Option Investor
Index Wrap

SIDEWAYS (TIME) CORRECTIO

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THE BOTTOM LINE -
After the market runs up a lot, a correction inevitably sets in. However, corrections are of two types: 1.price - the indices pull back and retrace some percentage of the prior run up, anywhere from a quarter to a half typically.

However, in an uptrend that is of above average strength, the market may just correct by going sideways and thereby consolidate its prior gains. Correction type 2 is a "time" correction as the index marks time and goes sideways instead of back down much. Markets correct by price and time and combinations of both. Both type corrections have nearly the same effect of "throwing off" (correcting) an overbought condition.

Time corrections are difficult for long option players, unless trading small price swings, as the sideways trend erodes the time premiums built into index options. Better to be out in trend-less periods and in when the market is running. Our crystal balls can't tell us when we're in one these non-trending periods - but, after a sharp run up followed by a lack of heavy selling pressures, you pretty quickly know you're in one of these.

It looks to me like there should be another up leg here before there is a more substantial PRICE correction in the S&P indices. I did get a Friday sentiment reading that flashed bearish however. Another up leg will only look to be underway if and when the S&P 500 (SPX) breaks out above recent highs in the 1195 area, especially on a closing basis. The S&P 100 (OEX) needs to pierce prior '04 peaks in the 574 area.

To suggest another up leg the Nasdaq Composite (COMP) needs to close above its '04 high at 2153, which it has not done and might not - right now the chart presents a possible double top. The Nasdaq 100 (NDX) has climbed above its prior 12-month highs in the 1559-1560 area, so only needs to stay above this area to maintain a bullish chart.

FRIDAY'S CLOSING NUMBERS -
The S&P 500 Index (SPX) fell to 1188, down 1.2 points and was off 0.3% for the week as a whole. The Dow 30 Average was off 9.6 points to 10,543.22 and dropped a half percent on the week. General Electric (GE) bucked the trend in the Average and rose nearly 2% after it raised its dividend 10% and said its board authorized a $15 billion stock buyback during the next three years

The Nasdaq Composite (COMP) Index was off a fraction of a point to close at 2,128, but lost near a full percent on the week.

FRIDAY'S TRADING -
The indexes ended a bit lower given some mixed signals on the economy and weakness in the dollar. Offsetting this was the fall in oil prices to a 4-month low.

The release on Friday of Producer Price Index (PPI), showed a larger than expected jump in November wholesale prices. The culprit was higher energy prices and it drove prices at the wholesale level up a 0.5% last month as reported by the Labor Department - expectations were for only a tenth of a percent increase.

So-called core producer prices, which excludes food and energy costs, were up 0.2%, in line with consensus estimates. The PPI has risen 5% in the past year, the biggest PPI rise in over a decade. Core producer prices are up 8% in the last year, the worst inflation rate at this level since the early-80's.

Pressures on the market stemming from the PPI release were offset somewhat later by a better than expected rise in the U. of M. consumer sentiment estimate.

Their figures showed consumer sentiment improving in early- December with the index rising to 95.7, from 92.8 in November. 95.7 was well above a Street consensus for 93.2. The improvement seemed brought about by falling gas and rising stock prices. Hey, nothing like a rising 401k valuation for stocks to help make us feel more bouncy.

Crude oil futures closed under $41 a barrel for the first time in 4 months which related to skepticism that OPEC would both cut production by a million barrels a day and that this level of cut would lead to any significant tightening in oil supplies and more price increases.

The Oil cartel did leave their options open for a future adjustment to the quota by agreeing to meet again on Jan. 30, ahead of their regular meeting in mid-March. The benchmark crude January oil contract ended down $1.82, at $40.71, and fell 4.3% on the week.

In the foreign exchange markets, the dollar actually rallied for a third day on Friday, due to the rise in U.S. wholesale prices. Such a rise only increases expectations for a hike in U.S. interest rates next week - and , over coming months.

The dollar was up 0.6% against the yen to 105.34. The dollar rallied against the euro as it dropped a half percent to $1.3193 and well under the week's high above 1.33.

Bond prices held onto minor gains even as the PPI suggested rising inflationary pressures, normally bearish for bonds - however, the bond market is mostly looking ahead to another rate increase by the Fed. The U.S. Federal Reserve is expected to raise interest rates one quarter of percent (to 2.25% for Fed Funds) at Fed Open Market Committee meeting this coming week.

The benchmark 10-year note ended up 5/32 at 100 26/32 to yield 4.15%. Hey if it gets up to 5, that's a real rate of return!

MY INDEX OUTLOOKS -
S&P 500 Index (SPX) - Daily chart:

At this juncture the S&P 500 (SPX) needs to break out above or below its trading range of the past 3 weeks to resolve its chart pattern. After a strong move, give the benefit of the doubt to the trend - assume that the next move will be up and for a move that will clear the sideways rectangle (cyan level lines). Of course the reverse is true - a break of the low end of the recent range would be bearish.

Based on the recent price range that SPX has been in, resistance looks to be around 1195 and support in the 1170-1172 area. Notice how the intraday low on Thursday took the Index under the 21-day moving average, but the close was above it. Closes maintained above this average keeps a bullish pattern also.

Friday's trading action spiked my sentiment indicator back into bearish territory. However, there have been these 1-day readings over November that have not precipitated or preceded any substantial fall. In a market like this - seemingly stronger than the actual current fundamental outlook - sentiment readings have to be taken in context. The backdrop to this market is that money mangers with cash to spend are continuing to buy stocks and are typically bullish around the year end/early new year period.

S&P 100 Index (OEX) - Daily chart:

The S&P 100 (OEX) is maintaining a bullish pattern of higher rally highs and lows. Not by a lot but there is no rule that new highs have to be way above the prior or reaction lows the same.

The 800 pound (well, maybe only 500 pounds!) gorilla for the OEX is the closeness of recent highs to the prior '04 peak at 573. Any yearly high is typically quite significant technically.

Near resistance is at 570, then key resistance at 573 - above this level is only air and it will go as high as market forces propel it, but at 585 OEX would again be at overbought extreme. 560 is near support, with a close under 557 a definite bearish development, especially if OEX continued to fall the day following this.

M If I was holding Index calls, which I'm not, I would be somewhat unsettled by the bearish price/RSI divergence (highlighted in the chart above), as the RSI failed to follow along to a new high when the index did.

This type divergence has been a reliable sell "signal" over the years, but no one indicator pattern is completely reliable - otherwise, everyone would get a free pass and a get-out-of-jail card every time this type divergence happens. Market timing is too challenging to have patterns that "work" ALL the time.

I spent last week's Trader's Corner writing about when indicators don't tell us the whole story. These musings are here

Dow 30 Average (INDU) - Hourly:

The hourly chart presents an interesting look at recent weeks' price action. There is a projected uptrend price channel highlighted by the blue dashed lines, with implied resistance in the 10655 area and support at 10433.

There is also an approximate double top at this point and also a rounding top pattern shaping up, but this is negated on a move through (above) 10580.

Technical considerations remain bullish until proven otherwise, but the Dow is lagging here as far as the S&P related indices.

Nasdaq Composite (COMP) Index - Daily chart: 2150-2153 remains the key resistance area in the Nasdaq Composite (COMP). 2100 is near support, with more solid support expected around 2050. The longer-term bullish up trend is maintained even on a pullback to, but not below, the 1977-1980 area. A correction of this much would be a good new buying opportunity in Nasdaq calls.

Any trader cannot overlook the possibility of a double top having formed. I assume it IS a double top on the first failure to clear the prior high. However, a pullback from an important high like this can be just a consolidation before buying pressures pick up again - stay tuned on this and watch that prior high.

And, since the Nas 100 is in new high ground, COMP is going to the be the index that may present the best clues to a possible reversal and a deeper correction than seen to date. Or, conversely, the best clues that Nasdaq is in a new up leg.

The long-term trend is definitely up now with the crossover of the shorter 50-day moving average to above the key 200-day average as seen above.

Nasdaq 100 (NDX) Index - Daily:

I peg "resistance" of sorts at around 1650 in the Nasdaq 100 (NDX)- this area being a next possible target at my upper trading band; one where NDX would again be at an overbought extreme and vulnerable to a reversal. Risk to reward! - the longer the index climbs up along the upper moving average envelope line, the more risk to jumping into new call positions.

I peg near support at last week's low around 1580 - also at the 21-day moving average. Key technical support is at 1560 at the prior 12-month high. A breakout move, such as is presented with NDX's move to new high, should find future support at that prior peak - resistance, once surpassed, "becomes" future support.

Major support is at 1485 in my estimation.

NDX presents the same pattern as other indices where the new price peak was not accompanied by a similar new high in the RSI. This type divergence puts me on alert, as a backdrop bit of information, for the possibility of a top. Acting on this indicator divergence is something else however, as price is the main determinant for staying in a position and so far all corrections have been shallow and the trend quite strongly up.

Nasdaq 100 tracking Stock (QQQ) Daily chart:

Thursday top touched resistance implied by the top end of the steep uptrend channel in QQQ - of course prices might just follow this trendline higher. Usually, at a minimum, approaching the top end of an apparent channel means that the rate of ascent will slow. This line of resistance continues up to 40 where I peg next key resistance in the Q's. T

Taking profits on the stock in the 39.75-40 area, even shorting it, is attractive based on what I see now - the price pattern, the overbought condition and falling On Balance Volume line suggesting that only limited new buying is coming in.

Daily trading volume has not expanded in the same direction as the recent price trend. Volume is a secondary indicator but volume trends should be a supporting, not diverging, pattern and this has not been the case over the past 8 trading sessions.

Good Trading Success!

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