What Does a 2% Pullback Mean To You?

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We saw the ninth correction of better than 2% in 2012 last week. Is this a chance to buy stocks after the rough week or is it a more troubling sign? The short term technical levels I gave to you last week did not hold. A bigger concern came when three of the four intermediate term support levels also gave way. The S&P 500 essentially closed right at intermediate term support. 

After last week’s selling, 63% of the stocks in the S&P 500 are sound technically and 59% of secondary stocks are either basing or advancing. Both readings are down significantly the last few weeks. The move lower last week was felt more in individual stock charts than in in the major averages. The averages masked some of the weakness last week. Breadth measures topped out four weeks ago and fewer stocks are driving the market. I will be watching breadth readings very carefully over the next several weeks.

Short term support levels for the S&P500/Dow/NASDAQ/Russell 2000 are now 1424/13,295/3038/821. Near term resistance is now 1440/13,430/3080/837. The past week was one of the worst in several months. With Q3 earnings season in full swing we will see continued volatility. The pattern of strong openings and a fade as the day progressed suggests a tired market.

There was a major surprise on the economic front last week. Consumer Sentiment numbers were well in excess of expectations. 71 economists are used in coming up with the consensus estimate. No one was even close to the actual number. Bulls are pointing to the large improvement in real estate in 2012. As people refinance their largest assets to reduce monthly payments, the value of that asset increases personal balance sheets.  Bulls are saying that the improvement in housing will lead to a better than expected holiday spending season. The fact that economists missed what appears to be a turning point in consumer sentiment is not a surprise. Economists take data and extrapolate into the future. By their very definition they are backward looking and essentially useless when we need the most guidance. If the latest data is negative that gets heavily weighted and estimates are skewed to the downside.

So, was the selling last week a precursor of a weak fourth quarter? Will the evil forces of fiscal cliff and Eurogeddon win out?  Or was it a healthy pause to refresh? The extent of the pullback last week was definitely a cause for alarm. I am not willing to move into the bearish camp quite yet however. The percent of stocks that remain in healthy technical condition will be my main guide. The decrease in those numbers last week was worse than I expected.

We all know the concerns that are out there. Concerns over quarterly earnings strength, the fiscal cliff, the impact of the elections, central banker plans in Europe are concerns for all market participants. As for what I think about the outcomes of these concerns, well the market doesn’t much care. The market is the ultimate leading economic indicator. Price answers all questions. We may not like the answers sometimes but we must deal with them. I am going to closely watch all of my holdings, and the movement of the entire market, at critical support levels. Names that roll over at support will be sold. Names that continue to trade well will be held. That is my drill and I am sticking with it.

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About Thomas J Smith CFA