With the holiday season in the rear view mirror and volume slowly creeping back into the marketplace, I can’t help but wonder what lies ahead. I’m hopeful the economy will continue to repair itself and the financial issues that plague federal, state and local governments will go away. The only problem with my hope is that massive debts and deficits do not simply disappear and I fear the problem will be a long and lasting one.

Federal Reserve Chairman Ben Bernanke indicated that unemployment numbers are likely to remain high, and that Quantitative Easing II needed to be continued in a vain attempt to keep interest rates low. Since its inception, treasury rates have done nothing but increase which begs the question whether the program is really doing anything.

In addition, the crisis in Europe continues to manifest in a negative fashion. Nearly every where we look we are surrounded by fundamental issues which directly impact risk assets. These issues have been constant for quite some time and the S&P 500 has shrugged them off and powered higher. The S&P 500 has put on quite a run since the March 2009 lows, and while we have had several corrections and a “flash crash” along the way, we have yet to see a major correction turn into bearish market conditions.

S&P 500

Friday’s market action is indicative that lower prices may be awaiting us in coming days and weeks. A reversal has been potentially carved out, but it remains to be seen if a top is in. Picking tops in a long term bullish trend is a fool’s game as bullish advances can be overbought for long periods of time as they advance higher. What is evident is that prices are being pushed lower and strong selling volume is confirming the potential for a longer term reversal. It is too early to tell if the price action is just working off overbought conditions or if this is a change in price action and market direction. The daily chart of the S&P 500 Index Options (.SPX) illustrates the possibility that a reversal or the potential for an intermediate term top to be in.

There are a few confirming signals that prices may continue lower. Recently Fridays have had relatively low volatility and light volume with the propensity to grind higher through the afternoon session and into the close. While the grind higher remains to be seen, volatility is rising. The CBOE Volatility Index (VIX) was trading nearly 3% higher on the day and is trading around the 18 price level as can be seen in the chart below. Price action remains at the upper bound of the lower channel. A breakout in the upper channel could result in additional selling pressure should that occur.

Another telling sign that additional sales pressure may be lurking next week or in the near future is the price action in the financials. The Financial Select Sector SPDR ETF (NYSE: XLF) was trading down about 1.6% on Friday and has completed a gap fill from last week. Price bounced as is typical, but selling pressure remains strong. If the financials continue to probe lower in coming days and weeks the S&P 500 will follow in suit.

At this point, all we can do is wait and see. As I have said before, adjusting stops and taking profits is likely a sound strategy until we know more regarding the price action in the S&P 500 this week.

Gold Futures

Most gold bugs are expecting a melt down in the dollar. I do not know, but if the crowd says the dollar is sure to get killed, the contrarian trader in me wants to get long the dollar in a trade with a good risk/reward setup and defined risk.

If we look at the gold futures it is obvious that they are moving lower and a serious correction could be taking place. If gold futures break down below the 1,330 – 1,315 support area a full fledged correction of 10% or more could take place. The next major support level in gold futures would be around the 1,250 area. The daily chart of gold futures illustrates the key price levels that are currently in play.

Gold has already pulled back quite a bit from the recent highs. At first glance I would expect more carnage here simply because of how bullish the retail crowd is regarding gold. Longer term gold will likely remain in a bull market, but for those that took profits and have waited patiently gold could give us a solid risk/reward entry. The traders and investors that purchased above the $1,400 an ounce price point have either stopped out or their money is currently trapped. If prices go low enough, those trapped traders will eventually capitulate near the lows. If history serves us well, just about the time the last remaining weak gold bull gives up will be right around the intermediate term bottom.

At this point I do not have a clear edge as to what is going to happen in the S&P 500 or gold. What I do know is that they are both under fire and the confirming signals in the VIX and financials is worthy of note.

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