After a slow slog downward in September, and a more rapid descent in latter October thru mid November, the market has staged the typical oversold bounce. Perhaps the move up happened in a quicker time span than many imagined but V shape bounces have been the rule not the exception in the past few years. The question of course is, does this play out like most of the bounces of 2009-2012 where the V continues ever upward leaving shorts in pain and underinvested longs saying "here we go again?" or was this bounce just the typical counter trend move in a much bigger correction. It would appear the next 2% or so should answer this question. Here is why…
The S&P 500 has been consolidating the large rally of some 60 S&P points the past two sessions. It has stalled at the 50% retrace of the entire correction – there is no shame in that as the move came very fast. A bullish view of the current situation is that the S&P 500 has formed an inverse head and shoulders formation with the "head" being the selling climax in mid November, and the left shoulder being the low 1370s to low 1400s. In that scenario the right shoulder is now forming (and can continue to form over the coming days), from which a break above the "neckline" of 1410 would lead to a move over those early November highs (mid 1430s), thus negating a series of "lower highs" that has been formed in the market since mid September. It would create the first "higher high" in months.
The bearish take is a lot simpler – this is simply a dead cat bounce and in time things roll over. A close below 1370 would negative the "right shoulder is forming" scenario and at minimum a retest of recent lows, if not a new low would be in store. Of course no one knows which scenario will play out but from yesterday's close of 1399, a 2.6% move would take the S&P 500 to the most recent high of 1435 whereas a 2% drop would take it to the 1370 level. Until the index breaks one way or the other everything in between is more of a white noise type of action.
The Russell 2000 has been outperforming this week which is generally a bullish sign but it too peaked yesterday near an important level connecting all the highs of the past few months. A positive move by the S&P 500 in the coming weeks would coincide with it breaking over this trend line seen below. If that fails, of course the condition would then continue to be bearish as it continues to make lower highs on each iteration of a short term rally.
As for yesterday's action it smelled very much like last year's debt talks or even the European issues we've been dealing with for years. An official here or there says something and the market rallies or drops 1% in minutes. Yesterday the same guy who set the market on fire a week ago Friday (setting in motion the intraday reversal pattern), Senator Reid, doused the flames with his comments about disappointment about negotiations on the fiscal cliff. So we're hostage to these comments which does not make for a fun environment.
I would also once again point out the Chinese market has made another multi year low; this despite the "green shoots" people are seeing in their official economic releases. The late September low was ~2000.
Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund's holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog