Consolidation, not steep correction

By David Russell,

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Stocks have enjoyed a nice meltup since late 2011, and now a period of consolidation could be in order. I expect it to be frustrating but doubt that it will result in a significant correction.

The reasons for the pause are slowing momentum and several key resistance levels. The overall technical and macro backdrops, however, remain quite positive.

The current environment seems to resemble what the market faced in early 1991, when the index had battled its way to new highs but then spent the better part of a year consolidating those gains. It repeatedly pulled back to test support around its previous peaks before eventually breaking out to new highs.

The technical event that caused the breakout was that a key long-term moving average, in this case the 200-day, eventually caught up with the S&P 500. It would then spend the next year coaxing the market higher.

The question now is which moving average is needed to support buyers. I suspect that it will be a shorter-term one such as the 50-day because, unlike the early 1990s, the economy is now in a much stronger expansionary phase.

Why am I not looking for a steeper correction? First, we have a positive economic backdrop, with rising employment trends. Second, we have a market that's underowned and undervalued. Third, we had a terrific rally in recent months that woke up many long-term buyers. And fourth, as I have outlined previously, both the yen and Treasuries have made long-term tops.

But the most important reason not to be bearish is that the chart isn't yet supporting that case. Last summer's selloff followed an " inverse head and shoulders " reversal pattern on the S&P 500, for instance, but nothing like that is in the cards now. Nor will it be a danger as long as we hold those 2011 highs.

Another trend that seems to be emerging is a shift toward healthcare as stocks consolidate. The SPDR Health Care (XLV) exchange-traded fund is emerging as the strongest sector index in the last two weeks after lagging the S&P 500 in the last six months. This group has seen some big acquisitions and now could get another shot in the arm if the Supreme Court rules Obamacare unconstitutional.

(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of April 4.)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

This article appears in: Investing Options
Referenced Stocks: XLV

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