The rally last week—a gain of 5.4% on the Standard & Poor’s 500 stock index—puts the stock market in a very interesting position as earnings season starts. (Alcoa ((AA) traditionally kicks off the week and the aluminum maker reported Monday July 12.)
Instead of going into earnings season oversold—as the market was before last week’s rally—and thus ready to move up in the short-term on any good news, stocks are headed into the hurricane of earnings numbers overbought and thus with a slight propensity to go down on reports that aren’t better than expected.
The degree to which the market is overbought isn’t extreme so I wouldn’t say we’re guaranteed of a pull back as investors ask, But what have you done for me lately? of stocks that rallied last week. But the odds this week do favor the downside.
Here are the levels to watch on the S&P 500.
Last week the market managed to climb through initial resistance at 1070 to 1078.
The 1070 level represented a 50% retracement from the June high and the 20-day exponential moving average. (See my post This stock market bounce has bought us the luxury of uncertainty for more on simple and exponential moving averages.) Those aren’t really, really major technical levels but still the market’s advance was important—if only because it meant that stocks didn’t fall far enough to make already worried investors really, really worried
The next level to the upside is 1085, and then 1093, and then 1100. None of these are hugely important numbers either but if the market can break through 1085, then optimism alone would keep it going for another 15 points.
On the downside the key number to watch is 1040. That represents support from May and June.
This is a level the really worries technical analysts since it represents what they call the neckline support in a figure that they call a Head and Shoulders Top. Suffice it to say that a conclusive break of that level—and we almost got one of those when the S&P 500 broke to 1010 earlier this month—would convince technicians that we’re headed to 950 on the index.
One important caveat, though: All this is about very short-term moves. Bigger moves, either up or down, are waiting on the resolution of fundamental worries about the financial system in Europe and the speed of global economic growth.