S&P 500: Stretched and Ready for a Pullback

Sep. 5.06 | About: SPDR S&P (SPY)

I have been arguing lately that the overall trend of the market is strong. My basis for such a call was a look at the intermediate and long term charts.

While many bears have been calling for a major decline in stocks, I disagreed for much of August and was for the most part vindicated. The long term trends held that the markets would finish strong into the end of the month. Currently, heading into September, I am holding an ultra long position which means I am long in the short term, the intermediate term and the long term. Is this too bullish?

Yes. The markets have extended themselves quite a bit into the end of the month. Many people were looking for a decline during the last week of August and instead ended up with another rally. Perhaps this was a sellers strike or shorts covering. In any event, the move up could conceivably set this market up for a decline into September.

Furthermore, there are many similarities between 2002 and 2006. First and foremost is the volume. It was light in August. Also there was some covering in August of 2002 much like 2006. Lastly, the number of stocks over their 200 day MA bounced into the end of the month but was below trend which is the same case today. In 2002, the markets capsized into September and through the beginning of October. Based on what I am hearing and reading from the smart money, I think many are using such comparisons to forecast a decline this September (then most are looking for a strong rally in the fourth quarter).

The funny thing about the S&P 500 though is its randomness. Many statisticians and traders say that the index is impossible to trade (I have had success so I guess it is not impossible) given its strange trading patterns from year to year. In short, what occurred last year has no bearing on what is occurring this year. This supports my belief that this market, while not exploding in the first few weeks of September to the upside, will not give much ground on the downside either.

The intermediate term chart looks very bullish and continues to build on the bounce from a few weeks ago. One could make a case for a double bottom from the 1225 level. Extrapolating a break of 1325 leads to a move to 1425 thru the fall. This implies upside of roughly 9.5%. As far as I can see, there are not too many looking for such a rally. Also supporting such a call is the long term chart. The trend model bounced off lower support, similar to 1995. That previous bounce lead to significant rally.

Over the very near term, I would probably look for a pullback of sorts from the current levels. The two models that I will attach each week (and post under the pages section) currently show a divergence of sorts.

The S&P Trend model has broken its 5 day moving average and is going higher. Since this indicator is stretched already, I would imagine that the break is limited. The pts model is also at is upper limit and arguing for a pullback. Thus, given this evidence, I have moved to an aggressive stop on my long position. If I am not tripped up on Monday, I will probably reverse to the short side on Tuesday.