Q1 2013 S&P 500 Outlook

Benjamin Hurn, CMT

signalpursuit.com

12/29/2012

Introduction: In the following slides I have reviewed various charts of, and related to, the S&P 500, in order to illustrate why I think we are entering 2013 with a high possibility that the S&P 500 is forming a top of importance for investors and traders alike. I will work from various monthly charts down to daily charts in order to reveal why I believe this is the case. It is important to keep in mind a few things while reading: 1. I am a trader and given the time frames I operate on it would be incorrect to assume that my trading will always mirror my forecasts. My job as a trader is to limit losses and make a profit on balance. It is not to make correct forecasts. You can read more about my trading method under the Strategy and Performance tab on the blog main page. 2. Much of the information discussed and presented within the charts is subjective. 3. Forecasts are subject to change. When my forecasts are wrong, which I'm certain many of them will be, I will issue an update with a revised outlook.

Monthly SPX, log scale

The first basic observation in the chart above, noted by the yellow shaded area, is that the S&P has recently run into important
monthly resistance zone which dates back to the May 2008 highs. In September and October of this year we can observe that while the real bodies of the monthly candles were able to challenge the May 2008 highs, any movement beyond that level was met with selling as indicated by the long upper shadows in both months. This level is important as I would estimate that a strong close above it would likely result in widespread confidence that a retest of the all time highs would soon follow. For now, this level has proven too much for the bulls to overcome. I've also used the percent measuring tool in StockCharts to show that the general size of the rallies are diminishing. Please note that given some limitations in the StockCharts chart drawing tools that these percentages are not exact high to low figures for each rally that is marked. My intent with this illustration is simply to show that as the market rise that started in March 2009 has matured, each successive leg of the rally has become shorter in time and smaller in size. I view this as an indication that underlying weakness in the market is building.

4 year weekly, log scale

The weekly chart above utilizes two 50% linear regression channels, one using closing prices (green) and the other using the (H+L)/2 method. Anyone that has traded in the markets for a good period of time has had to confront the danger of trend extrapolation. In other words, there might be danger in looking at the chart above and thinking that any price action near the lower channel line is a buy. Even the strongest trends come to an end eventually. Given that this is a forecast, when I look at this chart I want to start thinking ahead. How will this look by next March? At that time it may be said that the four year trailing price trend had a very strong upside bias. In my opinion this chart also gives the visual impression of a rally that is getting tired as we can observe that while prices are hitting new 52 week highs they are now doing so at the mid-point of the channel. If you have this study as a feature on your charting package I encourage you to take a look at some longer time frames such as a 10 or 15 year weekly chart using the linear regression channel. These time frame views may provide examples of downside inflection points if in fact the market is rolling over.

3 year weekly, log scale

The 3 year chart above uses the same linear regression channel as the previous chart. I have highlighted the price action around the mid-point of the channel in 2012. One of the great things about candlestick charts are the quick visual benefits you can get by looking at them and I think we have a good example of that here. The first oval is placed to highlight the breaking above the mid-point of the channel that took place during the weeks of 1/23 and 1/30, 2012. The second oval highlights the breaking above of the mid-point of the channel that took place during the weeks of 7/16 and 7/23, 2012. In the first two ovals we see price action attempt to break above that mid point in the first week which is met by initial selling. The following weeks (1/30/12 and 7/23/12) we see a weekly close above the mid-point with candles that exhibit long lower shadows, indicating underlying buying interest. Both instances then saw prices move higher over the next couple weeks, go through another minor correction that generally used the mid-point as a support area, and then ultimately go on to make new 52 week highs. Now look at the current correction. In a similar manner off the November 2012 lows the initial approach toward the midpoint of the channel was met with selling. We can then observe long upper shadows on the subsequent rally attempts in December and then a close back below the mid-point. The comparison of price action is bearish.

daily SPX w/CMB Composite Index + RSI 14

The above chart includes the CMB Composite Index and the Relative Strength indicator. For those not familiar with the CMB Composite Index you can read more about it here. In this slide I want to draw attention to the recent divergence between the RSI (bottom pane) which had been rising off the November lows and the CMB Composite (top pane) which is now moving to the downside and also has a recent moving average downside crossover.. While I have not extensively tested the CMB Composite I would note that over the last 10 years on a daily basis a reading of -20 to -21 often coincided with a bottom of some duration in market prices. The RSI indicator itself may also be of some concern here and will be closely watched early in 2013. The RSI indicator will normally fluctuate between a low end support zone of 40-50 and a upper resistance zone of 70-80. In a bear market trend the RSI will instead fluctuate between a low end support zone of 25-30 and an upper resistance zone of 55-65. While RSI has put in a strong move to the upside since the November lows the entire correction that began at the September highs has moved the RSI into a bearish trend zone on this time frame. I will be watching the shorter term frames closely in the new year for any indication that RSI is turning bullish.

The chart on the left shows the percentage of stocks trading above their 200 day moving average versus the S&P. As can be seen, over the course of 2012 as the market moved higher fewer and fewer stocks were trading above their 200 day moving averages during each rally leg. The chart on the right compares the $XVG to the $SPX in order to get an idea of what the average stock is doing and if any divergence can be observed with the S&P. The $XVG is an equally weighted price index of all stocks in the Value Line Investment Survey. As can be seen above the XVG has shown good relative strength versus the S&P since the November lows yet it has also run into resistance from the larger downtrend that has been developing over the course of 2012. It would be a positive sign if both of these charts were to overcome these trends in early 2013.

There is similar evidence in the Nasdaq as can be seen above. The chart on the left is the percentage of stocks trading above their 200 day moving average plotted with the Nasdaq. The chart on the right is the Nasdaq comparison with $NAAD. The $NAAD (Nasdaq Advance-Decline Issues) represents the difference between the number of advancing and declining issues.

The above chart is the nasdaq plotted against the High-Low Index combined with a 5 day moving average. The recent bearish crossover of the High-Low index is worth keeping an eye on. This has been a reliable signal of price weakness for the weeks ahead over the last 12 months.

Conclusion:

Up until this point I have not mentioned the fiscal cliff. I certainly couldn't tell you exactly how much influence it is having on prices right now but it is the "news" that is front and center as I'm concluding this report. My sense is that some market participants,, maybe even many of them, think the market is extremely strong and outside of the fiscall cliff we'd already be challenging new highs. Indeed, the rally that began in November has certainly had some positive attributes. In time that perspective may prove exactly correct. I currently hold a different view.

Perhaps by the second quarter I'll be concluding with similar comments about the debt ceiling. What a thought... In any event, the above projection is my best guess at how prices may trend over the first 12 weeks of the new year. The yellow shaded box is a general target zone for a further correction. I would not be shocked to see a price rally into the 1430-1440 zone in the S&P prior to a larger selloff. On a weekly basis any price action above 1448 puts the bearish outlook at serious risk. Any price action above 1464 will be the final stop level where bears have a chance to maintain control. I do not hold a short position as of 12/31/12 in the S&P though I suspect I will be taking one in the coming weeks.