The Week in Crayons

After a sudden snap back rally on Thursday, the selling in the markets continued on Friday making it two consecutive weeks now in which we finished in the red in the broad market indexes. While this marks the first such occasion in almost half a year in the S&P 500, I would be wary of those that claim we are now in a “bear market”. Rallies as strong as the one we have experienced to start this year typically take more than a few days to unwind and considering that the pullback we are currently experiencing is the first of any substance we have seen so far I would be hesitant to assume that the current rally is done. However, it does appear that the “easy money” channel we were in for the first quarter of 2012 is now gone and we are likely entering a more difficult sideways phase as we come to terms with the highs we printed a couple of weeks ago. Volatility has been slowly rising for a while now and we appear to be heading towards another bout of broad range consolidation similar to the one we experienced around the same time last year, as we now enter what is typically a seasonally tough time for the markets.

Looking at a chart of the S&P 500 e-mini futures contract, we can see that despite the recent bout of selling, the market’s technical health is still intact as we have all of our major moving averages properly aligned with the longer term averages still rising. We are also still above the only other halfway decent attempt at selling down this particular rally which occurred in early March around the 1333 level. This area will likely serve as magnet for future price action as it also coincides with area from which we topped out in the middle of last year and will likely become a critical level for the markets as we head into summer.

While I would suspect that this area will offer support initially, it will likely grow in importance the longer we linger around it, particularly if we do indeed start trading sideways over the next few months. Assuming we are now in a period of consolidation, we can now also consider the area around 1420 as a near term ceiling on price action until proven otherwise.

As I mentioned earlier, despite the weak action we have experienced recently in the markets we remain in a technically healthy state and I would be very hesitant to assume we have now topped out. However, it does appear that we have lost our upward momentum and are now in a more volatile state of consolidation as the market tries to find a new equilibrium between buyers and sellers. Because we are currently in what can be considered the middle of our likely range, I would caution traders to avoid fully participating in the current environment until we get further clarity on the state of our near term health.

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