The S&P 500 has been in a very tight uptrend. Overextended rallies such as this have a tendency to continue making new highs until an unforeseen catalyst sets the inevitable correction in motion.
The question is, when will the correction occur?
"Flashing yellow," shows the relative strength index (RSI) beginning to dip, reflecting a gradual deterioration in the underlying strength of the S&P. This weakness is underscored by prices hovering near the upper Bollinger band, an indication that the market is slightly overbought. As you can see, during the last three months we’ve experienced a pullback every time prices break this upper band.
Investors should take these technical indicators as a yellow light and initiate any further positions with caution or lighten existing longs.
There also are numerous fundamental reasons to be concerned about a near-term correction. Unrest in the Middle East, a soft U.S. real-estate market, stubbornly high unemployment, rising commodity prices and an excess debt in developed nations could serve as triggers to the above-mentioned technical weakness.
With corporate earnings beating the street seven out of 10 times, retail investors re-entering the market and an improving employment outlook, the only sell signals seem to be contrary to market momentum. Bulls remain in control, but be careful. This market could give back gains in rapid fashion sometime in the coming weeks or months. Watch for closes below the 10-, 20-, or 50-day moving averages for signs the correction has started and proceed with caution!
Jeffrey Friedman is senior market strategist for Lind-Waldock, a division of MF Global.