Technical Levels—Not News— Become Main Driver of Markets

As much as Greece, the oil spill and the economy, the markets these days are moved by wild swings between technical levels that at times overshadow the underlying fundamentals.


"Technicals matter in this market," Pimco co-CEO Mohamed El-Erian proclaimed in a CNBC interview Tuesday, underscoring and perhaps understating just how much statistical measures of market behavior influence trading.

In particular, analysts have been watching support tests on the Standard & Poor's 500 around the 1040 level and top-side resistance near 1110 as an important gauge for whether the market can stay out of the recently breached correction territory and resume the aggressive bull-market run that preceded it.

The S&P seemed to whack its head off 1110 again on Tuesday, hitting the level going into the final hour of trading and then stopping in its tracks.

"Since your valuations look good, people become more focused on technicals because now they're looking for another measure to gauge their risk," says Mike O'Rourke, chief market strategist at BTIG in New York. "They already know they're getting good valuations. You're looking for secondary indicators to key decisions off."

Of course, traders and shorter-term investors have always followed metrics like the 50- and 200-day moving averages—trend lines that track the market's movement over time intervals which are used to determine where it's headed next.

A close above a moving average for several consecutive trading days indicates a breakout higher, while breaching a low often means the opposite.

Such levels certainly can be driven by news events, but often became strong psychological barriers that trigger buying and selling independent of the headlines.

O'Rourke says he is watching the CBOE Volatility Index for clues. With the VIX holding below 30, he thinks the market could have an upward bias but will need help from economic indicators, in particular weekly jobless claims, which have stayed stubbornly high.

The market has bounced off a more than 13 percent correction-level downturn, with buyers stepping in whenever the S&P gets near the 1040 but hesitating when it approaches the 1110 barrier, which represents the 200-day moving average.

"From a macro basis, it's going to be a situation where you're stuck in this trading range, which is the technicals, unless something unforeseen happens," says Alan B. Lancz, president of Alan B. Lancz and Associates in Toledo, Ohio. "In that sense, it's going to take an awfully big piece of news to trump the technical levels right now."

In such an environment, the investment strategy is pretty straightforward, says Lancz: Sell into rallies and buy the dips until the market shows signs of a breakout.

"Get more defensive. Look at companies that haven't moved yet if you do have this trading-range type of market," he says. "You can buy more cyclical companies that have taken a beating—BP, energy—that can offer some opportunity for a bounce-back rally."

In a detailed analysis of the S&P's pressure points, Bank of America Merrill Lynch's Mary Ann Bartels predicts the range "could break to the upside" past 1110 on its way to the next resistance level of 1150.

However, she notes a break below 1044 would bring a test of 950 to 1,000 into play and probably would take the bullish forecast of 1300 by year's end off the table.

"It seems the market is finally in a position to react to oversold conditions in the short-term indicators," writes Bartels, the firm's technical research analyst.

A separate analysis from Standard & Poor's points out that the 13.7 percent correction decline that bottomed out on June 7 is right on the nose with the average of the previous 17 completed corrections since 1945.

While investors shouldn't be too quick to assume the correction is over—the averages have since left correction territory—Sam Stovall, S&P chief investment strategist, said the market "now may be ready to rally" even though gyrations likely are not finished.

Stovall identified 13 "sub-industries" that could benefit from a breakout, among them auto parts and equipment; office electronics; diversified financial services; apparel, accessories and luxury goods; and technology distributors.

"The decline for the S&P 500 was amazingly dead-on with historical average," Stovall said in a note to clients. "Yet these earlier sell-offs took an average of four months to bottom out, and a similar length of time to get back to breakeven. This recent decline took less than half that time to materialize, so we will likely have more ups and downs to endure before all is said and done."