Indicator Warning of a Mild Correction Ahead

by Sam Collins | December 24, 2012 7:46 am

On Friday, stocks fell on the opening following the Republicans’ inability to pass legislation that could keep the budget negotiations in play. The triple-digit fall by the Dow was the biggest decline for the index in over a month.

At the close, the Dow Jones Industrial Average was off 121 points at 13,191, the S&P 500 fell 14 points to 1,430, and the Nasdaq lost 29 points at 3,021. The NYSE traded 1.88 billion shares and the Nasdaq crossed 1.1 billion. The higher-than-average volume was because of the expiration of the options of four major exchanges (quadruple witching day). On both the NYSE and Nasdaq, decliners outpaced advancers by 2-to-1.

SPX Chart
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Trade of the Day Chart Key

The major indices, as illustrated by the chart of the S&P 500, are in a pattern of higher highs and lows despite Friday’s pullback. The S&P 500 has resistance at a line drawn from the September high with three declining points. This is an important resistance line, now at 1,445, that must be overcome if the advance is to continue. The MACD indicator is overbought.

DJT Chart
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After lagging for most of the year, the Dow transports broke free in early December in a straight-line advance. It’s hard to maintain such a sharp angle of attack and MACD is very overbought, so a correction is likely.

XLF Chart
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The financial stocks have been a strong leader in the December overall advance, with the Financial Select Sector SPDR (NYSE:XLF) breaking to a new high on Thursday. But its MACD indicator is overbought, so a mild correction is likely.

XLY Chart
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Consumer discretionary spending is the amount of income left over after consumers buy necessities like food, housing and clothing. The Consumer Discret Select Sector SPDR (NYSE:XLY[1]) had a breakout early last week but succumbed to a pullback, opening a gap down. The MACD is close to a sell signal.

IYK Chart
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The consumer goods sector includes autos, beverages, food producers, household goods, etc. This and the discretionary spending group account for almost 80% of GDP, so tracking it tells us much about the sustainability of an economic advance.

The iShares Dow Jones US Consumer Goods (NYSE:IYK[2]) often react prior to a move in the underlying index, and it issued a sell signal last week. The chart, however, is still bullish and is holding above support at its 50-day moving average (blue) line.

Conclusion: Despite the failure of politicians to take action to avoid the fiscal cliff, stocks have been strong. Near term the major indices have forged a series of higher highs and higher lows, but in every chart the internal indicator, MACD, is flashing warnings of a pullback. And there has been broad group participation in the uptrend, but the important consumer sector appears due for a correction.

Although the charts are strong, it is likely that a mild correction could occur before the uptrend resumes — that is unless Congress and the president bury the hatchet and work out a deal to avoid falling off the fiscal cliff. This is an event-driven market, and therefore difficult to trade. Traders should only take positions after extreme moves in stocks, and then exit on the opposite side of the move.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[3].

For a list of this week’s economic reports due out, click here[4].

  1. XLY:
  2. IYK:
  3. click here:
  4. click here:

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