Throw the Technicals Out the Window

12/23/2010 2:23 pm EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

The stock buyers don’t care the market’s overbought, and the price action is bullish, writes Lawrence McMillan, editor of The Option Strategist.

The Standard and Poor’s 500 (SPX) and other major indices are at new post-2008 highs. The latest advance, which began at the first of the month, has been accompanied by deteriorating technical indicators. However, price is the most important indicator, and apparently a good number of buyers are driven by a need to “catch up” in performance; such buyers care little about technical indicators.

Earlier this month, the S&P had stalled for several days near the November highs at 1225-1227. Then it gapped over that level and appeared that it would take off, thereby confirming the next leg up in the bull market. However, sellers appeared and drove the index back down that day, closing near its lows. That alone was very negative action, but there were other negative indicators from breadth and put-call ratios as well. If this had been any “normal” market—or a purer trading market, such as a commodity—that negative reversal would have continued on into the next day at least, and perhaps much more.

But it did not. In fact, the next two days, the S&P 500 crept higher. It has now exceeded the April and November highs, and on a chart basis alone, has targets in the 1280 to 1300 area.

Fear Strikes Out
The only technical indicator that is confirming this movement is volatility. The volatility indices (the VIX (VIX) and VXO (VXO) ) have made new lows. That confirms the breakout and is bullish for stocks.

The other indicators are somewhat less enthusiastic, although if prices continue to proceed upward day after day, breadth and put-call ratios will certainly be dragged along.

Both the standard and the weighted equity-only put-call ratios have rolled over and begun to rise. Those are sell signals. NYSE market breadth has been much less enthusiastic than “stocks only” breadth. As a result, the NYSE breadth oscillator is now on a sell signal. The “stocks only” breadth has been stronger. That breadth oscillator remains on a buy signal and in overbought territory. The difference between the two is historically very large. It hasn’t been this high since July 2008, and since February 2005 before that.

In looking at previous times when “stocks only” was more than 200 points higher than the NYSE-based, they generally indicated an overbought market, although these signals tended to occur early—before the actual market tops.

In summary, the chart of the S&P 500 is bullish and that is the most important indicator. There is support at 1220, and a violation of that might be problematic for the bulls. Aside from that, the path of least resistance is higher.

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