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Although this is the time of year when pundits come out of the woodwork with their annual forecast reports, I'll let the charts tell us what might be coming.
Based on several technical measures, such as trend, momentum and sentiment, I continue to look for the start of a much needed correction early in the year. Despite housing experts' now looking for a double-dip recession in that sector of the economy, there is not enough technical evidence to call for a broad bear market in stocks at this time.
Starting with the positive, the Standard & Poor's 500 rally has moved above a level considered important by technical analysts. There are two reasons for its significance, the first being its position as "regular" chart resistance from the April 2010 high of 1220, in round numbers (see Chart).
Chart -- Standard & Poor's 500
The theory of resistance is based on the idea that the market has a memory and prices that tended to bring out sellers in the past will do so again in the future. Indeed, this was the case in November as the index peaked at 1227.
Resistance does not repel market advances forever. When demand grew strong enough to absorb the supply appearing at this price level in early December, the technical breakout was complete. There is no denying December was a pretty good month for investors.
The second technical factor in play involves discreet retracement, or rebound levels of the prior bear market. Based on the Fibonacci sequence of numbers, a retracement of 61.8% often supplies additional resistance to the trend. Technical analysts can argue about the efficacy of this percentage but many eyes do watch it and in my personal experience it does provide somewhat of a speed bump at a minimum.
The 61.8% level was at 1229 and it, too, has been broken to the upside. The breakout from the combination of regular chart resistance and the Fibonacci level does put the wind at the bulls' backs for a continuation of the rising trend—all else being equal.
Unfortunately, all else is not equal as there is some negative technical evidence we cannot ignore. Many gauges of investor sentiment, such as the Investors' Intelligence survey, show bullishness surging to levels not seen since the April 2010 high. This is a contrarian indication that the market needs a good cleansing correction before it can move significantly higher.
Anecdotally, I have seen many year-ahead forecasts calling for a resurgence of the individual investor. After sitting scared on the sidelines after the so-called lost decade for stocks, individuals are seeking higher returns than they have been getting in fixed income securities. And now with bond prices falling, money is starting to flee that market causing many analysts to assume it will find a home in the stock market. It all adds to the generally good feeling now pervading the market as the proverbial Wall of Worry seems to be gone.
So how does the rising trend jibe with the contrarian bearish signal? One look back at the chart shows how.
The rally from the March 2009 low unfolded in a series of advances and pullbacks not unlike those found in Elliott Waves. Without getting into the details of that somewhat esoteric form of analysis, the structure of the advance from the June 2010 low does appear to be nearing a short-term peak. That would suggest a leg or wave lower—again as a correction—is in the cards.
There are forces now in play to suggest that it's time for the bulls to step aside for a while. Unless stocks drop to a major new low below the June low at 1011 on the S&P 500—a 20% drop from current levels—we have to assume a major buying opportunity is coming later in the year.
For investors, it might be a good idea to cut back on risk as the new year opens and wait for the frothiness in the market to be washed away.
Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
Comments? E-mail us at online.editors@barrons.com
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