More Room to Rally

With all the recent volatility, we thought it would be a good idea to assess where the market is on the basis of both price and internal indicators. The FOMC decision on interest rates is getting the blame for all this volatility. Let's separate perception from reality. It is not unusual, at all, to see volatility increase before and immediately after the FOMC decision, as the markets work through the implications and traders decide how they want to be positioned.

This particular Fed meeting and decision comes at an exceptionally choppy time. December is a difficult month in trying to determine a reaction because of all the year-end crosscurrents that happen this time of year. Those crosscurrents are not trumped by any of the other issues, they are compounded by them. Historically, the Fed has not often taken action one way or the other when it comes to interest rates in December because it hasn't need to.

Volatility increases traders' emotional responses, especially with the end of the year two weeks away. Let's face it, no one wants to see their gains reduced or lost. Investors are more interested in protecting profits than finding opportunities at this point. Bad news, disappointing economic data or a poorly crafted announcement by the Fed can give traders an excuse to sell.

When we step away from the noise over interest rates, we can take an objective look at where the market stands and what to expect in the future.

S&P 500

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From a pure price standpoint, the S&P 500 remains above its primary bull trend line that has been in place since the lows were made in 2002. The recent rally occurred after a somewhat successful test of the August lows. The rally from those lows recovered about 50% of the decline and brought the S&P back to resistance in the 1515-to-1525 area.

This is where we have run into trouble, and from a price point, it is not unusual to see a pullback at this level. The news background may simply offer the excuse to do that selling. The critical support is the 1460 level, and that level needs to hold to keep the oversold rally going.

40-day SARSI

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Internally, our SARSI indicators reached oversold levels, coincidentally, with the November low and have been recovering along with the index. This indicator saw a recovery to the 60% level and has since pulled back to around 45%. Typically, we see this indicator reach back to overbought levels closer to the 80% area after the oversold reading occurs. This suggests there is still further room for the rally to carry into year-end and early January 2008.

This may seem to be an overly optimistic position; we are concerned with the weakness of the past two to three days. However, for now, the market remains in the recovery rally phase that began in late November.

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At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned. Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.