Technical Analysis of the Stock Market

By Steven Ferguson:

Even as the S&P 500 Index has closed at a fresh new recovery high, we wanted to warn of dangerous underlying market conditions in this technical analysis of the stock market:

1. A confirmed Hindenburg Omen in mid-November points to a significant risk of market crash over the following 90 days. This indicator is extremely reliable. Note that the projected timing and magnitude of the ensuing "crash" are variables within that definition;

2. Technical non-confirmation of new index highs has remained in recent days. That is, the S&P 500 has made a new, intraday recovery high (although not a new closing high) while the Dow and NASDAQ remain below their previous high marks. This indicates classic price divergence and underlying market weakness, at least as long as the condition persists. If instead the Dow does make a new recovery high, that would bode well for a protracted rally, perhaps even into the second quarter. Should that occur, we would still remain vigilant and likely caution readers to "sell in May and walk away";

3. Market indices remain bound by a "Rising Bearish Wedge" pattern where the related trend-lines have provided very strong support and resistance. Index prices have already fallen out of the confines of that wedge but have recently retested the lower boundary. The only real question is how many more times will we trade up to that lower boundary before a more substantial drop occurs. This retesting could continue for some time, particularly if the Dow makes a new recovery high in the process;

4. The "official" Elliot Wave count supports a forecast of major downward movement in index prices;

5. Economic and political factors are pressing enough to provide catalyst for a big drop in the near future. See debt ceiling for more! A Fitch or Moody's (NYSE: MCO) ratings reduction in U.S. debt would almost certainly bring on a wave of selling in stocks. Ironically, this could lead to a flight from riskier assets back to bonds, the very instrument that's been downgraded. Makes us wonder about underlying motives!;

6. First quarter corporate earnings, projected growth and related P/E multiples don’t support much more upside in the near-term at least. Banks are particularly suspect as they trade at high multiples with more write-offs to follow (see Bank of America (NYSE: BAC) and Citigroup (NYSE: C) actions for examples). Good thing we keep relaxing reserve requirements and extending more liquidity …that's always provided adequate means to ensure the banking integrity, right?;

7. Seasonal fund rebalancing is in process though reallocation invariably takes place over a relatively long period to avoid impact on prices. Sell-side algorithms have become very sophisticated and can disguise this for weeks as 401K fund managers exit positions;

8. Bullish sentiment has once again peaked, providing a strong good contrarian indicator;

9. Volume remains very weak;

10. Based on demographics analyses (e.g. Harry Dent), consumer spending and investment patterns are about to change significantly and irreversibly. This observation alone is worth readers' attention, but has a much longer time horizon for lasting impact;

Readers should be mindful of the following technical levels to watch on the S&P cash index:

• 1475 - Significant breakout above could extend rally into second quarter
• 1440 - Significant breakout below would forebode more substantial decline

In any event, new long positions in stocks should be added only with extreme caution.

This technical analysis of the stock market is relevant to broader market interests, including investors in index relative securities including the SPDR S&P 500 (NYSE: SPY), SPDR Dow Jones Industrial Average (NYSE: DIA) and the PowerShares QQQ (NYSE: QQQ).

Disclosure: Ferguson is short the S&P e-minis

Please see our disclosures at the Wall Street Greek website and author bio pages found there. This article and website in no way offers or represents financial or investment advice. Information is provided for entertainment purposes only.