Stock Market Bias Remains Bullish but Resistance Is Ahead

by: Chris Ciovacco

We head into the new week with some good news from the Middle East, Europe, and the United States. The bias on the Street remains positive, but from a strategy perspective we have potential resistance to contend with near 1,315 and 1,326 on the S&P 500.

Below, we outline a possible approach for the week from a portfolio management perspective. Quick reads from this morning’s news capture the early tone for Monday.

From Bloomberg:

According to data compiled by Bloomberg, 72 percent of Standard & Poor’s 500 Index companies reported more revenue last quarter than analysts estimated, the largest proportion since at least 2006. Sales beat projections by an average 2.3 percent, the most in two years.

Talks between Egypt’s government and opposition parties eased pressure for the immediate departure of President Hosni Mubarak, helping the country’s financial system to return toward normality.

And again from Bloomberg:

The highest yields on German short- term bonds in two years relative to Treasuries are boosting the euro, easing pressure on Chancellor Angela Merkel as Europe’s leaders consider expanding a rescue program to end the region’s debt crisis.

Below, we have provided an updated version of our S&P 500 support and resistance table, which was originally presented on January 7, 2011. Possible support and resistance levels mean little until we see how market participants behave once key levels are reached. Therefore, the levels outlined here represent a map in terms of where to pay attention. A high volume reversal near one of these levels would make us more apt to sit on cash and review areas to protect profits should the situation deteriorate further in the coming sessions.

A close above 1,326, especially on impressive volume and healthy breadth, would make us more likely to deploy some additional cash into the markets. We would review energy (including IEZ and XLE), agriculture (including DBA and RJA), semiconductors (NYSEARCA:SMH), and broad market, U.S.-focused ETFs (NYSEARCA:SCHB) as possible buy candidates this week.

Our comments from Friday (summarized below) still apply to our approach for cash and long positions:

In terms of strategy, the markets remain in a good position to hold longs that we added to or established roughly two months ago, including XLE, XLB, XLI, XLY, and IYW (see 12/05/10 ETF post). In the short-term, it is difficult to justify adding to long positions with potential S&P 500 resistance coming in near 1,313 and 1,326. Best case scenario for new cash would be to buy on an orderly pullback. If our technical models become overextended as outlined in yesterday’s post (Are Stocks Making a Major Top?), we would be more inclined to look to reduce risk from weaker positions, such as EEM. From where we sit, more information is needed prior to making any moves with our longs or cash. A pop in the U.S. dollar (see below) would also add to our short-term hesitation to deploy new cash. The S&P 500 and market breadth can help us manage all our positions, including those mentioned in this paragraph.

Table below updated as of Friday’s close:

Technical Analysis Blog - Stock Market Support and Resistance

Technical Analysis Blog - Stock Market Support and Resistance

The charts below allow you to see the relative importance, in the minds of market participants, of the key areas to watch. The more prices congregate or cluster around a given area the more relevant it is to today’s market.

Stock Market Blog - Stock Market Support and Resistance

Another thing to look for is areas where sharp reversals took place in the past. Reversal resistance, where the intermediate-term trend changed in the past (for a few weeks), is much more important than ‘pause resistance’, where the prevailing trend was simply slowed, but remained intact. On the right side of the chart above, notice how the market advanced for five weeks, but was turned back at 1,313; that is an example of ‘reversal resistance’. The sharper and longer the reversal, the more we should pay attention to the level where the reversal took place.

Investment Blog - Stock Market Support and Resistance

Financial Blog - Stock Market Support and Resistance

Disclosure: I am long IEZ, XLE, DBA, RJA, SCHB, XLB, XLI, XLY. Generally, I am long global stocks and commodities.

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