The S&P 500 is still trading below its 200 day moving average (DMA) and is still experiencing the higher level of volatility that is present when the stock market trades below this average.
In addition, the overall market trend is still pointing downward.
This trend line is important since it has become a brick wall dividing the bulls and the bears. As I frequently mention, these trend lines are used by both technical and computerized trading systems — a very large portion of the stock trading community. If the S&P 500 can break through this “brick wall” then we will see traders becoming much more aggressive in the market and I would expect to see a Christmas/year-end market rally.
However, the problems in Europe still continue and the low trading volume in the stock market is an indication that investors are taking a “wait and see” approach instead of speculating what the end result may be.
In addition, as investors are willing to come back to the market and add risk to their portfolios, we should see small cap stocks outperform their large name counterparts. Typically small cap stocks are viewed as more aggressive companies who are more sensitive to economic conditions. As a results, they tend to be more volatile to the upside and downside.
Looking at the Russell 2000 index, which tracks the small cap stock universe, we can see that the index is still trading well below its 200 day moving average and is trading below its longer term trendline. A break above this trendline and the 200 DMA will be a good indication that “risk” is back in favor and traders are starting to get more aggressive.
As we get closer to the holidays, many traders will start going on vacation — possibly delaying any major movement in the market until next year. So will there be a Christmas rally this year? Historically, the answer is yes. However, the downward trendlines are providing strong resistance due to short term traders taking profits and shorting the market at this level.
Some nice historical perspective from Bronson Capital Markets:
Unless some very positive news comes out of Europe, I would expect the markets to end the year right at their downward trendlines – unfortunately, nothing too exciting for investors looking for a reason to celebrate.