Table of Contents


• Broad Market Analysis - A look at the long-term charts of the S&P, Nasdaq, and Dow
• MTG Stalk of the Week - MER short
• ETF Trend Tracker weekly commentary

Broad Market Analysis - A look at the long-term charts of the S&P, Nasdaq, and Dow

Despite a shaky start to the new year, most of the major indices have once again moved to new highs. Prior to yesterday's selloff, the S&P 500 was trading at a new six-year high, while the Dow Jones, Russell 2000, and S&P Midcap 400 indices all were trading at fresh all-time highs. Only the Nasdaq Composite, which failed its breakout attempt in mid-January, remains in a range. The market has certainly been resilient and the overall trend remains "up," but we noticed that rallies over the past month are lacking the power they formerly had. Rather than valiantly galloping to new highs, driven by powerful sessions of institutional buying, the major indices have been grinding out their gains with minimal momentum. Such action could conceivably carry on for a long time, but we view it as a market that is getting tired. So what has prompted this potential change in the market's underlying momentum? A look at the long-term monthly charts may shed some light on the situation.

As short-term traders, we tend to focus primarily on chart patterns that develop on the hourly, daily, and even weekly charts. However, studying the long-term monthly charts on a regular basis is important because it enables one to know the "big picture" of where the market stands. In turn, it becomes easier to make sense of perceived changes in market sentiment. Below is a monthly chart of the S&P 500 Index:

As you can see, the S&P has been trending steadily higher for nearly four years, since about the middle of 2003. From 2003 through 2006, a clearly defined trend channel developed, which is illustrated on the chart above. Until the end of 2006, every rally into resistance of the upper channel was followed by an eventual move down to support of the lower trend channel. But since November 2006, the S&P has been trading above resistance of the upper trend channel. Furthermore, January marked the eighth consecutive month the index has closed higher. The last time the S&P managed to gain for eight months in a row was from November 1995 through June 1996, more than ten years ago! During that period, the S&P 500 rallied 15%, but the ninth month was nasty. In July of 1996, the index plummeted as much as 9.7%, more than 60% of its eight-month gain, before closing the month with a 4.6% loss. Curiously, the current eight-month winning streak in the S&P stands at a very similar 14% gain. So far, the ninth month of February is unchanged and is forming a "doji star" candlestick pattern, which often precedes major trend reversals. Next, let's take a look at the monthly chart of the Nasdaq Composite below:

In comparison with the S&P 500, notice that the Nasdaq is less extended overall. Unlike the S&P, which has closed higher for eight consecutive months, the Nasdaq rallied from August through November of 2006, then entered a period of consolidation from December through January. Such consolidation at the top of a range ("correction by time") is generally bullish because it forms a base of support that eventually allows stocks to make another leg higher. However, notice that the Nasdaq is also trading at resistance of the upper channel of its primary uptrend. As such, it may first need to correct by price, at least down towards the middle of its trend channel, before rallying significantly higher. Generally speaking, the Nasdaq is less "overbought" than the S&P 500 on its long-term chart, but is still trading at resistance of its upper trend channel. Next, check out the monthly chart of the Dow Jones Industrials:

Because the Dow broke out to a new record high in October 2006 after several years of sideways consolidation, its current uptrend channel is technically less significant than whether or not it holds above the pivot of its breakout point. Like the S&P, the Dow has not had such a monthly winning streak for more than ten years. Trading at an all-time high, the Dow technically has no overhead resistance, but all indexes and stocks eventually correct within the context of their trends. When it eventually does, look for the Dow to find major support at the prior high of January 2000 (the blue dashed horizontal line). If you've been waiting for a decent correction in the Dow before buying stocks or ETFs in a long-term retirement account, any pullback down to near that level presents an ideal entry point.

Obviously, we have no way of knowing if this history will repeat itself by the S&P 500 correcting sharply on the ninth month of its rally, but this historical information should at least serve as a reality check for bulls who are fearlessly buying at current levels. Its parabolic rally above the upper channel of the long-term uptrend, the fact that the S&P has not seen a meaningful correction in nine months, and the "doji star" pattern that is forming this month should all combine to serve as a yellow flag for astute traders. We're not advocating fighting the long-term uptrend, but merely warning against a stock market killer named "complacency." Consider tightening your stops on all long positions and be prepared with a list of stocks and ETFs for the short side in the event of a substantial correction. For now, a mostly cash position is probably your best bet.

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In this column, MTG presents you with a FREE, actual trade setup that we are stalking for entry at some point during the week. Note that, unlike the daily guidance that regular Stalk Sheet subscribers receive, this free Stalk of the Week does not take into account overall broad market conditions that can easily affect the trade over the next several days. This week's setup is: