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Why Stocks Can’t Sustain Their Recent Run

The technicals are throwing up some warning signs


Just over a week ago, the S&P 500 was testing its 200-day moving average (solid red line), but then the European markets exploded higher as a result of Greece’s austerity plan being passed and the U.S. economy delivering better-than-expected results.

SPX Chart

Trade of the Day Chart Key

The S&P 500 vaulted through its 50-day moving average (blue line) and its intermediate resistance line (red dash line), closing out the best week in over two years with an explosive 5.6% rally. And so the big week ended with a shift in both the short-term and intermediate-term trends.

The next resistance for the S&P 500 is at the May 31 and June 1 highs at 1,345, while initial support now rests at the 50-day moving average and intermediate support line (former resistance line) at 1,317. The major support zone (black dash) has not changed.

Nasdaq Chart

Trade of the Day Chart Key

The Nasdaq’s chart is interesting in that there is a clear resistance zone at 2,835 to 2,840 that must breached before it can successfully launch an attack on its former high. It was the failure at the high at 2,835 in June that resulted in the big May decline. Also, it is obvious that last week’s rate of climb, annualized at about 350%, just can’t be sustained.

Each of the major indices has, in just a week, staged an astounding but impossible-to-maintain rally. The Wall Street Journal reported that the rally lacked commitment in that volume on the NYSE averaged less than 800 million shares per day, which is 12.5% less than the average June volume. And reports that buying was driven by heavy short-covering are unsettling.

Quarter-ending pops like last week’s are typically driven by institutional “window dressing,” as bonds are traded for stocks. Finally, the central theme of buying in the second quarter, according to Dorsey Wright & Associates, was focused on growth stocks versus value stocks. And less aggressive areas did better even in foreign markets as developed markets outperformed emerging markets.

Conclusion: The current pace, which if continued would provide annual gains of over 300%, can’t continue. Note that both major indices’ Relative Strength Index (RSI) is at a high level and pushing against the top resistance line. And low volume and thin market breadth are strong negative indicators. But the market has emerged from the uncertainty of major geopolitical and economic battles on much firmer technical ground than we saw in mid-June. However, market leadership is lacking due to money shifts from the termination of QE2, and until that is sorted out, traders should cash in their profits and investors should protect their gains.

For one stock that has a bit farther to run, see the Trade of the Day.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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