Market Technical View: As Autumn Approaches, Will We Witness Another Seasonal Slaughter?

To many in the Northeastern United States, the fall months are a spectacular time of year. As the weather cools, we seem invigorated and energized after the sweltering summer heat and humidity. The deciduous trees turn from their summer greens to brilliant yellows, crimson reds and bright orange, lighting up the landscape with an amazing glow. Unfortunately for Wall Street, the fall months many times are the most painful, gut-wrenching time of the year, conjuring up a lot of red and sometimes black.

We don’t have to repeat history with a bunch of mind- numbing statistics; it’s all on the charts. For some reason, weakness invades equity markets in the months of September and October, and this year looks like it may happen again.

Fortunately, there is a counter to all this pessimism. Just as the leaves begin to fall, and we lose all that beauty, the bears come out of the woodwork, the market panics to a major bottom, and with the blink of an eye, the bull is reborn and rejuvenated. Fortunately for the bulls, we do not see a major topping formation from which prices could cascade into a major bear market -- a major correction, maybe, but we see the bull extending into 2014.

On Thursday, the S&P 500 stock index broke important short-term chart support, slicing through the 1,676 level, and in the process, completed a small head-and-shoulders top. The size of the pattern was about 34 points, so we could see a measured move down to the 1,642 level, in our view. The case for a really large decline is difficult to make just based on the price chart of the “500.” Remember, big top = big drop and as we said, we don’t see a big top yet.

However, because the rally from the June low of 1,560 occurred so rapidly, and with little in the way of price consolidation, there is very little chart support until we get below the 1,600 level. If this turns into a rout to the downside, it could happen very quickly.

As we have commented on in recent weeks, the problem we see with the market comes not from price, but from weekly momentum, and we think these data point to the possibility of a major move lower. We have bearish weekly momentum divergences on the S&P 500 as well as on the key leading sectors, including Consumer Discretionary, Financials, and Health Care. We believe the leaders look susceptible to a decent decline and many times, when the leaders roll over, it is generally not good for the overall market. These are the first weekly momentum divergences we have seen since the spring and summer of 2011.

In addition, we have seen plenty of divergences from market internal data, suggesting that the underpinnings of the market are weakening. The NYSE advance/decline line failed to confirm the recent highs in the S&P 500. New 52-week highs on the NYSE also failed to confirm the price highs on the “500.” The advance/decline line of NYSE advancing volume and declining volume looks to be tracing out a double top. The percentage of stocks on the NYSE above their 200-day moving average did not confirm the recent price highs as well.

From a sentiment standpoint, the 30-day CBOE [Chicago Board Options Exchange] equity-only put/call ratio continues to decline and remains firmly in the danger zone. The 30-day fell below 0.60 on Wednesday, its lowest reading since May 2011. On Tuesday, the daily reading was 0.49, the second lowest of the year.

Rydex investors are showing a huge propensity to trade the long side. The percentage of bears on the Investors Intelligence survey fell to 18.5 percent last week, the fewest since May 2011, which was not a good time to be in the market.

NYSE margin debt appears to be breaking its uptrend, and we think this is another warning for stocks. Many times, when margin debt rolls over, stocks follow to the downside.

Gold prices rocketed above key chart resistance at $1,350/oz. on Thursday, completing an intermediate-term bullish reversal formation. We think that based on the size of the pattern, we could see prices head sharply higher up toward the next major resistance in the $1,500/oz. region. COT [Commitments of Traders] data remains extremely favorable toward the yellow metal, with commercial hedgers (smart money) heavily invested in gold on a historical basis and large and small speculators (dumb money) heavily under invested in gold on a historical basis. In addition, sentiment remains very bearish toward gold. We think this is a very bullish combination for prices in the months ahead.

We thought that weakness in the equity markets would lead to a counter-trend rally in Treasury prices. That has not happened as yields on the 10-year have broken out of a small base and appear headed toward the 3 percent level, potentially higher. While rates remain low historically, rising rates have been highly correlated with falling stocks of late. One has only to look at the housing stocks or junk bond ETFs [exchange-traded funds] to see the damage that rising rates have inflicted.

While COT data as well as sentiment point to a potential fall in Treasury yields, the trend remains higher. Interestingly, higher Treasury rates may be enough to slow an already sluggish economy and delay the much anticipated tapering of monetary stimulus by the Federal Reserve. Maybe this is part of the reason why gold prices have rallied nearly $200/oz. since late June. The big decline in the U.S. Dollar Index over the past month has certainly not hurt metals prices either, in our view.

Mark D. Arbeter, CMT is Chief Technical Strategist at S&P Capital IQ