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The major indices have been unable to break above some key levels of longer-term resistance, and at the same time, higher beta indices are weakening on a relative strength basis. This, we think, is a warning sign that a pullback or correction is coming.

While the major blue chip indices such as the S&P 500 and the DJIA posted new recovery highs this week, other higher beta indexes are struggling to maintain their footing. When the troops fall back and only the bosses are left, we all know where that will lead. While it may be too early to call an end to the advance off the March lows, as many of the key indices have not yet rolled over, we think there is enough technically apparent to throw up a yellow flag. And with volumes likely to tail off as we move into the end of the year, the short-term call becomes even trickier.



The S&P 500 is fighting with two important pieces of resistance, and the combination may be too tough to deal with at this point, considering how far the index has rallied since March. The 64% advance in 176 trading days is the greatest over that time period since 1933, so we are in rare territory. The first key technical resistance is a 50% retracement of the bear market and this targets the 1,121 level. We did not quite reach that price, but the intraday high on Monday of 1,113.69 came pretty close. We will note that the advance off the October 2002 bear market low was halted right near a 50% retracement and the market ended up pulling back over the next six months. Secondly, the bear market trendline, off the peaks since October 2007, looms just above current prices when using a semi-log chart.



Despite these looming pieces of resistance, there are many pieces of support not far from current prices. Trendline support off the lows since July and November sits at 1,070 when projecting out to the end of the month. The rising 65-day exponential moving average lies at 1,053, while the pivot low from late October/early November provides potential support in the 1,030 to 1,036 region. If this region of chart support is busted, a lower low will have been traced out, which, in our view, would open the door for a potential correction.



The next tier of support below 1,030 sits down near 1,000. Chart support from the pivot low in early September and early November resides in this area. A 23.6% retracement of the March to November rally also lies in this zone. Additionally, the rising 200-day exponential average comes in just above the 1,000 level. More important chart support sits down at 950, and this represents the high from this summer as well as a 38.2% retracement of the rally. In addition, if the S&P 500 traces out a head-and-shoulders top, it would set the stage for a potential measured move down to 950 to 960, based on the size of this bearish formation.



With the lack of powerful follow through to the upside, daily price momentum indicators have traced out a series of bearish divergences, and while that does not mean the market has to enter a full-blown correction, it is a warning sign, in our view. The 14-day relative strength index (RSI), based on the price action of the S&P 500, peaked in August up near the 76 level, and has been tracing out a series of lower highs and lower lows ever since. While it is not uncommon for momentum to correct with the passage of time even though prices do not correct, we find it disconcerting that the 14-day RSI has put in a series of bearish divergences with the latest occurring early this week. The daily RSI indicator is in a clear downtrend as price momentum has waned. What may be needed is for the 14-day RSI to fully cycle into oversold territory down to at least 30 before we can get another thrust higher in the indices. The 14-week RSI has printed two minor bearish divergences and that is also a warning, in our view. The weekly MACD has flattened out but has yet to cross below its signal line, which would be another thorn in the market's side.



Unlike the S&P 500, which we think has much less chart resistance sitting right on top of prices, the NASDAQ has run into a potential brick wall. This is what makes the shorter-term call so tricky, with some indices having potential room to run, while other indices have moved up to strong chart resistance. The NASDAQ has bumped its head against major chart resistance at 2,200 since the latter part of September and has not been able to make very much progress over the last couple of months. The 2,200 level represents the key pivot low in March 2008, and there was a fair amount of buying off that low. This potentially means that overhead supply is thick starting at 2,200, and it may take some backing up by the NASDAQ to recharge its batteries before taking another stab at this key level.



As the NASDAQ has struggled, we have seen a slow and moderate shift into the blue chip indices, which are considered much more defensive in nature. This defensive shift on the part of investors is also a warning, in our view, as many times, when the blue chip indices outperform on a relative basis, the overall stock market has trouble. The NASDAQ started to outperform the S&P 500 in early December 2009, well before the ultimate price low for many indices. This outperformance lasted until late-July, with the "500" starting to generate some mild relative strength vs. the NASDAQ. It appears that the "500" is bottoming out vs. the NASDAQ from an intermediate-term standpoint, and that could be trouble for the overall market.



As we noted two weeks ago, small cap indices have already traced out a lower low and have now put in a lower high. Another index that leads the overall market many times, the Philadelphia Semiconductor Index (SOX) has also printed a lower high and a lower low. Like the NASDAQ, the SOX ran into strong chart resistance in the 335 level from multiple pivot lows from early 2008 and then in July 2008. The SOX may be tracing out a complex H&S top, and to complete this bearish pattern, prices would have to fall below the recent lows in the 285 to 290 range. In addition, the peak in relative strength vs. the "500" occurred in July, with the RS line putting in a lower low and lower high ever since. Just another warning for a tired market!

/Mark D. Arbeter, CMT

We would lighten up on equity exposure and wait for the current technical warnings to resolve themselves.

The correction we were looking for has been delayed so if the S&P 500 can close convincingly above 1120, we think that would be very bullish an open the door for a move to the 1200 to 1250 region.

While the S&P 500 battles to stay above trendline resistance off the peaks since the bull market top, and faces additional resistance just overhead at 1,120 from a key Fibonacci retracement of 50% of the bull market, the Nasdaq is facing more critical resistance at 2,200 from a thick layer of overhead supply created back in 2008. We note, however, that some sectors and foreign ETF's have been able to start to eat away at key overhead supply from respective pivot lows in 2008, and if the Nasdaq can do the same, with think the resolution to the latest pause in equity prices will be to the upside.



We think the most bullish resolution for the stock market would be a shallow pullback in the S&P 500, back to the recent pivot high near 1,100, followed by another thrust to the upside. If the "500" can then put the 1,120 level behind it, we think the index could see a pretty good rally into early 2010, taking it up to the 1,200 to 1,250 region. If the "500" can not sustain a move over 1,120, then we think it could see at least another pullback before a strong rally can ensue.



On a weekly basis, the U.S. Dollar Index has made little indication that the intermediate-term trend to the downside will abate any time soon, with the series of lower highs and lower lows strongly intact. The Index is oversold on a weekly momentum basis; however, we think the formation of a bullish divergence could be weeks, if not months away. While the Euro is overbought on a weekly basis, momentum has yet to trace out a bearish divergence many times seen at major intermediate-term tops. We think this suggests further dollar weakness and additional Euro strength.



Gold prices are in a very strong advance, and we think have a clear shot at the $1,200/oz. level before seeing any type of major pullback. This target is based on a Fibonacci extension of the recent consolidation. A measured move based on the width of the latest consolidation targets the $1,300/oz area.

/Mark D. Arbeter, CMT

If the S&P 500 can overtake the 1120 level, we would increase equity exposure. Pullbacks toward 1100 can also be used to increase exposure. Only a break below 1070 would raise the caution flag.