The low-volume market rally Friday didn't do much to change my feeling that major averages are ready to pause here and consolidate gains.
In other words, after two straight days of institutional selling Wednesday and Thursday, investors still have good reason to tread cautiously. It's likely long-term investors aren't paying much attention to the increasing signs of distribution in the indices -- but if you're a top-down investor and started buying high-quality names after the market confirmed a new uptrend Nov. 23, there's nothing wrong with taking partial or full profits here. If recent new buys are struggling, meanwhile, protecting capital and keeping losses small would be a sound strategy.
Headed into Monday, the broad-based NYSE showed six higher-volume declines and a "stalling day" on Jan. 24 -- that is, it closed higher, but was well off its highs in higher volume. Selling has been less pronounced in the Nasdaq and S&P 500, though both have shown three higher-volume declines and a stalling day. When higher-volume declines start to cluster in the indices, the action can often presage more price weakness.
What's hard to believe is that, after a 14% rally for the Nasdaq and S&P 500 since the mid-November lows, these indices have only pulled back between 2% and 3% from their recent highs. That's not much of a consolidation. A major support level for the NYSE is its 50-day moving average around 8710. The S&P 500's 50-day line is at 1475 and, for the Nasdaq, it's 3109.
The risk for more downside is clearly there, especially with a slew of retail earnings reports on the horizon. I'd like to think that retail CEOs will be confident about overall business and consumer spending in 2013, but we could hear a different tune. The SPDR S&P Retail ETF (XRT) hasn't broken down yet by any means, but it looks vulnerable, given its two recent higher-volume reversals on Feb. 15 and Feb. 20. Next week, we're slated to hear from Home Depot (HD), Macy's (M), Saks (SKS), Target (TGT), TJX (TJX) and J.C. Penney (JCP), among others.
It's been tough watching solid gains evaporate over the last two sessions, but the market is in dire need of a consolidation phase -- not a full-blown correction, but a modest pullback that will give stocks time to catch their breath. The worst thing the market could do here would be to head higher again without adequately consolidating gains. Recent distribution in the market tells me this is unlikely.
So how low can the major averages go from here? At this point, I'm expecting the indices to pay a visit to their last breakout areas, which are all 5% to 6% below recent the respective highs. The NYSE's last breakout area was at 8519; for the Nasdaq, it was 3062; and for the S&P 500, it was 1448. Pullbacks to these areas could take a few weeks to play out.
My growth screens are showing scant buy prospects and are filled with extended stocks. A consolidation phase would change this and present new buying opportunities in due time.
As a result, we've been scaling back in recent days in my Ultimate Growth Stocks newsletter and model portfolio. We booked a nice gain in Linkedin (LNKD) and cut losses short in Facebook (FB). The portfolio only holds three names at this point. For a 30-day trial, refer here.