for the Nasdaq 100 as it lost 16.5%, compared to the 21.6% drop in SPY.


• In 2010, the Nasdaq 100 matched the SPY’s 17.2% decline.


• The long-term uptrend, line d, is currently at 2345.


• The weekly on-balance volume (OBV) has dropped below its WMA, but did confirm the September highs.


• The OBV has important support now at line e.


• The 40-week MA is at 2670 which now represents first weekly resistance.

NEXT PAGE: Is a Market Bottom in Sight?

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The SPDR Diamond Trust (DIA) has dropped further below its support at line b. This may have completed a rising wedge formation, which would have quite negative implications. DIA is currently down 7.8% from the September high at $136.48.

• The next support is at $124, which is the 38.2% Fibonacci retracement support level.


• Using basic Fibonacci analysis a weekly close below this level will indicate a decline to the 50% support at $120, which also corresponds to the May low.


• The weekly relative performance or RS analysis has risen for the past two week, but is still below its WMA and the downtrend, line c.


• The weekly OBV did make higher highs in September, but violated its uptrend, line d, three weeks ago. It is now further below its WMA.


• There is weekly resistance now in the $130 area and the flat 40 week MA.

The iShares Russell 2000 Index (IWM) closed decisively below its uptrend, line e, last week and is now down 11.2% from the September highs.

• It is just above the major 38.2% Fibonacci support from the October 2011 lows, which lies at $76.50 with the August low at $76.22.


• The 50% Fibonacci retracement support is at $73.40, which is just above the June low at $72.94.


• The weekly relative performance shows a pattern of lower highs, line f, and just recently turned down from its declining weighted moving average (WMA).


• The weekly OBV looks ready to close below its uptrend, line g, and is well below its declining WMA.


• There is strong weekly resistance now in the $80-$82 area.

What it Means: Before a sustainable market bottom can be on the horizon we need to see a sharp oversold rally. Based on the plunge last week a rally would have been expected by Wednesday, but instead the sharp decline means we may not see a rally until next week.

It would take a weekly close below the May lows to create a pattern of lower lows. For the SPY, this level is at $127, which is 6.5% below current levels.

Though I cannot rule out another 2-3% drop over the short term, the risk on the short side is too high now in my opinion to be buying an inverse ETF.

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