Stock Market's Next Bounce May Be Lower, Not Higher

Whether the number is 8,000 on the Dow or 800 on the S&P, the stock market has found something of a comfort level from which it refuses to deviate very far.

False bottom

As they have several times in recent weeks, the averages tested their support levels Friday and managed to bounce back—even in the face of bad news. So while investors have shown little inclination to stage a broad rally, they've also eased off the sell trigger once the psychological numbers have been breached.

"Every time we get to 805, 804 in the S&P it bounces. It could be in anticipation of us holding 800 on the S&P," says Dave Rovelli, managing director of US equity trading at Canaccord Adams. "I think what happens when we get there is the shorts start to cover and the day traders jump in along with them."

While it makes for predictable market movements in the short term, there is a sense of doubt about what happens should the market fall through the support levels and retest the November lows, when the Dow hit 7,552 and the S&P saw 752.

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Still, there are some glimmers of hope. Technology stocks have often helped to turn the tide against negative market momentum, and many analysts are placing their bets squarely in the sector, which easily outperformed the rest of the market Friday. They're also looking for consumer staples and exchange-traded funds that make broad moves on market sectors as the averages dip above and below key levels.

A torrent of earnings and economic news next week—including the first report on fourth-quarter gross domestic product—will provide stern tests for the market's backbone.

"Most technicians say you want to go down and test the bottom, then we get a double-bottom and move higher," Rovelli says. "I have this gut feeling that if we retest it we're going to go through it because the world economy is in shambles."

Indeed, the quest to find a low in this market has been a largely futile endeavor since the credit crisis hit and the economy entered recession.

"Let's be honest, it's a gloomy outlook to have but it's one we have at my firm and it's right," says Mike Larson, an analyst with the Weiss Group and editor for its Money and Markets online newsletter. "We have to work through this. It's going to be a tough slog and you have to be defensive. You don't want to be overloaded on equities right now."

"All of the bottom calls have been premature," Larson adds, "and if you want to be less polite, dead wrong."

Search for Strength

For bears, playing the market entails a lot of exchange-traded funds that pay investors for moves downward in the various sectors and indexes.

Among those Larson favors are the ProShares Short Russell 2000 , which bets against the small-cap index, and the ProShares Short S&P 500 , a move against the entire index.

But even someone as cautious as Rovelli is finding positions in various stocks, though as a trader he's nimble and is carefully watching support and resistance levels for the various stocks he's buying.

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McDonald's continues to be in favor as a play on the economy and consumers looking for cheaper alternatives when eating out. He also is strong on Clorox as a consumer staple that people will continue to use even in an economic downturn. Rovelli's also buying Intel shares when they slip below $13 and is broadly long on China and energy, where he particularly likes ConocoPhillips .

To be sure, not everyone is a disbeliever in the market, with some banking on an end-of-the-month rally and others looking down the road to help from a government stimulus package.

"For the rest of the this month we're probably out of the woods," says Matthew Tuttle, president of Tuttle Wealth Management and a pretty consistent bear over the past several months. "I'm bearish as far as I don't see a reason to rally but I'm not so bearish because I don't necessarily see a reason to go below 7,800. All the news we're getting is bad, but we expected all that."

In fact, as far as near-term positions go Tuttle says he can't get much more bullish for the next few weeks. His firm is 60 percent in long positions right now, which is close to as high as he'll go. He's primarily buying ETFs that play gains in indexes, with his biggest long position, at 25 percent, in the Nasdaq.

Tuttle is not alone in his enthusiasm for the tech space. Strong earnings from International Business Machines and some of the sector's other top names are stoking the enthusiasm.

"If you wanted to actually start looking at a group that seems to be relatively washed out to some degree ... the tech area is the place to look," says Michael Cohn, chief investment strategist at Atlantis Asset Management. "The IBM news was actually incredible--making this type of money in this environment."

But even that enthusiasm is tempered with warnings that investors will need to lower their expectations until the worst of the economic headlines have passed.

"We need to get expectations down to the levels where stocks can have some chance of beating them. Until we can do that we're under pressure from all different angles," Richard Cripps, chief market strategist at Stifel Nicolaus, said on CNBC. See accompanying video. "What we need is the reality gap to close."

© 2009 CNBC.com