This line could set off a "major sell signal" for stocks

The stock market action this year is eerily similar to 2007.

 

Back then, the S&P 500 started off the year with a strong rally before a summertime correction gave back all the gains. Stocks rallied again and hit their highs of the year in October. Then we got a sharp drop in November and a rally to a lower high in December.

 

Stocks started off strong in 2012. Then a summertime correction gave back nearly all the gains. The S&P 500 rallied to hit its high of the year in October. Then we got a sharp drop in November and a rally to a lower high (so far) this month.

 

The anecdotal evidence is similar, too. Restaurants aren't filling up anymore. And in-store Christmas shopping isn't as robust as expected...

 

By the end of 2007, I turned bearish. Not because of anything mentioned above – but because the monthly chart of the S&P 500 closed below its 20-month exponential moving average (EMA).

 

The 20-month EMA is the line in the sand that separates bull markets from bear markets. As long as the S&P 500 is trading above the line, stocks are in a bull market. But when the index drops below the line, the bear is in control. As you can see from the following chart, this indicator timed the bear markets of 2001 and 2008 almost perfectly...

 

 

Today, the monthly chart is well above the 20-month EMA – which is down around 1,350. So there's no risk of closing beneath it at the moment.

 

But here's what I can't stop thinking about in the back of my head...

 

What if the folks in Washington finally solve this whole "fiscal cliff" issue, and the market reacts to it like it reacted to the debt ceiling deal last year? Back then, the S&P 500 fell 15% in just a couple weeks.

 

Similar action today might lead the market to retest its November lows – and offer the great buying opportunity I've been looking for. But if it happens near the end of the month, the S&P 500 stands a risk of ending December below its 20-month EMA.

 

For now, there are a lot of "ifs" that have to happen for things to turn bearish. But it's something to keep an eye out for.