Technical Lines in the Sand; All Eyes on the FOMC

Let's take inventory of where the major averages sit. The Industrials have now recovered to the point where I believe it's fair to say that the initial correction from previous highs is complete. We've put in the initial correction lows that will now act as our bearish trigger. For the Industrials, that line in the sand comes in at 16,100. A rise above 17,280 would put us back to new closing highs, and if confirmed by the Transports would give us a reconfirmation of the bull thesis. Those two scenarios are outlined below using the green and red arrows.

Most likely, we'll see the Industrials trade within the range it has now set (the two horizontal lines) for a while before we see a conclusive break one way or the other. Investors still seem shaken by the extent of the recent sell-off and while recent economic data has been positive, they will probably want to wait for more evidence before pushing the market decisively one way or the other. There's a chance we won't see any major moves until we get a reading from the Fed following the FOMC meeting this week. On Wednesday we should know what lies ahead for QE and rate increases.

Here's the setup in the Transports. Buoyed by lower oil prices the Transports have retraced more of their recent sell-off than the Industrials. They currently sit a mere 150 points below the prior closing high. Our bearish price threshold sits at 7700 while a rise above 8,676 would put us in new-high territory. Note that the Transports have reclaimed both the 200-day and 50-day moving averages.

The broader S&P 500 has also retraced more than half of its recent losses. I've included Fibonacci retracement levels for the prior sell-off and as you can see, we're sitting right at the 61.8% retracement. I have to be honest, I'm including the Fibonacci ratios more for the delight of a few subscribers than out of personal preference. I admire the Fibonacci sequence and golden ratio for their aesthetic beauty and their incorporation into nature and architecture, but in my experience I have not found them to be exceptionally valuable in technical analysis (save your hate mail Fibonacci fans, we're all entitled to our opinions!). As you've probably noticed I'm not much of a cycle guy either; I prefer technical patterns that are rooted in psychological behavior and herd mentality.

Finally, the Russell 2000 small-cap index. This index recently plunged below the trading range it has been tracing out since late 2013. Notice that this average is also displaying the textbook bearish action of lower highs and lower lows (red lines). Had the S&P 500 confirmed this action, I would have taken it quite seriously. However the S&P 500, just like the Industrials and Transports, did not make a respectable attempt at new highs until just recently. So in my book this non-confirmation deserves a watchful eye but no immediate action. If the Russell cannot rise above at least its most recent high before dipping below 1050, I would consider that quite bearish. Stay tuned.

Lastly, the NYSE Advance-Decline line. After taking a beating, advancing issues are now starting to consistently outperform declining issues, causing the A-D line to rebound. We're a ways off from reaching new highs here but at least the free fall has come to an end. Note that here and with all the charts presented above, the daily (short-term) MACD has returned to a bullish state.

I don't usually comment much on gold but I thought this was worth pointing out. Many people felt that the triple bottom gold recently traced out was a bullish sign, as a major support line held. What may have been lost in that perspective is that gold is tracing out a textbook bearish descending triangle. There is a war going on between gold bulls and bears, and frankly, I'd have to give the advantage to the bears at the moment. Note in the chart below that each successive rally since mid-2013 has failed to penetrate previous highs. This is almost as textbook as it gets. These patterns suggest that gold will eventually break below the support at 1180. A significant and sustained rise above the upper declining trendline would be your indication that something has changed and the bulls may once again be taking charge.

I've also included the "zoom thumbnail" to the right which provides us an up close view of the most recent action. Here we can see that gold was unable to penetrate through resistance at its 50-day moving average and has since turned down. All these factors together suggest that gold is still facing headwinds and the bears are still in control.

The above content was an excerpt of Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.

Related:
Will the FOMC Minutes End Dollar's Correction?

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Chief Investment Strategist
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