S&P500 - In the Mouth of the Dragon

The S&P500 made a small but important move today, closing up barely two points for the day. The broad market index advanced as high as 1145 but gave up most of its gains before the closing bell. This is hardly surprising. The S&P is right in the middle of a strong resistance zone or, as I like to call it, the mouth of the dragon.

Without a question, selling pressure will be present at this level. First, there are those who bought just around the January highs and are now at break-even and just can't wait to get out and end their pain. And then, there are those who pledged to take profit at 1150 but didn't and are now getting a second chance. Lastly, there are still many bears out there. For them, this is a great time to short the market for one simple reason - they can quantify risk (i.e. they know where to set a stop and have a pretty good idea of potential reward).

We can also expect buying to be tepid at best. After climbing a "wall of worry", the market will need some encouraging data/news to break through the 1150 ceiling. In the absence of positive data or, worse, in the event of bad economic data, we can expect with a high degree of certainty that the stock market will succumb to reality and pull back.

There are, however, a few encouraging signs. First, the Nasdaq Composite Index has already closed above its January high. Technology is a favorite sector as many analyst predict it will lead the recovery. In addition, the DJ Transportation Index is also at its January high. As for the S&P500, despite its end of day retreat, it was able to pierce through the 1140 level which is the lower which is the lower boundary of the resistance zone (see the two red lines in the chart below).

We must also pay attention to the our fear gauges - the yen and the VIX, both of which declined today. The yen actually did not regain any strength, even after the stock market closed. This is a strong indication that fear has abated to some degree.

It is impossible to guess what will happen next. The chance of a pull back in stocks is high. Depending on its severity, such a pull back will cause the dollar and yen to rise. A strong break to the upside might also cause the dollar to rise, especially against the euro and GBP, and the yen will slide. The most critical reports this week, which are likely to impact the markets direction, are the unemployment report on Thursday and retail on Friday.