Market outlook - 3 July 2013 - Up or Down? Decision Time for the Market

(Barron's; Wed July 3, 2013) Stocks are sandwiched between two key technical levels. Which one blinks should make the difference between a summer rally and a rainy day at the beach.

Despite a smorgasbord of fundamental and geopolitical news to digest, the stock market is now coming face-to-face with very important technical levels. A move above them and the correction ends. But a move below and it may be a long, uncomfortable summer.

The dominant feature for the Standard & Poor's 500 through last month was the rising trendline drawn from the November 2012 low (see Chart 1). However, on June 20 it broke to the downside a day after the Federal Reserve indicated again that it may scale back—"taper," in Fed speak—its bond-buying program later this year.

Chart 1

Standard & Poor's 500

This not only set a short-term decline in place but also moved the index under its widely followed 50-day average. With trading volume running higher than average, the end of the rally from last year was confirmed.

In technical analysis, chart features that formerly acted as support tend to switch sides to act as resistance once they are broken. That suggests a tough ceiling is now in place in the 1,624-1,633 area—the zone between the 50-day average and the old trendline. Wednesday, the index closed at 1,615.

There is another feature in the area—the June 20 "gap." A gap is an important technical formation, although it is getting less common in a 24-hour trading world. Simply stated, a gap is an area on the chart where no trading occurred because supply and demand got too far out of balance overnight. A gap caused by strong selling provides strong resistance for any rebound because anyone who was trapped with a long position gets a second chance to sell. Supply swells and prices tend to stop going up, all else being equal.

For the S&P 500, that gap is between 1,625 and 1,629, right in the middle of the resistance zone mentioned above. The more technical features that say the same thing—resistance, in this case—the more important the message becomes.

As they say in late-night infomercials, but wait, there's more!

Last week's low established a series of lower highs and lower lows since the market peaked on May 22—again, just before the Fed said it was considering trimming its bond-buying program. That is the minimum definition of a falling trend, and the new trendline guiding it lower is also in the resistance zone.

On the other side of the argument, support comes from the key zone between 1,598-1,601. That is where the S&P 500 bounced off its major trendline in early June, and it was also where the bulls have made three intraday comebacks over the past week. This is more readily seen in the chart of the SPDR S&P 500 ETF Trust (ticker: SPY).

This exchange-traded fund has been trapped in a sideways range for the past week (see Chart 2). At the bottom of the range, $159.90 stopped premarket declines twice on June 28 and once July 3. Wednesday, the ETF traded at $161.28 at the holiday-shortened close.

Chart 2

SPDR S&P 500 ETF Trust

Should the ETF trade below $159.90—which is equivalent to 1,600 for the S&P 500 index—then its new declining trend will be confirmed, as will the larger breakdown below its respective rising trend from November. In that case the summer season should live up to its reputation as unfriendly for investors.

And if the market moves above its resistance features—1,624-1,633 for the S&P 500 and $162.45-$163.50 for the ETF—then the bulls win and a return to May's highs would be in the cards.

The all-important jobs report on Friday morning may be the trigger that causes the market to decide which scenario it likes better.