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Sell Into This Dead Cat Bounce

The breakdown has been so violent that any initial rally is suspect


Stocks rebounded Tuesday following a five-session losing streak for the Dow industrials and a three-day losing streak for the S&P 500. Over the past week, a decline in emerging market stocks and foreign currency upheavals created uncertainty, but calm returned to those markets, and that had a soothing effect on the U.S. stock market.

Apple (AAPL) beat earnings and revenue estimates, but iPhone sales were not up to expectations and the stock fell 8%. This, in turn, put pressure on the Nasdaq, which failed to keep pace with the other senior indices.

Even though the broad market was positive, investors failed to chase after some of the high-P/E stocks that have been hit hard in the past several days. They appear to be awaiting news from the Federal Reserve, which began its first two-day policy meeting of the year.

Durable goods orders fell 4.3% in December versus expectations of a 2.1% increase. The November S&P/Case-Shiller home price index rose 13.7% year over year versus an expected 13.8%. And the Conference Board’s Consumer Confidence Index rose to 80.7 from 77.5 in December.

At Tuesday’s close, the Dow Jones Industrial Average rose 91 points to 15,929, the S&P 500 gained 11 points at 1,793, and the Nasdaq was up 14 points at 4,098. The NYSE traded total volume of 3.4 billion shares, and the Nasdaq crossed 2 billion shares. Advancers outpaced decliners on the Big Board by 3-to-1, and on the Nasdaq, advancers were ahead by 2-to-1.

SPX Chart
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Chart Key

The S&P 500 bounced from an oversold condition that is clearly indicated by the low Relative Strength Index (RSI) reading. Monday’s RSI of 39.59 closely matched the October low of 39.19. The difference is that on the day of the October low, the market reversed following a mild penetration of its 50-day moving average, and within two days, flashed a MACD buy signal.

Conclusion: Technically, the yellow caution flag is flying because the S&P 500 violated its support at the breakout point of 1,813 on high volume, accompanied by extremely negative market breadth (down volume ruled by a margin of 13-to-1 on Friday). And the other most-watched indices (Dow industrials, Nasdaq and Russell 2000) have violated their 50-day moving averages, as well.

But RSI and MACD are very oversold, and therefore, the market is due for a bounce. However, in order to reverse what is now an intermediate downtrend, the S&P 500 must close above its 50-day moving average, as well as the important December breakout line at 1,813.

The breakdown has been so violent that any initial rally is suspect. Thus, traders and investors alike should sell into what will more than likely turn out to be no more than a “dead cat bounce.” At best, it will probably take many weeks to repair the damage of just a few days, and a further decline would likely threaten the S&P 500’s 200-day moving average at just over 1,700.

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.

Article printed from InvestorPlace Media,

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