The Short-Term Bullish Case

I see some reasons to be optimistic about the market, at least in the short term. Of course, the much longer term -- going out a year or more, which is very long term for me -- also looks quite bullish from where I sit. But after a short-term bounce to work off the current oversold condition, I would have to bet on more of a correction for the intermediate term, for several reasons.

Let's first take a look at the intermediate-term outlook for more of a pullback, before examining the case for a short-term bounce.

S&P 500 (SPX) Turned back (again) by the intermediate-term downtrend line Source: Lind-Waldock

Last week I highlighted the longer-term trend line in the S&P 500 (SPX) going back to the highs of May 19, 2008. I noted that the rally into the June 11 recovery highs had been previously turned back by this trend line and that last week's rally also stalled right at that line. That was another bearish development for the intermediate term.

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SPX (With Simple Moving Averages) Back below the 200-day Source: Lind-Waldock

Then there is the much-ballyhooed 200-day moving average; the SPX has now closed below this line for two consecutive sessions for the first time since the pullback into the June 23-24 lows. Before that, you have to go back before the June 1 blastoff, as that marked the first time in over a year that the SPX was above the 200 day.

While this break below this simple moving average may not be a good sign for the bigger picture, note that the June 23-24 period marked the recent lows and so was a pretty good time to be a buyer of stocks.

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SPX (Intermediate Term) Breaking below the 0.618 retracement on an intraday basis Source: Lind-Waldock

Check out the now-infamous 0.618 retracement level at 877.35, which had been holding since the market gapped off that level in early May. It was breached yesterday by a pretty good margin -- about 8 points. That's not something I wanted to see.

On the other (more bullish) hand, at least the SPX closed above this level. And that was a minor positive. Another positive is that the SPX finally filled that nagging gap at the 877.52 level that I have been on the lookout for since early May. So that's a mission accomplished.

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SPX Head-and-shoulders pattern Source: Lind-Waldock

But wait, we're not quite done yet -- the intermediate term also has the widely cited head-and-shoulders pattern to contend with, and that isn't good news. Note that no matter how you draw it, the right shoulder is now complete, and the SPX has convincingly broken the neckline.

Though there are varying interpretations as to how negative this might be for the market, yesterday's break has generally cemented downside projections in a range of 60 to 80 points below the break of the neckline on the SPX. Of course, the neckline is showing up at different levels on various technicians' charts, as high as 895 and as low as 880, so that converts to a wide range of downside targets.

According to most technical types, the head-and-shoulders pattern now projects a further decline that should be about the same distance as the move from top of the head down to the neckline (about 70 points on my chart). Accordingly, the SPX should be headed for a low somewhere in a range of 806 to 835, depending upon how the neckline is drawn. Though the entire drop needn't happen right away, it should be expected over coming weeks.

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At the time of publication, Schiller was long SPX, NDX and Dow mutual funds up to 30% invested; long bullish call spreads in the QQQQ, DJX and SPY calls; short SPY and QQQQ puts, although holdings can change at any time.

Dr. Harry Schiller is a Registered Investment Advisor with the California Dept. of Corporations. He holds a Series 7 General Securities license as well as a Series 4 Options Principal license. He has been owner and editor of the Short Term Consensus Hotline since 1988. For more information, see www.harryschiller.com. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.