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June 26, 2007

Markets Hanging by a Thread
by Michael Swanson

Yesterday the DOW, S&P 500, and Nasdaq all headed back down to their June lows. Watch the 1492 level on the S&P 500. If it breaks over the next week then the market averages will be in a confirmed correction. Below 1492 support on the S&P 500 is around 1450, the point of a support downtrend line going back to last summer, and then 1425, the level of the index's 200-day moving average. I think a move down to there is most likely.

Think about things this way. Imagine if the market had been falling for a year. Then all of a sudden in the past month it stabilized and entered a trading range. During this time sentiment has swung to the bearish camp, with investors intelligence showing the largest number of bears in the past two years. At the same time the volume on up days has been much larger than the volume on the down days, while multiple days in which 90% of the volume was to the upside on the NYSE have been registered.

If these things were happening I would think we were seeing a major bottom. I'd be flipping through sectors to find out which ones have held up during this decline and piling into their leading stocks.

But in reality the opposite has happened. The market has gone sideways for a month. Sentiment is wildly bullish. The market averages have appeared to have made double tops and distribution days have been plenty.

In short we've seen all of the signs of a classic top being put in place.

Distribution days are highlighted in the chart above. 1492 is the number to watch on the S&P 500.

We just closed 5 points away from that level yesterday. Futures are ticking up this morning into the opening. We could bounce a bit off of 1492, before going through it, but we could also just see a gap up and fade this morning. This is a treacherous market and I'm not interested in making bets on the long-side to play a coin flip on what happens after the opening. My plan is sit on the sidelines in cash and let the correction unfold. I'll then go long and play the next rally.

If the market bounces a bit from here then I may consider taking some short positions, but I'm not in a big hurry to short unless I get a good entry point - which is difficult when the market makes its first top.

Gold stocks were once again among the worst performing sectors in the market yesterday. The XAU failed to close above its upper downtrend resistance line last week, which makes it likely that it will test support at the 134 level - the point of the XAU's lower 10-day bollinger band and lower support trendline. A close below this level and a larger and faster drop in gold stocks will begin - one that will likely take the XAU down to the 125 area.

For more updates on the market action subscribe to Mike Swanson's weekly gold stock report: http://www.wallstreetwindow.com/weeklygold.htm.

Michael Swanson,
WallStreetWindow.com

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