The S&P 500 Takes a Step Back From the Cliff. Just One Step.

The S&P 500 logged a very bullish Monday, but the move wasn't nearly enough to shake the index out of a bearish groove

Just when it looked like stocks were on the brink of a complete meltdown at the end of last week’s trading, the bulls stepped up the plate again on Monday. Even with the rebound effort though, the market remains on the defensive.

By the time yesterday’s closing bell rang, the S&P 500 had mustered a 20.06-point gain (+0.86%) to end the session at 2349.01. The move was led by financial stocks, logging an average 1.36% advance. Wells Fargo & Co (NYSE:WFC) and Bank of America Corp (NYSE:BAC). The former was up 2.7% following reports that the bank’s CEO and chairman of the board invested $5 million of their own money between them, while BAC shares jumped in sync with the bullish news surrounding WFC, and in front of what should be an encouraging earnings report from BofA on Tuesday morning.

Even Tuesday’s weakest sector wasn’t a disappointment, however. Healthcare stocks brought up the rear with a 0.24% advance.

The marketwide advance materialized in spite of a disappointing reading of the National Association of Home Builders’ Housing Market Index for April — which fell three points — and a lackluster New York Federal Reserve’s Empire State manufacturing index. It fell to 5.2 last month, down from the previous month’s score of 16.4.

It was a gain with healthy participation as well. For the NYSE, 77% of its volume was bullish, and only 20% of its trading volume was bearish. Advancers outpaced decliners by a ratio of almost 3-to-1.

The Nasdaq was similarly healthy, with its advancer/decliner ratio for Monday rolling in at 2.4-to-1. Volume-wise, 77% of its action was bullish, and only 21% was bearish. Monday’s close of 5856.79 for the Nasdaq Composite was 0.89%, or 51.65 points, better than Thursday’s last trade.

Blue chips were strong too … slightly stronger than other segments. The Dow Jones Industrial Average gained 0.9% to end the session at 20,636.92.

And yet, despite the big gains, stocks are still on the defensive.

Monday may have been a good day for the S&P 500, but in the background, several technical headwinds continues to firm up. Namely, as of Monday’s close, the S&P 500’s 20-day moving average line is below the 50-day moving average line for the first time since November. It’s a subtle sign that the near-term undertow for the worst has turned into a full-blown trend. The index has room and even reason to test the 20-day moving average line as a resistance level, but unless it can actually hurdle it, the bigger trend remains in a downward direction.

A short string of lower highs underscored this idea.

S&P 500 daily chart
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Dow Jones Feeling the Heat from International Situation

That being said, while large-cap indices like the Dow and the S&P 500 are getting their usual oversized dose of attention, it’s arguably the Russell 2000 small-cap index we should be watching to glean the market’s true undertow.

As has been the case since November of last year, the Russell 2000 remains trapped in a sideways trading range between 1,341 and 1,390; the extreme lower edge of the zone is 1,333, where the index hit a low a couple of times last month. Although the Russell 2000 is still perfectly content to hover in the middle of those boundaries, it also remains within easy reach of a breakdown. One or two bad days would do the trick.

Russell 2000 daily chart
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In that small caps tend to lead the market higher and lower, and in that the Russell 2000 has given us some crystal clear floors and ceilings, we should use them as guideposts … perhaps above all other clues. It’s just not telling us anything clear-cut yet. Give it time, though.

The potential wrench in the works: The VIX. Though it’s still nowhere near an absolute high in the lower 20’s we’ve seen achieved with the market’s major bottoms since early last year, Monday’s bar for the VIX is a pretty decisive outside day reversal, to the downside. If the VIX is going to be forced lower, that will coincide with upward pressure on the S&P 500 that just might be enough to carry it above the 20-day line currently at 2,353.

In that light, the question is, does the dog wag the tail or the tail wag the dog?

Even in the bullish scenario though, we’d want to see the Russell 2000 make its way above a familiar ceiling at 1,390 before coming to any firm conclusions.

Editor’s Note: Sam Collins could not write the DTA due to technical issues. He is expected to return Thursday, April 20. As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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