Is the Market Ready to Roll Over? These Signs Say Yes

Stock market traderThe U.S. stock market has been on a tear since Sept. 1, but technical caution flags are now appearing in the charts. They're signaling that the market may be about to roll over.

For a technical snapshot, let's turn to one of the more reliable indicators, the VIX Volatility Index, and then examine charts of three key indexes: the broad-based S&P 500 (SPX), the big-tech-dominated Nasdaq 100 ($NDX) and a widely known exchange-traded fund, Financial Select Sector SPDR Fund ETF (XLF).

The VIX operates as one end of a see-saw, with equities on the other end. When stocks are rising to new highs, the VIX is plumbing the depth; when stock are cratering, the VIX shoots up.

This is clearly visible in the chart: The VIX spiked to 80+ during the global financial meltdown of late 2008 and then fell to lows around 15 at the market's high point in late April, 2010.



That signaled extreme complacency, which generally sets up a reversal and a return to volatility. Interestingly, the key indicators of MACD (moving-average convergence/divergence) and stochastics have fallen to levels not seen since late April -- right before equities fell into a three-month swoon.

This return to complacency is at odds with the actual risks facing the global economy: Eurozone debt issues, currency wars and the foreclosure/mortgage crisis, which is already hurting the U.S. financial sector.

Interestingly, although the stochastic indicator has reached the same low notched in late April, the VIX has not fallen to the April lows. That establishes a "higher lows" uptrend, suggesting the possibility that volatility may be slowly rising in the background.

The low VIX is flashing a very strong caution signal to participants eerily similar to the warning it issued in late April 2010.

Big Tech Names Lead the Nasdaq

Another way to assess market strength is to look for broad-based bullish action and rising volume. Unfortunately for the bulls, caution flags are flying here as well.

One way to look at the relative strength of large-cap technology names such as Apple (AAPL), Google (GOOG) and Amazon (AMZN) is to look at the Nasdaq 100, which is dominated by the big tech companies.



As we see on the chart, this tech-heavy index recently notched a new high, and some technical indicators such as MACD are still undeniably bullish. But signs of weariness are evident even here: The stochastics are toppy and threatening to roll over, volume is still significantly lower than in April and the 20-day moving average (MA) has converged on the 50-day MA, signaling a weakening short-term trend.

On a more positive note, the two moving averages are still rising, and the index is well above the long-term support of the 200-day moving average.

The chart of the broader-based S&P 500 isn't quite as rosy, and that suggests a narrowing of leadership in the market. This is worrisome to observers who recall the early days of 2000, when a few big tech stocks were powering the entire market higher. A few months later, when the "Four Horseman" leaders finally rolled over, equities cliff-dived into a savage multiyear bear market.



The SPX chart is chockful of cautionary signs. Where the NDX climbed above its 200-day MA back in late 2009, the SPX has yet to surmount that key technical resistance. The bullish cross registered in August 2009 when the 20-day MA crossed above the 50-day MA has been countermanded by a negative cross in August 2010, and volume is still far below the highs of April, suggesting tepid demand for equities. While volume has notched higher, it doesn't align with the breathtakingly steep rally since Sept. 1.

The indicators are also bearish: The stochastics have rolled over, and the MACD has been in a downtrend since April, having barely breached the neutral line.

Financials Are Looking Sickly

Leadership in the market is often like a baton being passed from one sector to the next, but technology and the financial sector are generally viewed as providing solidly bullish leadership. With that in mind, let's look at the financial sector ETF XLF.



This chart reflects the sickly technicals of financial stocks. Volume has markedly decreased, and both MACD and the stochastics are in downtrends. The 20-day moving average has slipped below the 50-day moving average, indicating a reversal of the uptrend. And rather ominously, price action has traced out a flag or wedge: lower highs and higher lows.

Wedges tend to break up or down in a big way as the indecision implicit in the chart is decisively resolved one way or the other. With banks facing legal limbo in mortgage foreclosures and potential lawsuits on multiple counts, it stretches credibility to expect the financials to reap rip-roaring profits in the coming quarters. More likely, banks will suffer declines in revenues and rising costs, crimping future profits.

Technically, lots of dead air is under the current price level, and if the XLF sags into a downtrend, then its impact on the broader market will likely be negative.

Can a handful of tech companies like Apple, Google, Amazon and Priceline (PCLN) keep the broader market aloft? History suggests a market dependent on a narrow leadership is vulnerable to reversals.

Disclosure: The author owns puts on the XLF.

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125 Comments

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vinmanla

Its wise to check these forecasters accuracy from time to time. For the record, the S&P is up more than 50 points or approximately 4% since this article was written less than 2 months ago. Fortune telling is a tough business.

December 08 2010 at 9:10 AM Report abuse rate up rate down Reply
Bob

Fascinating, all these "facts" and yet my insurance and in fact nobody I know has had this 75% increase or in fact any at all. Didn't know the Obama team was put under oath , must have missed that one as well. Didn't know that a president could raise insurance rates , must be a new thing. I am also very confused at all the paving and road projects , that yes have slowed me down in traffic while I read the Amrican Recovery Act signs , I guess they were not "Shovel" ready but boy am I enjoying the new pavement and wider lanes. Wonder who is paying the contractors that built them. Why don't you get your facts straight before posting anything See full article from DailyFinance: http://srph.it/a0dCSP

October 19 2010 at 7:02 PM Report abuse rate up rate down Reply
jagcapt007

Lets recap in a short version of Obama and the filibuster proof DNC congress. Bush destroyed the economy and creating TARP which is today 95% paid back in full. The DNC took over GM which can't repay its loan in full now, but may hopefully in the future. Obama care raised the insurance premium for 75% of all Americans and most businesses. When put under oath the Obama Team admitted it was a tax increase, and NOT a Commerce. The teachers UNIONS, it's biggest supporter demanded and exception and got it. They also got a 26 Billion dollar bailout in return for 176 million DNC political contributions. The one trillion dollar shovel ready stimulus package had no shovel ready projects, and now need 200 Billion more to increase IRS services to enforce it, and future Obama care. The Middle Class suffered its largest loses, than any other recorded time in US history, and FOOD STAMPS are now our new modern day CURRENCY. America Now need 58 million new 6 figure employees, as well as a four fold increase in the top 2% population to break even, and settle for a 14-16 trillion dollar debt forever. Oh yeah That is Hope and Change I can believe in. Oh yes China now has hugh tax breaks, and lands for sale, for american businesses, research and development teams, and multi millionaires who wish to immigrate. Illegal Mexicans, and other minorities, Need NOT apply. Our US Senators made $85,000,000 profit this year. The Middle Class suffered its largest loses, than any other recorded time in US history under a complete filibuster proof DNC congress. Now that is... PRICELESS

October 19 2010 at 2:14 PM Report abuse +1 rate up rate down Reply
Frankie

The stock market will improve unless republicans get their dirty hands on congress. Then it's back to DEEP recession!

October 19 2010 at 6:47 AM Report abuse -7 rate up rate down Reply
1 reply to Frankie's comment
S&VEnterprises

yeah well wake up man the democrats have had the congress for 6 years. Get pelosi out of there and the rest of them repulicans and democrats and start a new

October 19 2010 at 8:51 PM Report abuse +2 rate up rate down Reply
jctrame

BEWARE BEWARE BEWARE Read the disclosure: This author has posted a self-serving (he hopes) blog. He knows that the media plays an important role in the ebb and flow of the market. 168 comments and no answer from the author. That should be a clue.

October 19 2010 at 6:36 AM Report abuse -1 rate up rate down Reply
Hi wes

To put in terms that we can understand, regardless of wether the democrats win or lose, they will end the Bush tax cuts during the lameduck session and that will kick off the roll over. It's going to hurt.

October 19 2010 at 1:37 AM Report abuse +6 rate up rate down Reply
adavis1527

I am not sure that he general public is concerned with all this statistical stuff. They either see the price of gas rising or dropping at the pump, on a daily basis or they see a light at the end of the PELOSI tunnel with the upcoming elections and the dumping of those responsible for uncertainty in the public's pocketbook. If they are bombarded with constantly rising gas prices as was the case prior to the fall in the stock market, they rightly see a loss in their ability to afford things. If they are forced to live under OBAMADOOM taxation, they see the same lack of purchasing power and maybe inflation in their future. With the looming possibility that America will be freed of OBAMA ANTICS in November, I think we are seeing the stock market rising in expectation of some common sense things. If Obama,Pelosi, and Reid's agenda is dumped our industries may once again know what is going to happen in their financial future rather than worrying that these 3 baffons will suddenly raise their hidden taxes and reduce the income level at which they can rob the public of its earnings. If they are booted out I think the country's confidence in the reapearance of sanity may come forward again.

October 18 2010 at 11:21 PM Report abuse +8 rate up rate down Reply
P.J.

The stock market will remain strong until after the elections.It's all smoke and mirrors folks!

October 18 2010 at 11:12 PM Report abuse +3 rate up rate down Reply
steve51517

I'am not into the stock market, and being poor i have just learned to listen alot. and what i

October 18 2010 at 11:02 PM Report abuse rate up rate down Reply
jagcapt007

The poor demand to be made rich via entitlements, and redistributions of others wealth and paychecks. Everything that All others pay for Today, is owed them for reduced cost, because they breed for profits. The rich only want to keep more of their wealth that they created, for more investments, and survival syndrome. They are business driven semi deist, not social driven DNC marxist. Once any society agrees equality is income based, rather than production based, utter collapse is inevitable. The needy (takers) always breed (explode) faster than the creators, and thus economies implode. The Middle class was always the true safety nets of society, not entitlements or redistributions. The Middle class always vacillated between both directions thus causing confusing, with minimal stabilization properties. Darwinism is today manipulated and ignored, via its elite Liberal defenders, for a new world order of redistribution science. We the people utterly lose, as businesses become pawns, of elite dictatorships and governments of corruptions thrive. The greatest gifts of wealth are mobility; they can only thrive within sane governments of jobs before entitlements. Deviation from this formulary created Obama Care, Hugo Chavez, and NOW China. The middle class can only serve both Masters in exchange of a paycheck. For those in the middle class today, your life sucks immensely. You are becoming an endangered species under DNC elitist and UN redistribution Globalist. The Middle Class suffered its largest loses, than any other recorded time in US history under a complete filibuster proof DNC congress. Now that is... PRICELESS

October 18 2010 at 10:46 PM Report abuse +7 rate up rate down Reply