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The major indices have broken key trendline support off their respective March lows, and it appears that once a short-term kickback rally ends, more corrective action is in store.

Most of the major indices have broken their bullish uptrend lines off the March lows, a potentially bearish development. We think we are currently seeing kickback or throwback rallies to these trendlines, which have reverted to important resistance lines. However, once this short-term bounce ends, we expect more corrective price action for the stock market.



The S&P 500 is bouncing back toward the major trendline that acted as support since March, and this resistance sits up at 1,070. This corresponds to the top of the left shoulder in a potential head-and-shoulders (H&S) top. To complete this bearish pattern, the S&P 500 would have to break the neckline down near 1,030. We would also like to see the "500" take out the October low in the 1,020 to 1,025 zone to confirm an intermediate-term top. A break of the October closing low at 1,025 would represent the first lower high and lower low for the "500" since the pullback in July, confirm that the intermediate-term trend has turned bearish, and we believe, open the door for another corrective leg down.



There are a couple of important pieces of support not far from current prices, so we think the potential downside for S&P 500 is fairly limited. The first support comes in near 1,000, and this level corresponds with the early September low as well as a 23.6% retracement of the March to October rally. The second and more important 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, a completion of the potential H&S top would set the stage for a potential measured move down to the 950 to 960, and this is based on the size of this bearish formation. This would represent a 12% to 14% decline, making it the first correction since the bull market started.



There are a couple of other potential pieces of support that may come into play over the near term, one of which has so far acted like a floor for the "500." The 65-day exponential moving average lies at 1,036, and many times, this average acts as support during intermediate-term pullbacks. This average has flattened out for the first time since this summer, and if it starts to decline, we think it represents another cause concern in the short- to intermediate-term. The rising 200-day exponential average is down at 992 and is considered a longer-term piece of support. This average corresponds closely to the early September lows in the 990 to 1,000 region. Once this pullback is over, we still see the major indices posting recovery highs either later this year or in the first quarter of 2010.





One area of the stock market that has been particularly weak during October and into November comes from the small-cap universe. From October 15 to November 2, the S&P SmallCap 600 index dropped 9%, much greater than the losses suffered by the larger-cap indices. Not only has the SmallCap 600 dropped below its intermediate-term trendline off the March lows, but it is one of the indexes to complete a bearish reversal pattern of a double top. Fortunately, in our view, the size of the double top was relatively small, so a measured move based on this pattern only equates to a decline down to the 280 level, not that far from the index's closing low of 299. Interestingly, the 280 region is the location of the summer high for the index, and therefore, very important chart support.



As always, when looking at relative strength, the bigger picture must be analyzed as the relative underperformance by the small-caps is a bit of a misnomer. The S&P SmallCap 600 soared 81% from March to October, leaving many other major indices in the dust. So it appears that institutions are selling some of their big winners before the end of the year, to lock in those juicy gains.



The U.S. Dollar Index is in a short-, intermediate- and long-term bearish trend, but we could see at least a counter-trend rally in the near term. To turn the short-term trend back to bullish, we think the U.S. Dollar Index will have to break above immediate chart resistance in the 77.5 area. This level is near the falling 65-day exponential average, which, many times acts as resistance during a downtrend. If the dollar is bottoming, we think it could take many months of basing before an uptrend takes hold. Prices are oversold on a daily basis, and we have put in some bullish divergences recently. Weekly momentum has also cycled into oversold territory for the first time since late 2007, early 2008. Sentiment is very bearish toward the U.S. dollar, and very bullish toward the euro, suggesting we may be in the bottoming process for the U.S. dollar. In addition, commercial hedgers (smart money) have been increasing their long positions in the U.S. dollar and decreasing their long positions in the euro so that they are net short. Large speculators (dumb money) are now net short the U.S. Dollar and net long the euro.



We still think crude oil has the potential to get up near the $90/barrel region before a pullback or correction sets in. However, we are getting concerned about crude oil prices because commercial hedgers (smart money) have one their largest short positions and large speculators (dumb money) have one of their largest long positions in about the last 1-1/2 years. This, in our view, raises the possibility of at least a decent-sized pullback. If crude is unable to extend its rally toward the $90/barrel region, which would be a 50% retracement of the bear market, we think the $75/barrel is the critical level. This area represents the breakout area for crude oil, and if it gives way, the bullish breakout will have failed, setting the stage for further damage in prices.



In the near term, we think gold prices could pullback to chart and trendline support in the $1,065/oz. to $1,070/oz. area before moving much past the $1,100/oz. zone. Once the pullback ends, we think the longer-term rally in gold will continue with prices reaching $1200/oz. to $1300/oz. in the second half of 2010. /Mark D. Arbeter, CMT

We would use price strength to lower equity exposure.