Over the past three weeks, we have seen a significant correction in the U.S. equity markets. At this point most investors and traders are wondering whether the downturn will continue or whether stocks will rebound from these levels and begin advancing again.

If only we knew for certain!

We are closely watching our indicators and analyzing what they mean. Unfortunately nothing is definitive so the best we can do is to try to make some educated guesses and err on the side of caution. We sold our small position in Fidelity Select Software and Computers (FSCSX) as a defensive measure because the technology sector has been hit hard in this correction.

The chart below shows the New York Stock Exchange over the past year. The blue line is a support line I added. At its most recent low, the NYSE retreated back to the same level as it was at the end of November 2009 and October 2009. If it should break below support at this level (6800), there is support at 6500. Below that the next technical support level would be slightly above 5500—a level last seen in July 2009. That is about 19% below the current mark and it would certainly result in renewed pain for investors.

The gold line on the chart is a 200-day simple moving average (MA). The 200-day MA is usually an area of strong technical support for longer-term cycles. So far, this level has not been broken. The chart also has two areas I highlighted with pink ovals: the current downturn and the downturn of June and July 2009. Right now, these two corrective periods look similar.

In that earlier correction, stocks rebounded after about six weeks of decline and quickly erased losses from that correction. At the time, we were warning investors that fundamental economic factors did not support the rally that was occurring. The irony of the current correction is that it has occurred when the fundamental reports have been surprisingly good. The fourth-quarter GDP number was much better than anticipated as was the most recent unemployment report.

The middle portion of the chart is a moving average convergence divergence (MACD). This tool is negative, but had not reached an oversold extreme. That would indicate a possibility for additional declines; however, a rebound from this level would not be unusual. In July 2009 the market rebounded when the MACD reached the zero level.

Finally, the bottom portion of the chart is a stochastic oscillator. It reached an oversold level in late January and the NYSE responded with a couple of days of positive action. But the oscillator only completed a half cycle before turning negative again. Normally that is a sign of market weakness. This oscillator turned positive again this week.

The combination of these indicators and improving economic fundamentals lead me to believe that stocks could hold at this support level and stage a new short-term advance. But there is certainly no guarantee that will occur. And if something happens to drive stocks sharply below this support level, the market could get quite ugly with a downturn similar to the one we saw in the early months of 2009.

Much of the eastern U.S. is currently hunkered down and waiting for the recent storms to pass. That seems to be a good strategy in response to the recent market storm as well.
F.S.