Short-Term Sell Signal In The S&P 500 Index

The failure of the auto bailout to get passed today (Thursday) after it moved through Congress last night was a factor for selling today, but I think it was more a technical situation (see below). The Dow (^DJI) closed the day down 194 points or 2.2% and is now down 0.8% on the week. The S&P 500 (^GSPC) dropped 25 points or 2.9% and is off just slightly for the week. The NASDAQ (^IXIC) was the worst of the Small 3, falling 57 points or 3.7% and is virtually unchanged on the week.

The market action will remain volatile and trade on the economic news and 2009 expectations, but on the back of trader’s minds will be the outcome of the potential auto bailout. In the short-term a bailout would likely send stocks just as the TARP did a few months back. However, over the long-term an auto bailout may not be looked upon in the same manner if the companies keep burning through cash. The best thing for the situation in my opinion is an organized bankruptcy that allows the production to continue and at the same time let the restructuring that must begin sooner rather than later. The longer the politicians drag this on, the worse things get for the autos. Hopefully a decision in one direction is made soon.

SELL SIGNAL IS FLASHING

The S&P 500 and Dow both attempted to break through a very important indicator every day this week, only to falter each time. The elusive indicator I am referring to is the 50-day moving average.

The 50-day MA can be used in a number of strategies that range from long-term to intraday. The street tends to look at the very popular indicator as a gauge to the strength of the market. If the indices are above the 50-day MA they are typically in an uptrend or about to begin a new rally. Even more so the indicator is used as support and resistance; during an uptrend the 50-day MA will act as support and in a bear market it will be resistance. This week has shown the importance of the indicator as two major indices halted their respective rallies as soon as they came upon the 50-day MA.

The chart below shows the S&P 500 and the importance of the 50-day MA going back several months. Other than a few feeble attempts at a breakout above the indicator in August, the index has not trading above the moving average since May. After a sizable rally on Monday (+3.8%), the index gave back just over 1% the next two sessions. As of yesterday I was still undecided about whether the index would attempt a breakout or fail below the indicator. After early gains this morning the market turned lower and once the low of the week (882) was taken out it was a signal that the S&P 500 was not going to breakthrough this time around.

The failure to breakout this week led to a new short-term sell signal that could see the index pull back another 5% or so from current levels before finding support. If this occurs I would look for the index to build another short-term base and make another run at rallying through the moving average. My view remains on the side of the bulls when looking out to the end of the month, but a few days of weakness should be on the menu according to the chart.

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