Here's what chart analysts want to see before they trust the stock market comeback rally

Published Wed, Dec 22 20212:54 PM ESTUpdated Wed, Dec 22 20214:30 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Stocks look to have shaken off the worst of the selling with this week's bounce back, but chart strategists say under the surface, the market still can't be trusted The major indices were higher Wednesday after sharp gains Tuesday. In afternoon trading, the S & P 500 ended up 1% at 4,696, still holding above its 50-day moving average. The 50-day moving average is a closely watched indicator for stocks and indexes. It simply is the average of the last 50 days closing level, and a close below that level indicates weakness. "Our short-term gauges have not recovered yet, so we would not rule out another test of support in the days ahead," wrote Kate Stockton, founder of Fairlead Strategies. "For the SPX [S & P 500], we continue to watch support (4,546) and resistance (4,719), between which a neutral bias seems appropriate." Strategists say more of the market needs to participate in a recovery, with defensive sectors outperforming over the past month. The leading sectors in that timeframe were consumer staples, utilities, health care and REITs. Those defensive sectors lagged Wednesday, while tech and consumer discretionary were notching the biggest gains. "FAANG has proven to camouflage some of the underlying deterioration," said Mark Newton, Fundstrat global head of technical strategy. Microsoft and FAANG names Facebook parent Meta Platforms, Apple, Amazon , Netflix, Google parent Alphabet have had an outsized positive impact on indexes. Even FAANG and Microsoft are being put to the test. His composite of those names shows the stocks at a critical level of "make-or-break" support. Newton said he wants to see more signs the market is recovering beyond gains in the broader indexes. For this time of year, breadth is "sub-par overall" even while the S & P 500 is less than 1% from all-time highs made eight trading days ago, he added. "I don't want to be the resident Grinch," he said. He said while possible, there's no guarantee that the market sees a Santa rally at year end. The official Santa rally period begins Monday and would run through the following Tuesday, according to Stock Trader's Almanac. But December is often a positive month for the stock market. "It's like a foregone conclusion the market has to rally during this time of year, and that obviously isn't what happened in recent weeks," said Newton. "Everyone is blaming this on omicron, but this started in November." The sell-off for the S & P 500 was fairly shallow before the bounce back, but some high-flying stocks have fallen sharply and have not recovered. The Ark Innovation ETF, a poster child for the selling in high growth, is down 9.4% in the past month and was negative again Wednesday, declining 0.1%. Global X Cloud Computing also closed lower Wednesday. Frank Cappelleri, executive director at Instinet, said he follows 175 ETFs and many are showing signs of forming a double bottom or other positive bullish chart formation. But he would like to see growth stock ETFs continue to bounce, as they did Tuesday. "It would be obviously impressive if they continue yesterday's bounces. It's more about what we see into next week. Is it going to be another failed rally attempt with lower lows or could these be the building blocks for a move to the upside," he said. "It's important to see some follow through." While the rally needs to broaden, the market is not looking terrible either. "You need to see the larger benchmark indices really crack to think the market is really going to roll over and that hasn't been seen, " Newton said. "It's a crazy year of sector rotation and musical chairs." Newton said it's difficult to gauge the market in the two trading days before Christmas when the volume is light. "Weakness in the staples would be interesting," he said. "If you see Treasury yields start turning up a little more that would be encouraging for me for the financials. I think we're seeing the opposite." The Financial Select Sector SPDR Fund ETF, representing the S & P financial sector was up 0.5% Wednesday but down 2.4% over the past month. In that same four-week period, the S & P consumer staples sector was up 3.7%, compared to the smaller 1.8% gain in technology and the 1.4% decline for the communications sector. An ETF representing the sector is the Consumer Staples Select Sector SPDR ETF. While improved, the percentage of S & P 500 stocks above their 20-day moving average on Tuesday was 54.9%, while the percentage above their 50-day was 51.3%, Newton said. "Both rose from a couple days ago but I still find this market weaker under the surface with just half of SPX above its 50-day," Newton notes. Newton also points out that the advance/decline line of stocks on the Nasdaq is at its lowest level since the spring of 2020. He also notes that small caps and mid-caps broke down sharply since November, but they did hold key levels, tried to snap back but they still need to push higher. Another warning may be in the corporate bond market. He notes that the iShares iBoxx $ Investment Grade Corporate Bond ETF LQD is trending positively versus the SPDR Bloomberg High Yield Bond ETF, JNK, the junk bond ETF. "Junk bond spreads could widen in January," Newton notes. "Most of this is troublesome and shows a market that really needs some 'oomph' before making a bold call for new highs," he added.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., September 29, 2021.

Brendan McDermid | Reuters

Stocks look to have shaken off the worst of the selling with this week's bounce back, but chart strategists say under the surface, the market still can't be trusted