Wednesday, February 22, 2012

Sell Into the Rally Before the Correction Good news from Greece could take markets to new highs before sharp correction

Progress toward an agreement to bail out Greece led to a higher close for the Dow industrials on Friday, pushing them to another 52-week high, while the S&P 500 only missed its best close in four years by a fraction.

All eyes were on Brussels, while Greece is again the subject of a “final” bailout agreement. But whether or not Greece gets what it needs, it is unlikely to change the picture of the markets from the view of technical analysis since an agreement of some sort appears already discounted. However, technical analysis can tell us the probable future direction of U.S. markets.

On Friday, the Dow Jones Industrial Average rose 46 points to 12,950, the S&P 500 gained 9 points at 1,361, and the Nasdaq fell 8 points to 2,952. The NYSE traded 897 million shares and the Nasdaq crossed 553 million. On the Big Board advancers led decliners by 1.4-to-1, while on the Nasdaq advancers and decliners broke even.

SPX Chart
Click to EnlargeTrade of the Day Chart Key

As analyst Michael Murphy points out, it is important to note that “we have not had a 1% drop in the S&P 500 in a single of the 32 trading days this year.”

And according to the SentimenTrader, only 12 other years since 1928 have been able to last 30 days or more into a new year without a 1%-down day. Murphy also points out that all but one of those years ended with a positive return. Thus, the chances are very high that we will have a positive return this year.

The “Greek tragedy” has been dragging on so long that it is likely that the markets have already absorbed an agreement. Thus, look for a one-day or less rally following an agreement followed by a sudden pullback to the S&P 500 1,322 to 1,333 support zone.

Dow Chart
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On Friday, the Dow made a new 52-week high. But before that, the Dow had nine days of consolidating, which resulted in the Dow’s RSI to fall from an overbought reading at over 70 to a more neutral 65.76 — a positive development that could eventually lead to higher levels.

DJT Chart
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Despite all of the positives, and there are many, there is one major technical problem — the failure of the Dow Jones Transportation Average to “confirm” the breakout of the industrial average.

Thus, Dow Theory purists will say that a bull market has yet to be confirmed. As for the transports chart, pullbacks have thus far been turned back at the 50-day moving average now at 5,168. The index is in an uptrend but must break through the resistance at 5,425 to 5,550 in order to confirm that a Dow bull market is in force.

Conclusion: The market is in a powerful uptrend but still very overbought. However, a settlement of the Greek issue could trigger a rally that would take the Dow industrials, the S&P 500 and the Nasdaq to new highs followed by a sharp correction. Traders should sell into the rally and wait for a pullback before initiating new positions.

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