S&P's long-term chart points to potential correction

Global stock markets have experienced numerous volatile days recently as investors decide whether or not to participate in a potential end-of-the-year, or Santa Clause, rally. December is usually a positive month for the US stock markets, possibly because of the effect of ‘window dressing’. This is when money managers buy stocks that have been trending strongly in order to show off to their clients that they are holding the ‘correct’ type of stocks. These stocks tend to be large caps, which have more of an impact on the major indices compared with the small caps. Indeed, this may be the reason why the indices are still holding up well despite the market breadth narrowing i.e. only a handful of large caps are supporting the overall markets, with lots of small caps underperforming.

From a technical point of view, the S&P is looking shaky. The weekly chart of the S&P is pointing to a potential correction, barring a ‘last minute’ rally either today or tomorrow. As can be seen, it has created two doji candles just below its bearish trend line in as many weeks, a technical pattern which points to indecision. But although the low of last week’s candle is breached, it hasn’t been done so on a closing basis yet. So, who knows, the “Santa rally” may still be on the way. BUT the market is looking very tired at these elevated levels. While a 2008-style crash may be out of the question, a severe correction is nonetheless probable.

On this time frame, the key support to watch is around 2000, which is still some 55 S&P points away. On the smaller time frames, 2040 is an important support level. So if 2040 breaks then the S&P may initially drop to 2000 before deciding on its next move, which may well be to the downside. Additional long-term supports come in around 1942, which is the 61.8% Fibonacci retracement level of the rally from the August low, followed by the medium-term bullish trend somewhere around 1925/30 (depending on the speed of the potential drop). There is a horizontal support level around 1890, which comes in about 56 points above the August low at 1834. The central bullish trend, which has been established since the markets bottomed out in March 2009, is some distance below, around 1800.