Technical Analysts Worried by Light Volume

As the mammoth three-month rally has run up against resistance in the form of January's highs, technical analysts say a resumption of big volume on the upside is needed to extend gains.
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One of the largest three-month rallies continues to roll on, but technical analysts warn that breaking through overhead resistance will be tough, because volume has been lighter on days when the market advances.

Last month,

technicians argued that the recovery rally may still have some legs

, providing those who missed the initial run a chance to participate. At the time, the

S&P 500

traded below the 900 level, before the index went on to close between 919.14 and 887 throughout the rest of May.

The next leg higher eventually came in June, as the S&P 500 has jumped more than 3% to 948, where it currently sits. The rally helped the index break through the January high of 943, which is an important threshold for technical analysts.

However, the S&P has closed above that level only once in June, as the index has run up against resistance at the January high. The index has closed between the tight range of 931.76 and 944.74 over the last eight sessions.

"The early January highs make a logical place to encounter major resistance," said Ryan Detrick, senior technical strategist with Schaeffer's Investment Research. "Given the S&P 500 has been trending sideways for nearly seven days, it is becoming clearer that this level will be tough to clear without a major catalyst."

Phillip Roth, chief technical market analyst with Miller Tabak, is more concerned with the low in March rather than any high made now. Understanding that the low in March was a primary low is important, he argues, because breadth and all the price indices made a new low.

"You cannot tell if this advance that is still in progress is the beginning of a new bull or bear market rally," Roth said. "The rally by itself doesn't answer that question, but the next correction might. At some point, this advance will fizzle out and we'll have a correction. It might end up being a test, or it might end up being something worse than that."

Instead, Roth says the most important story in technical analysis now is the absence of strong volume during market advances. As the good news of the oversold condition in March gets exhausted, Roth says the market will only be able to push through resistance if traders see a resumption of big volume on the upside.

"Volume has been petering out here, and that has made the advance look old and mature," he said. "A big volume burst on strength would reinitiate the momentum, and that's not going to happen in a vacuum. There will likely be a reason for that. However, I take my cue from the market, not from the news."

Detrick agrees that the fact the market is advancing toward a past peak and volume isn't increasing actually decreases the odds of a solid breakout. "Still, we are in the summer months now and volume is historically lighter, but a concern nonetheless," he said.

Another major concern is the lack of leadership from the financials, Detrick says. While the sector led the market higher during the sharp rally in March and April, financials have been lagging since early May. The

Financial Select Sector SPDR

(XLF) - Get Report

, or XLF, surged 112% between March 6 and May 8, but is down about 4% since then.

"In fact, the XLF still hasn't broken above its 200-day moving average, whereas the major market averages already have," Detrick said. "This underperformance could be a warning sign that the three-month rally is due for a well deserved break."

Roth says he's not as concerned about financial leadership because it was the most punished sector from during the bear market's beginning in 2007 until now. "Not only were they decimated, they went below several previous bear market lows, putting them in a very weak position," he added. "I think it's a sector that will top out before the rest of the market for that reason."

Instead, Roth is focused on strength in technology and other cyclical stocks, such as energy and basic materials. Weakness in utilities and other defensive sectors is also worth watching.

"The message of the market is that people are buying because they believe the economy has seen its worst and is going to get better," Roth said. "That emphasizes the cyclically sensitive stocks. Other defensive stocks, in addition to utilities, would be health care and consumer staples, and they don't look good either."

As a final warning, Roth points out that stocks are going up at the same time commodities and interest rates are rising.

"That can't continue," Roth says with emphasis. "At some point, the rise in rates will choke off everything else. The reason the market collapsed was because housing went to hell, and now mortgage rates are backing up again."