The stock market rallied and stayed high last week, in spite of higher than expected Jan inflation data, e.g. the PPI, Import Prices, and Capacity Utilization. So, perhaps, the unwinding of Feb options skewed direction. Also, the underperformance of Nasdaq is typically negative for the market.

Moreover, there are many potential crises developing, e.g. Iran's nuclear program (which may cause a spike in oil prices), a slowing housing market (although Jan housing data were strong from the unseasonally warm weather), slowing profit growth (from rising employment, which is reflected in the inverted yield curve), a potential debt and dollar crisis (since U.S. consumers are overextended), along with the potential of inflation accelerating (from rising input costs and lower productivity). There are inverse relationships between inflation and unemployment (i.e. Phillips Curve) and between employment costs and corporate profits (because of diminishing marginal productivity), when the Unemployment Rate is below 5%.

The first chart below is a VIX (S&P 500 Volatility Index) daily chart. There's generally an inverse relationship between VIX and SPX. Also, VIX is better at predicting SPX tops than bottoms. The VIX 200-day MA (not shown) fell from above 30 in early 2003, which is roughly when the cyclical bull market began, to 12.53 Fri, which is a multi-decade low, except for the brief fall to 12.29 in mid-Feb 1994 before the 7.4% SPX decline in the second half of Mar 1994 (although the total SPX decline from early-Feb to late-Mar 1994 was 9.7%).

The VIX 20-day MA generally creates peaks and troughs. Recently, the 20-day MA was moving towards a peak. However, it turned down last week. Nonetheless, given that VIX closed at 12.01 Fri and the 20-day MA is at 12.76, i.e. VIX closed below the 20-day MA Fri and both are at low levels, the MA may resume the uptrend similar to the previous two periods (see circles). So, there may be little SPX upside and far more downside over the next month.

The second chart is an SPX weekly chart. SPX has traded within the rising wedge over the past two years, except for one day in the second week of Jan '06. The upper line of the wedge is 1,300 and the lower line is 1,200 (both almost exactly). Moreover, the 20-week MA, which is the middle of the weekly Bollinger Band, is about 1,249 (roughly in the middle of the wedge). There's also an extended Price-by-Volume bar around 1,200. The upper weekly Bollinger Band is 1,316 and the lower weekly Bollinger Band is 1,181.

SPX closed at 1,287 1/4 Fri. Major resistance levels are the Jan high at 1,295 and the upper line of the rising wedge at 1,300. Major support levels are around 1,250, i.e. 20-week MA and a multi-year Fibonacci level at 1,246, and 1,200 to 1,230, where there are several major support levels. The MACD bullish crossovers of OEX and SPX early last week, and of Nasdaq and QQQQ on Fri, created a rally. However, it seems, the market will top next week and SPX will be much lower by mid-Mar.

Charts available at PeakTrader.com Forum Index Market Forecast section.

Arthur Albert Eckart is the founder and owner of PeakTrader. Arthur has worked for commercial banks, e.g. Wells Fargo, Banc One, and First Commerce Technologies, during the 1980s and 1990s. He has also worked for Janus Funds from 1999-00. Arthur Eckart has a BA & MA in Economics from the University of Colorado. He has worked on options portfolio optimization since 1998.

Mr Eckart has developed a comprehensive trading methodology using economics, portfolio optimization, and technical analysis to maximize return and minimize risk at the same time and over time. This methodology has resulted in excellent returns with low risk over the past four years.

http://www.peaktrader.com