Indices Keep Fulfilling Their Missions

In my simple world, every rally, every selloff has a purpose and usually an easily identified target. Not all targets are met, but when they are, it's usually time to get off that particular train.

Take the recent selloff to new lows. I recently talked about my expectation that a break of the prior lows in the S&P at the 817.50 level of the futures would likely lead another 50 points lower, down to the October 2002 lows in the cash at the 769 level. True, the break carried a little lower down to the 741 level. So? The point is, that target was reached. I said I would buy at that level, and I did -- so far, nobody is complaining.

Then, after making those new lows, there were some targets on the upside, the most significant being the prior lows in the S&P cash at the 840 level. And during the 130-point pop in the S&P over the past few days, I did some selling as that level was approached. This was another target that was quickly exceeded, but again, cutting back into this explosive rally hasn't worked out too badly.

This is a methodology of sorts. Its central premise is that there is order in the universe (and in the market), and the market tends to return to prior lows after breaking those lows, and return to prior highs after taking out those highs. That's one of the market's rules that I live by.

Here's another rule: It fills gaps, and in the S&P, it does so with persistence and precision. In the chart of the S&P futures below, you will note that there was recently the Nov. 19 gap at the 866.50 level that was beckoning.

S&P Futures Pulling back after filling the Nov. 19 gap

Click here for larger image.

Despite the sharpest two-day percentage gain in the S&P in 21 years, the rally into Monday's highs couldn't quite fill this gap. The high on Monday was 866.00, just 0.5 points shy of the gap; from there, the S&P sold off into the close, settling at the 848.00 level.

The market was poised to open lower Tuesday, but the Fed came to the market's rescue before the opening and lo and behold, the S&P gapped up, in the process filling that Nov. 19 gap and returning to the Nov. 18 highs at 869; from there, it collapsed. To where? Back to another pivotal level, the 834 level of the futures that had marked the new low in the futures back on Oct. 27. It exceeded that level by just half a point, and from there turned back up toward the morning highs. So a couple of missions were accomplished in the S&P -- first one on the upside, then one on the downside.

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At the time of publication, Schiller was long mutual funds up to 30%-50% levels; short bond funds up to 20% levels, 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.