S&P 500 HAS REACHED FIRST UPSIDE TARGET BUT SHOULD REACH HIGHER LEVELS DURING FOURTH QUARTER -- DISCRETIONARY AND TECHNOLOGY LEADERSHIP IS POSITIVE SIGN -- REGIONAL BANKS LOOK BETTER -- % OF NYSE ABOVE 50-DAY AVERAGES IS CLIMBING
S&P 500 HAS REACHED TOP OF WAVE FOUR ... Two Thursdays ago (October 6) I suggested that the S&P 500 had completed a five-wave decline which should lead to a fourth quarter rebound. I also suggested that the rebound would reach the top of wave 4 which was the peak formed after the August rally. Chart 1 shows the S&P 500 having just about reached that upside target. That would be a normal spot to expect the rally to stall or undergo a short-term correction. Yesterday's sharp stock selloff may have been a warning of that. That doesn't necessarily mean that the fourth quarter rally is over. As Arthur Hill explained last Friday, a counter-trend rally usually takes place in three waves. Chart 2 shows that the S&P 500 has retraced 50% of its May/October decline which may also provide some short-term resistance. If a short-term setback does materialize from those levels, a second upwave could take the S&P 500 toward its 61.8% retracement point (upper blue retracement line). That would also bring the S&P up to major resistance at its June low and its 200-day moving average (red line). That would also fit into the seasonal pattern for strength through the end of the year. Unfortunately, I also warned that bear markets don't usually end with five-wave declines. If the fourth quarter rebound unfolds as expected, that would still leave open the strong possibility of another downleg sometime during 2012.
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Chart 1
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Chart 2
DISCRETIONARY AND TECHNOLOGY STOCKS SHOW LEADERSHIP ... Two bright spots in the recent stock rebound have been upside leadership by consumer discretionary and technology stocks. Chart 3 shows the Consumer Discretionary SPDR (XLY) in the process of challenging its September high and its 200-day moving average. Its relative strength ratio (below chart) has been moving up as well. Chart 4 shows the Technology SPDR (XLK) having already cleared those two resistance barriers. Its RS line has been rising as well. Although that by itself isn't enough to turn the major market trend up, it may be enough to help extend its rally through the end of the year.
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Chart 3
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Chart 4
REGIONAL BANKS ... BARRONS ran an article last weekend recommending buying banks. I don't know if that's a good idea but, if you're tempted, you might want to consider regional banks. For one thing, they're much less effected by European debt concerns and other problems that plague larger U.S. banks. Three of the stronger bank stocks shown below are all regional banks. All three have cleared their 50-day lines and are starting to show some modest market leadership. The three are BB&T (BBT), Fifth Third Bankcorp (FITB) , and State Street Corp (STT). State Street is the strongest of the three today. It's 6% gain makes it one of the day's standout performers in a strong financial sector. So if you're thinking of following BARRONS advice to buy banks, think "regional".
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Chart 5
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Chart 6
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Chart 7
50-DAY AVERAGE TREND IMPROVES ... All of the major stock indexes have risen back above their 50-day moving averages which is a positive sign for the market's shorter-term trend. The blue line in Chart 8 is the percent of NYSE stocks that are trading above their 50-day averages. During the summer, that line had dropped into oversold territory below 20% which was the lowest reading since the spring of 2010. Since August, the blue line has risen above above 50% which means that at least half of NYSE stocks have cleared that resistance line. The green line in Chart 8 is the NYSE Composite Index. Turns in the blue line led the upturn in the market during 2010 and downturn this spring. So its rebound since this summer is an encouraging sign for the market's short- to intermediate-term trend. Unfortunately, the same can't be said for its longer-term trend. The red line in Chart 9 is the percent of NYSE stocks above their 200-day lines. It remains in oversold territory below 20% which is the lowest level since the first quarter of 2009. Unfortunately, that's still deeply in bear market territory (below 50%), and there's little evidence of that situation improving. That leads me to conclude that the market is in the midst of a bear market rally.
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Chart 8
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Chart 9
VIX STILL ON THE DEFENSIVE... My October 6 message also showed the downside reversal day in the VIX Index that took place on October 4 right at its August high around 45. I pointed out that downside reversals from that level have usually led to market rallies. The good news is the the VIX is still on the defensive. It dipped below its summer lows near 30 before rebounding yesterday. It looks to me, however, like the VIX is headed to lower levels. That should continue to support stocks during the fourth quarter. The VIX would have to rally sharply to put the stock rally in danger.
