Time to Consolidate

As the Book of Ecclesiastes says, there's a time to weep, a time to laugh, a time to cast away stones and a time to gather stones together.

The same is true in the market. There's a time to buy, a time to sell, a time to break out and a time to consolidate.

In the past 12 months, we've wept the near collapse of our financial system. We've laughed with pleasure as stocks doubled, tripled and quadrupled in value. We've watched indices like the S&P 500 make moves we'd never have thought possible. The one thing we haven't done is consolidate -- and that's what we're going to do now.

The first reason is that the S&P 500 is now up 60% from its March 9 closing low of 676.53, an impressive gain for any seven-month period. Even though it was rebounding from a 57% plunge over the previous 18 months, that's a huge move no matter how you cut it.

Taken by other measures, the rally is less remarkable. If we manage to finish October in the green, it will mark the eighth straight positive month. The post-WWII period has seen longer runs than that, especially in the 1950s, when it went on two 11-month streaks:

Nor are the numbers thrilling on a monthly basis: The biggest gain was 9.39% in April, which doesn't even make the top 10 best months in the history of the index.

What's unique about the current market is that it combines a longer-than-average run with above-average gains. For instance, the two longer rallies of the 1950s only saw total increases of 32% and 36% respectively.

And some of other big monthly pops were followed by prolonged moves sideways (August 1984, December 1991) or outright selloffs (March 2000). In other words, this has been an amazing run -- as everyone knows in their gut. And, the gains have been slowing, which suggests some red ink is coming next.

Instead of just looking at absolute numbers, let's also look at the market in relation to itself: The S&P 500 was almost 21% above its 200-day moving average on Oct. 15. The only other readings above that level were November 1982, followed by two months of barely grinding higher, and June 1975, which preceded a steep correction.

Additionally, we're now within striking distance of the 500-day moving average, my favorite long-term technical indicator. The last time we rallied up to the 500-day like this in June 2003, the rally paused for a three-month bullish flag. I think we're going to repeat something like that process now. Any way you cut it, the 500-day is important and we're not going to take it out without paying dues first. We're also encountering this important average at the also-key 1,100 level, which so far we've failed to close above -- despite passing it by a hair on Oct. 19 and Oct. 21.

In other words, an area should be resistance, and the price action confirms it. The message: It's resistance.

One more troubling thing about the chart above is the clear slowing of momentum seen in the declining MACD oscillator at the bottom. This kind of bearish divergence doesn't always precede a correction, but it's a warning sign to the bulls. Combined with the resistance looming overhead, the chart is giving lots of warning signals against getting long right now.

That's all technical stuff, which is nothing more than a graphical reflection of underlying investor sentiment. And that's where we really need to take a break. Equities started rallying back in March because the market was undervalued and the shorts had to cover. We continued the run into April and May as leading indicators suggested the recession was over. The buying hit a near-term peak in June and took a break until good earnings launched us on a big run in July and August.  That trend continued into September and October as most economic numbers remained positive and earnings continued to show improvement.

At this point, I don't see any new bullish factors that can be priced in -- unlike in early July when we were sitting atop the 200-day moving average and everyone was nervous. We're currently priced for perfection. And, nothing's perfect.

Intermarket analysis provides more reasons to expect consolidation. Other charts like the euro/dollar cross is sitting at the key 150 level that served as resistance in late 2007, early 2008 and again in September 2008. Oil has made a beeline from $65 to the psychologically important $80 level and is pausing at its own 500-day moving average. Declines on either of these charts will likely correspond to lower stock prices.

Taking all this into consideration, I expect the S&P 500 will push down toward the 1,065 area where the market peaked in September. We could then hold that level and wait for the 50-day moving average to catch up before taking out resistance. Or, we could break toward the 1,038 neighborhood that served as an intermediate top in late August, at which point we'll probably languish until the 100-day moving average catches up and leads us higher once again.

The key takeaway is that new positions should not be initiated yet because everything points toward consolidation if not a mild correction. But on the other side of it, the bull market will continue.

 |  |