Market Insight

Rally Under Pressure; 50 DMA Line Breached

Friday, October 12, 2012
Stock Market Commentary:

The major averages fell last week and broke down below their respective 50 DMA lines for the first time since July. So far this is nothing more than a normal pullback after a big run. The S&P 500 is less than -4% below its multi year high of 1474. Normally, one would like to see the bulls show up and defend the 50 DMA lines for the major averages and leading stocks. The fact that all the major averages violated their respective 50 DMA lines last week put pressure on this multi-month rally. Remember, over the next several weeks as we make our way through Q3 earnings season- it is very important to not only focus on the actual numbers but more importantly how stocks (and the major averages) react to the numbers.

Monday-Wednesday’s Action: Rally Under Pressure As Nasdaq Slices Below 50 DMA line

Stocks ended lower on Monday as fear spread that EU tensions may escalate and Q3 earnings season in the US may disappoint. Volume was light as most of the country was off in observance of the Columbus Day Holiday. The World Bank and the IMF reduced their respective forecasts for the global economy, citing weakness in emerging markets. The European Stability Mechanism (ESM), Europe’s latest rescue vehicle, began on Monday and speculation spread that Spain may ask for a bailout in the near future.

Stocks fell on Tuesday, led lower by shares of recent winners such as Apple (AAPL) and Google (GOOG). The tech-heavy Nasdaq and Nasdaq 100 indices violated their respective 50 DMA lines for the first time since late July. Normally, healthy markets (and stocks) pullback and find support at or above their respective 50 DMA lines. Therefore, the fact that the 50 DMA line was breached bodes poorly for the bulls. Alcoa kicked off Q3 earnings season when they reported their latest results after Tuesday’s close. The stock lost nearly -5% of its value on Wednesday which bodes poorly for the rest of earnings season.

Stocks fell on Wednesday as global growth concerns and a lackluster start to third quarter earnings season dampened investors’ expectations. The IMF said the current situation in the eurozone was dangerous and would expose the region to “capital flight, breakup fears and economic decline.” The IMF went on to say that European banks could lose a whopping -$2.8 trillion in assets by 2014 if the situation does not improve. Technically, the action in the major averages is beginning to weaken. The Nasdaq composite, Nasdaq 100, S&P 400, and S&P 600 indices all broke below their respective 50 DMA lines, effectively putting pressure on this latest multi-month rally.

Thursday & Friday’s Action: Stocks Bounce But End Week Lower

Stocks opened higher on Thursday, helping the S&P 500 and the Dow Jones Industrial Average bounce off their respective 50 DMA lines. One of the catalysts for Thursday’s bounce was a series of healthy economic data from the US. Before Thursday’s open, the Labor Department said jobless claims fell by 30,000 to a seasonally adjusted 339,000 which is its lowest level since February 2008. This continues the recent trend of healthier activity from the jobs market. The trade deficit widened in August to $44.22 billion which barely topped the Street’s estimate for $44 billion. Meanwhile, import prices rose +1.1%. Stocks were quiet on Friday as investors digested mixed to negative earnings data from Wells Fargo (WFC) and JP Morgan (JPM).

Market Outlook- Rally Under Pressure:

The multi-month rally is currently under pressure as the major averages trade near to slightly below their respective 50 DMA lines. Normally, when this happens we begin to raise cash and adopt a more defensive stance. We will turn more bullish if/when the major averages jump back above their respective 50 DMA lines. Until then caution is king. As always, keep your losses small and never argue with the tape.

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Adam Sarhan

Host Of The #SmartMoneyCircle Podcast, Founder and CEO of 50 Park Investments. Adam provides weekly market updates to ChartYourTrade.com readers. He is a FORBES Contributor and is a frequent guest on all the major financial media outlets.

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