Market Faces Critical Test

11/23/2009 12:00 pm EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Lawrence McMillan, editor of the Option Strategist, says the S&P 500 is at a key resistance point at 1100, which could determine the market’s direction.

The Standard & Poor’s 500 index ($SPX) underwent a correction of 70 points in two weeks during the last half of October. The October highs and now the November highs are at essentially the same level—1100. This is major resistance, which is reinforced by the presence of the declining 500-day moving average at this 1100 level.

The current rally has now reached the declining 500-day moving average [at] the 1100 level, exactly where $SPX has risen to. Moreover, $SPX has already failed at that level once, in mid-October. This makes the “battleground” at $SPX 1100 perhaps even more significant than it appears to the average technician.

From an intermediate-term chart perspective, the $SPX chart is still positive, because the trend line connecting the March lows and the October lows is intact, and—more importantly—because the series of higher lows continues in place. These patterns define the current predominant bullish trend.

The VIX futures gave a buy signal at the late October lows, but now the futures are trading at a premium to the VIX. In a normal market, that is the predecessor to a sell signal. The term structure of the VIX futures continues to slope upward, and that is bullish.

This has not changed, even during corrections in this bullish phase that began last March, and we would not expect it to change again now—assuming that a mere overbought correction is about to occur. However, if the term structure begins to slope downward, that would a much more bearish sign.

In summary, the intermediate-term trend of the SPX chart continues to be bullish. However, there are several potential short-term negatives which mean that another correction could be about to emerge. A close above 1100, however, would essentially end bearish thoughts and should be traded from the long side.

A breakout above 1100 would be bullish, and could probably propel prices to the 1150 level without much trouble. However, a failure at 1100 means that support areas would be important. There is support at 1060-1070, near the 20-day moving average, and then below that at 1030, the late October lows, followed by 1020, the early October lows.

Our longer-term view of the market is not favorable (we expect that, after this current rally ends, the market will take years to make new highs), and so we feel there is a decent chance that the $SPX Index will not be able to push on through the 500-day moving average—at least not at this time.

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