Why Near-Term Prospects in the Stock Market May Be Limited

Near-Term Prospects in the Stock MarketThe investment climate is at a crossroads. While the market bias is slightly positive, there’s still a sense we could be headed for a market correction. But it’s amazing how resilient the equities market has been in spite of the concerns regarding sequestration, the eurozone recession, debt risk in Italy, and potential stalling again in China. We are also still dealing with an unemployment rate of nearly eight percent, and it’s not looking like it will improve for several years.

The U.S. equities market suggests some near-term stalling. About 73.5% of U.S. stocks are above their respective 200-day moving averages (MAs), which is impressive, but it’s below the 77.4% a month ago. On a short-term basis, only 62.6% are above their respective 50-day MAs, well below the 84.5% a month earlier. A note of caution: there are now 47. 8% of U.S. stocks below their 20-day MAs, compared to 74.0% that were above their 20-day MAs a month earlier. The readings indicate a potential reversal or stalling in the equities market, based on my technical analysis.

On the charts, we have seen the Dow Jones Industrial Average close above 14,000 on four occasions since the first move on February 1, closing at a new record high of 14,286 yesterday. But the index has failed to hold on three occasions and could be at risk for its fourth setback on Monday. This is not a red flag for the equities market.

The S&P 500 is also facing a multi-year top just above 1,500. The S&P 500 has edged higher in four straight months, but be careful, as the index may be approaching its third top following its first two tops in 2000 and 2007, as shown by the blue circles on the chart below. Also notice the declining moving average convergence/divergence.

$SPX S&P 500 Large Cap index stock chart

Chart courtesy of www.StockCharts.com

Take a look at the upward move of the S&P 500 stocks to above the 200-day MA, which is over 86% as of March 4, versus the 47% level in mid-November 2012. Be careful, as historical patterns have shown that stocks will inevitably move back toward their moving averages.

$SPXA200R S&P 500 Percent of stocks above 200 day stock market chart

Chart courtesy of www.StockCharts.com

So while the equities market is holding up fairly well at this time, the near-term potential looks limited and, in my view, it’s one major negative headline away from a possible sell-off.

There’s one thing for sure: the rate of the January advance in the equities market is clearly not sustainable, especially as shown by the muted growth in February. And we are also heading toward the end of the best six months of the year  (November to April) for investing in the equities market, according to the Stock Trader’s Almanac.

So while the current market bias is bullish, you need to be careful. Make sure you take some money off the table. Better yet, have some put options in place. (See “Here’s a Low-Risk Strategy Given the Big Risk.”)