Stock Market Stuck As Sequestration Deadline Approaches

The U.S. stock market and its major indexes drifted sideways for yet another week as economic reports were mixed and the clock ticks towards the sequestration deadline of March 1st. Stock market participants remain complacent as VIX, the CBOE Volatility Index, remains near historic lows and major indexes remain overbought. The next two weeks are likely to provide a catalyst, one way or other, for future directional moves.

On My ETF Radar
As described, the stock market remains overbought and momentum has slowed dramatically after the recent run up. Volume remains low and daily moves are extremely tight, suggesting a lack of commitment to push the market higher.

Furthermore, stock market breadth is beginning to weaken as the percent of all stocks above their 50 and 200 day moving averages is in decline and various breadth indicators are turning down.

In the chart below, we can see the percent of stocks above their 200 day moving average and how the stock market is currently at elevated levels which have proven to be tops before a number of both mild and as well as significant declines.

It’s easy to see that the stock market has arrived at a quadruple top level with 82% of S&P 100 stocks above their 200 day moving averages. History would suggest that the stock market has reached a point at which it needs to retrench to some degree before it could advance farther.

Major declines associated with current levels include a 17% dip in 2007, a 15% slide in 2010 and an 18% drop in 2011, all occurring within the space of 3-6 months. Of course, no one can forecast if, when or how deep such a retrenchment might be, however, it will take a powerful catalyst to push the stock market higher from today’s overbought conditions.

ETF News You Can Really Use.
For the week, the S&P 500 (SPY) eked out a 0.1% gain while the Dow Jones Industrial Average (DIA) fell for the second straight week, slipping 0.1%. The Nasdaq (QQQ) followed suit with a decline of 0.1% for the week.

The big news for the stock market hit Friday with Wal Mart declining 2.5% after the leak of an internal company email that described February sales as a “total disaster.” The company has an upcoming earnings report on February 21st which will be closely watched to gauge the health of the American consumer.

In economic reports, the University of Michigan consumer sentiment index rose to 76.3 and the Empire State Manufacturing index regained positive ground after several months in the negative column. Retail sales were marginally higher, initial unemployment claims dropped to 341,000 and industrial production slipped 0.1% in January.

Merger activity was also hot last week as Warren Buffett bought H.J. Heinz Co. (HNZ-P) and American Airlines (AAMRQ) joined U.S. Airways (LCC) in a merger.

Sequestration Countdown
The sequestration countdown continues with just ten days remaining to March 1st when the automatic spending cuts are scheduled to kick in. Last week the Senate proposed a plan that included both revenue and spending cuts which was rejected by the House, and to make matters more interesting, the House voted to go into recess on Friday, leaving just four days in session to make a deal. Both sides appear to be blaming each other for the deadlock and so the possible outcomes start to narrow as the clock ticks.

One outcome would be some kind of real deal to avoid the mandatory cuts but still put the nation’s finances on a better course. The second outcome would be more of what has happened before, a last minute, band-aid agreement that simply postpones the day of reckoning for another day. The third possible outcome is that the sequestration cuts go into effect which would result in immediate and substantial reductions in spending and an unknown amount of turmoil in global financial markets.

Next week brings an array of economic reports including February Home Builders Index, housing starts, the minutes from the last Federal Reserve meeting, PMI and the Philadelphia Fed report, all happening before Thursday in the holiday shortened week.

Bottom line: Significant technical and fundamental factors point to an increasingly risky period for the stock market between now and March 1st. Stock market participants have become accustomed to last minute “saves” by politicians and the Federal Reserve and appear to be betting on another rabbit being pulled out of the hat between now and the end of February. Should the rabbit not materialize, the stock market will likely react in a negative way with increasing volatility ahead.

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