After a pretty good seven-day pattern in which the Santa Rally exceeded the average of about 1 ½%, with the S&P 500 (SPX) up 23 points or about 1.9% over that time frame, it was no big surprise the market was set up for a bit of a pullback at the opening. So this morning, there were down openings across the board -- at least in that part of the board where gaps appear.
One place where the gap wasn't visible was in the SPX, though yesterday's close of 1277.30 gave us a pretty good idea of where a gap would be if it showed up. Now, after the early pullback that would-be gap has already been filled as the SPX has turned positive for the session. Though still well shy of its highs from Tuesday when the SPX stalled just pennies shy of its Halloween Gap at the 1285.08 level. The high on Tuesday of 1284.62 was just fractionally shy of that gap and now, as of this morning's lows, the SPX has pulled back almost 20 points from Tuesday's highs. Not bad, especially if you were selling into the Halloween gap in anticipation of a pullback, as I suggested in my column on Tuesday. The top of the Halloween Gap at the 1285 level remains resistance for now. But if that level is exceeded by more than a point or 2, especially on a closing basis, it becomes support.
The chart of the E-Mini futures is again more relevant to what's really shaking because it gives us a more accurate picture of the gaps and now-filled islands. We again have to do some creative charting in order to show the latest island (which has now been aborted). This is because we are showing the island and some of the older gaps (from October through December) through the lens of the December contract, which expired a couple of weeks ago. But you get the idea. The island, as I suggested on Tuesday, has now been aborted, but a portion of the Jan. 3 gap in the futures still remains. On Tuesday I explained: "Taking out that island at 1264.50 in the futures will be the first objective of the market on the downside. Eventually, I would look for the entire gap to get filled, but if this year repeats last year's pattern, maybe it won't happen for two to three months."
The island was actually put to rest yesterday with the pullback to 1262.75. Today's lower low of 1259.75 goes further into the gap (which I incorrectly showed on Tuesday as beginning at 1254.00 but it was actually 1252.50 as shown below). But the gap remains partially intact and continues to act as support. On the upside, note that the Halloween Gap at 1281.00 is still partially unfilled as Tuesday's high of 1279.75 was a little over a point shy. That's still a preferred spot for selling, and if the gap gets filled and the market stalls there (again) as it should, I will be cutting back further in bullish positions and selling short call premium.
But it wasn't only about the S&P. The Russell 2000 (RUT) again played a role in calling Tuesday's near-term top. And look at what it has done since then! The high on Tuesday was about 1 2/3 points shy of the big gap at 761.00. The RUT topped out at 759.37 and from there sold off to not only fill Tuesday's big 8-point gap at the 741 level but it also almost filled the gap from Dec. 29 at the 735 level. Now, after taking care of all that downside business (or almost taking care of it), the RUT is popping back up again. And here, similar to the SPX, the critical area is the Halloween gap at 761. A move above it will point higher, presumably to the resistance in the 769-770 area. But a failure to pop above 761 will add to the significance of that gap as a barrier to the upside.
Keeping me a bit circumspect at current levels is that the market had become pretty overbought at Tuesday's close and the sideways action since then hasn't done much to relieve the overbought condition. The McClellan Oscillator is a case in point as it registered an overbought +143 on Tuesday and yesterday was still at +115. It's not at extremes, though it is a long way from oversold, which is where I'd like to see it if I am going to do any more buying.
Then there is the sentiment picture, which also doesn't get me too excited as complacency is once again the dominant theme. The CBOE Market Volatility Index (VIX) hovering just above its recent multi-month lows illustrates this fact. It's nothing that a good selloff and a run for the exits (and the bidding up of puts) wouldn't remedy. That's what I'll be on the lookout for before I add to my positions. Until then, I am cautiously holding bullish positions, but only up to 40% levels in stocks.