Stocks snapped their near-term winning streak yesterday, as the broad market came under solid distribution. After opening slightly lower, the major indices quickly settled into a steady intraday downtrend that persisted into the close. The S&P 500 and Dow Jones Industrial Average both fell 1.4%, while the Nasdaq Composite shed 1.8%. The small-cap Russell 2000 plummeted 3.0%, but the index also showed relative strength and gained the most during the market's recent rally. The S&P Midcap 400 was lower by 1.5%. Just after mid-day, stocks attempted to recover from their morning losses, but a wave of selling in the final forty-five minutes caused the main stock market indexes to finish at their dead lows of the day.
Total volume in the NYSE increased by 18%, as volume in the Nasdaq swelled 16% above the previous day's level. The broad-based losses on higher turnover caused both the S&P and Nasdaq to register a bearish "distribution day." However, institutional selling was not overly aggressive because volume levels in both exchanges remained well below average. Market internals were nonetheless ugly. Declining volume in the NYSE trounced advancing volume by nearly 8 to 1. The Nasdaq ratio was negative by more than 4 to 1.
Over the past week, we've been warning against getting overly aggressive with new positions ahead of the New Year's Day holiday. Yesterday's action was a good example of why we have been so cautious. When the market rallies on extremely light volume, it only requires the slightest amount of selling pressure to rapidly erase those gains. Not only did the sell-off send the S&P 500 back to negative territory for the month, but it also caused the breach of several key areas of support. Most notably, the index slid back below its 200-day moving average. Recovering from the November sell-off, the S&P first moved back above its 200-day moving average on December 6, but plunged below it again only four days later. This time, the index only stayed above its 200-day MA for two days before falling down again. Support of the 50-day MA was also broken yesterday:
"Swing high" resistance in the S&P 500, as well as the other major indices, has now been established at the December 26 highs. A rally above this level could be quite powerful on a technical level. Support will now be found all the way down to December 18 "swing lows," a break below which would be equally bearish. As long as stocks remain trapped between these pivotal support and resistance levels, one should expect choppy, indecisive trading in the near-term.
Many of the financial news outlets blamed yesterday's decline on news of the assassination of Pakistan's former leader, Benazir Bhutto. We view the news as merely a convenient excuse to justify the market being a product of its environment. When the stock market rallies on extremely light volume, the gains simply cannot be trusted for more than a day. For this reason, we intentionally passed on a few bullish setups over the past week, but we certainly don't regret our cautious stance. Remember that the major indices are still showing bearish "head and shoulders" patterns on their weekly charts, which hold more bearing than the shorter-term daily charts. There will be plenty of time to get positioned on the right side of the market when stocks eventually make their intermediate-term intentions clear. Until then, especially ahead of the New Year's Day holiday, cash is the best position.