What Will it Take to Get Stocks Rallying?

The stock market is always looking for leadership. If it can't find it in Washington, it will look elsewhere. If it can't find it elsewhere, stocks may just tumble.

If you don't have the hardcore optimism needed to rely on Washington for leadership, you are probably wondering where the next stock market alpha male will come from.

The Obvious Choice

Yes, the obvious choice is the second biggest company in the world (based on market capitalization) - Apple (NasdaqGS: AAPL). Apple has been driving the Nasdaq (Nasdaq: ^IXIC) and, by extension, the stock market.

How big of a driving force is AAPL? AAPL accounts for 14% of the Nasdaq-100 and Technology Select Sector SPDRs (NYSEArca: XLK). From June 16 - July 26 the Nasdaq-100 gained 10.9%. Over the same period of time AAPL rallied as much as 27%. AAPL single handedly lifted the Nasdaq-100 by 2%.

Over the last few weeks however, AAPL has lost its magical touch. The broader non-tech focused Dow Jones (DJI: ^DJI) and S&P 500 (SNP: ^GSPC) saw a nasty correction, while AAPL is less than 4% away from its all-time high.

A closer look at the Nasdaq-100 shows that APPL's strength is masking weaknesses in other tech stocks. The average component stock of the Nasdaq-100 is down more than 14% from its 52-week high, while the Nasdaq-100 is off by 'only' 6%.

It appears that a few strong holds are able to buoy the Nasdaq-100. The strong holds include Apple, Microsoft, Google, Intel, and Amazon. These five names account for a third of the Nasdaq-100.

If the big money starts leaving this strong five-some, it's time to head for the exits (this may have started already).

The Drag on the S&P

The biggest drag on the S&P 500 has been the financial sector. While the Russell 2000 (NYSEArca: IWM), Nasdaq -100, Nasdaq Composite, MidCaps (NYSEArca: MDY) and various sectors like consumer discretionary (NYSEArca: XLY) and industrials (NYSEArca: XLI) were able to rally to new all-time highs, financials lagged behind.

The Financial Sector SPDR (NYSEArca: XLF) has failed to provide any kind of leadership and is now trading below an important support shelf at 14.60. In the past, this support has caused a spike in financials and broad stock indexes, at the very least.

The ETF Profit Strategy Newsletter referred to this support shelf twice before. On June 23 and July 17, the Newsletter used XLF as a proxy for the broader S&P and noted that XLF found support, which should translate into a rally for stocks. The fact that financials sliced below support is less than confidence inspiring. For stocks to rally, financials need to participate.

Do or Die Time

But before we talk about the potential for higher prices, we need to acknowledge the down side risk. The S&P has sliced below structurally important support. The S&P trades now slightly below the March and June low. What does that mean?

On March 16 the S&P bottomed at 1,249. On February 18, with the S&P at 1,344, the ETF Profit Strategy Newsletter expected a correction and commented that: 'The scope of any correction might set the tone for much of 2011. If stocks don't fall below 1,229, we expect new recovery highs.' The March correction was followed by new highs.

On June 16 the S&P bottomed at 1,258. Sentiment had turned extremely bearish, which pointed towards a potential bottom. The sentiment message was confirmed by technicals.

The June 15 ETF Profit Strategy update stated: 'The 200-day SMA at 1,257 is sandwiched between the 1,255 Fibonacci projection level dating back to 2002 and this week's s1 at 1,259. Wednesday's low was at 1,261.9. If this low is not enough, there is a strong cluster of support at 1,259 - 1,245. A drop into the 1,259 - 1,245 range would prompt us to close out short positions and leg into long positions' (long positions were closed out at 1,345).

The S&P is now below where the March and June declines stopped. Will it find support ?

It may, but the odds for a bottom are less favorable than they were in March and June. In March the S&P didn't even get close to the 200-day simple moving average ( SMA ). In June the S&P bounced off the 200-day SMA. A few days ago the S&P broke below the 200-day SMA.

The same is true regarding two rising trend lines originating from the March 2009 lows. Lower prices from here may validate a head and shoulders top and point towards even lower prices ahead. The chart below plots the S&P 500 against various support/resistance levels outlined by the ETF Profit Strategy Newsletter.

D on't Trust the News

Yesterday's sell off, following the passed and signed debt limit bill, is just another example that basing investment decisions on news events is treacherous. Not knowing the standoffs outcome, the ETF Profit Strategy Newsletter made a simple recommendation on Thursday, July 28:

'A break below the 200-day SMA and the trend line may trigger panic selling. One way to avoid missing out on a potentially big opportunity is to use the 200-day SMA at 1,284 as delineation between bullish and bearish bets - buy as long as the 200-day SMA serves as support, sell if it becomes resistance. If the S&P seesaws, repeat the process (see June 2011 Newsletter, page 10 for details on how to deal with a potential seesaw).'

It sounds deceptively simple, but selling against resistance and buying against support has kept subscribers on the right side of the market nearly every step of the way leading up to, and since, the May 2 high at S&P 1,370 (this article includes a small track record of past recommendation: 3 Reasons Why This Summer Could Get Ugly ).

The ETF Profit Strategy Newsletter boils down complex technical analysis to important support/resistance levels. How do you trade a market that's just broken important support? Yesterday's special update provides a short, mid and long-term perspective along with the best strategy for right now.

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

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

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