DJIA: potential for stocks to bounce back, FOMC eyed

By the end of today’s session we may have a good idea in terms of whether the so-called “Santa Claus Rally” is still on for stocks. Not only do the major indices look oversold from a technical point of view, there is also the potential for the Federal Reserve to deliver a surprisingly dovish statement at the conclusion of the FOMC meeting this evening. Although the employment situation is continuing to improve, there is a risk that inflation may start heading lower once again from its current 1.7% rate and away from the Fed’s 2% target due to the recent plunge in oil prices. So, if the FOMC or the Fed Chair Janet Yellen sound concerned about path of inflation in 2015 then the market’s expectations regarding the timing of the first rate hike may be pushed further out. If so, stocks could find some much-needed support today. That said, deflationary concerns in the Eurozone and the currency crisis in Russia and some other emerging markets are still weighing on risk sentiment and there could yet be further falls before the markets bottom out.

Technical outlook

As can be seen on the 2-hour chart of the Dow, yesterday’s rally came to an abrupt halt after the buyers failed to hold their ground above 17400. As well as the prior high and the resistance trend of the bearish channel, this level also marks the 38.2% Fibonacci retracement of the recent sell-off from the record high. In other words, the bulls lacked conviction to increase their positions above a key technical area. Sensing this, the bears quickly moved in and drove the index lower before booking profit near the prior low at 17050. From here, the index future has drifted slightly higher but it still remains in danger of dropping further lower as it descends inside the bearish channel.

Indeed, a potential break below the 17050 support level could pave the way for a move towards the Fibonacci extension levels of yesterday’s range, at 16925 (127.2%) and then 16790 (161.8%). But as shown on the daily chart, in-between these Fibonacci extension levels is the 200-day moving average, which comes in at 16880. And further lower still is the 61.8% Fibonacci retracement level of the upswing from the October low, at 16670. The index could find support from any of these levels.

Meanwhile a closely-watched momentum indicator, the Relative Strength Index (RSI), is currently pointing to a potentially bullish scenario at these current levels. The daily RSI has already drifted in the oversold level of below 30. The last couple of times the RSI was at this level, a significant rally followed in the markets. Thus if history were to repeat itself, another leg higher could start as early as today. Meanwhile the RSI on the intraday chart has created a triple positive divergence i.e. it has made 3 higher lows even though the underlying Dow Jones index has formed lower lows. This also suggests that the bearish momentum is weakening, which is thus a potentially bullish development.

So, while there is potential for further losses, we have seen some bullish indications too. Thus going forward, the bulls should watch the resistance trend of the short term bearish channel closely, for a break above it could mark the resumption of the long-term bullish trend. This comes in around 17300. If broken, the first resistance to watch is that 17400 level that I mentioned above. Thereafter the next potential resistance levels are the 61.8 and 78.6 per cent Fibonacci retracements at 17625 and 17785 respectively.