Things Are Looking Up

 | Jan 31, 2012 | 4:00 PM EST  | Comments
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The July 27 gap did its thing last week as it marked a short-term top, and for now, that top continues to hold. Will it mark an important top and become a major barrier to the upside? Beats me. We'll know more in the weeks ahead, but for now it's short-term resistance. Recall, that I had talked about the July 27 gap at the 1332 level of the SPX in my Jan. 20 column. It was cited as an upside objective, and it has certainly done its job on that score. The S&P 500 (SPX) made a high last Thursday of 1333.47, about 1 1/2 points above the gap. From there, the SPX has now sold off 33 points, or almost 3%, into yesterday's lows, just above 1300. People who think that this stuff doesn't matter -- or worse, think of it as hocus pocus -- need to invest in a computer and maybe even some charting software. Who knows? They might be surprised.

But now that the obligatory pullback has occurred, the question is: Was that it, or is there more to come? Monday's low at 1296.00 in the emini futures or 1300.49 in the cash will likely be important in answering that one. If those lows give way, then the market is likely headed for another wave of selling. The next downside target following a break of those lows is shown in the chart of the SPX below: the Jan. 17 gap at 1289. Not to say that the market can't sell off some more, but that would be a reasonable spot to expect the market to bottom, if yesterday's lows are breached.

SPX -- Backing off from its July 27 gap
Source: optionsXpress

As usual, a more accurate picture of what's going on is provided by the chart of the futures below. This time I am primarily showing the current front month March contract, but the gap that was filled from July 27 is based on the front month at that time, which was September, which has long since disappeared. So again, this chart is a kind of hybrid -- it's not really a continuation chart, but it is with respect to the now-filled-gap of July 27.

Here you will notice that there is no Jan. 17 gap at all. That's because the emini filled its Jan. 17 gap (at 1287.75) on Jan. 18, by pulling back to 1286.50. So in the futures, the nearby downside gaps have been filled. The islands have been aborted and all is good with the universe, as not much beckons below.

E-Mini S&P Futures -- No January 17 gap here
Source: RJ O Brien Futures

Now, all the futures have to do is to take out the resistance marked by last week's highs, just above the now-filled gap from July 27. Therefore, a move above 1330 in the futures, especially on a closing basis, should point higher.

Supporting the near-term bullish case are a couple of other things. First, the short-term seasonal pattern has now turned positive for the remainder of this week as the end of January is upon us and the first few days of the new month are directly ahead. And no, this isn't more hocus pocus. It, too, is firmly based in historical precedent and lots of verifiable data.

And then, there is the pending golden cross. Yes, much is being made of this technical development in which the 50-day moving average crosses above the 200-day. I am always amused to hear the reporters on CNBC ask analysts if they "believe in the golden cross." I mean can we get a clue here? This is not the Tooth Fairy, folks. Asking if you believe in the Golden Cross isn't like asking if you believe in Santa or in the Greek god Zeus. It's more like asking if you believe that leap year occurs every four years. So if you say you don't, then you are an imbecile. That's all there is to it.

Now, I am not one to rush out and buy stocks just because of a pending Golden Cross. On the other hand, its record -- especially in bull market conditions -- is undeniable, just as the Santa Claus Rally is undeniable. And anyone who says they don't "believe in the positive seasonal bias of the Santa Claus Rally" is also an imbecile. But I digress. According to Birinyi Associates, there were 26 instances in the past 50 years when the S&P 500's 50-day moving average crossed above the long-term 200 day moving average. In these cases, the S&P 500 rose 81% of the time, with an average increase of 6.6% in the next six months. That's not a justification to rush out and buy stocks today, but it's a positive factor, nonetheless. So there is that as well.

In addition, the market has finally begun to relieve its recent overbought condition. Along these lines, yesterday, the McClellan Oscillator settled back on the overbought side of neutral at +65.56. That's at least a step in the right direction. And sentiment isn't quite as frothy as it had been. Note the Market Volatility Index (VIX) has popped back up to the 20 area. This is also a step in the right direction.

VIX -- Popping back up to the 20 level
Source: optionsXpress

As the market sold off on Monday morning, I used the weakness to add to my positions in the SPX for my accounts at Rydex. I got the morning pricing with the SPX at 1304. I am not back to aggressively bullish positions, but at least I returned to maximum exposure of 40% invested levels again, which includes positions in junk bonds and short Treasuries. Oh, and as noted in my brief comment on Friday, I have taken profits in my precious metals funds now that I hear that lots of folks -- like Dennis Gartman -- are "bullish of gold" once again.

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