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Craig Allen: NASDAQ Composite Direction Change a Leading Indicator for Overall Market

March 9, 2014, marked the five-year anniversary of the bull market, which began March 9, 2009, when the Standard & Poor’s 500 bottomed at 666 (intraday). Since that bottom, the S&P 500 has advanced approximately 185 percent, reaching an all-time high of 1,897.

As impressive as this gain is, it pales in comparison to the gain experienced by the NASDAQ Composite Index, which advanced 245 percent during the same period. Recently however, the NASDAQ Composite has shown some signs of stress, which could be an early indicator of a change in direction for the overall market.

During the first quarter of 2014, stocks generated lackluster performance, after a stellar 2013 in which the S&P 500 gained about 30 percent. During first quarter 2014, the S&P 500 gained 1.28 percent, the NASDAQ Composite added 0.54 percent, and the Dow Jones Industrial Average lost 0.72 percent. The Russell 2000 Index (the small-company index) added 0.8 percent.

With tax time looming, and the strong gains experienced during 2013, it was not clear whether stocks were simply taking a breather before making another advance to new, all-time highs, or if a top was forming, to be followed by a correction phase, or possibly even a bear market.

After ending 2013 at 1,848, many investors assumed the worst was behind us when the S&P 500 fell to as low as 1,740 on Feb. 3, or by almost 6 percent, before rebounding and rallying to a new, all-time high of 1,897.

Since that new high was set April 4, however, we’ve experienced some extreme volatility, with stocks selling off quite dramatically. From the April 4 high, the S&P 500 has dropped 81 points (through the April 11 market close), or by 4.27 percent (so far). During this same time, however, the NASDAQ Composite, which contains a large weighting in technology stocks, has fallen to 4,000 from 4,267, or by 6.25 percent.

The Dow, NASDAQ Composite and S&P 500 are all teetering above major psychological levels — the Dow is just above 16,000, the NASDAQ is at 4,000, and the S&P 500 is just above 1,800. Should any of these levels be penetrated, those who watch technical indicators will view it as a sell signal. More important, the S&P 500 has penetrated both its 50-day and 100-day moving averages — also significant sell signals for the overall market.

The S&P 500’s 200-day moving average sits around 1,760, and further support lies at the 1,740 level. These two points on the chart are critical for the S&P 500. Should they be violated, technicians will view this as a major negative and a strong sell signal.

For the NASDAQ Composite, support lies at the 4,000 level, and the 200-day moving average (the index has also penetrated its 50-day and 100-day moving averages) sits at roughly 3,940. Since the NASDAQ appears to be leading the rest of the market lower, I would expect to see these levels violated first, with the S&P 500 following soon after.

With the recent weakness in the NASDAQ and the market overall, any trigger — even a relatively minor one — could be enough to send stocks into freefall. The rising tensions in Ukraine over the weekend, or a few weak earnings reports from key companies, could serve as probable cause to send stocks through the key support levels mentioned above.

The S&P 500 has some support at 1,700, and a bit more at 1,650 and 1,625. Should stocks test these levels, we could see buyers step in and try to rally the market, so it would not be surprising to see some rebound moves along the way (“dead cat bounces”). Once stocks build some momentum on the downside, however, I would expect to see a sizable correction of a much larger magnitude than 10 percent.

A move of 30 percent or so would bring the S&P 500 down to around the 1,200 to 1,300 range, where I feel it would find good support. This level, should we trade this low, would be an excellent buying opportunity for those holding cash. I will certainly look to re-enter the market, should we see stocks trade down to this level.

But I would not view a correction of this magnitude as an end to the bull market or an end to the economic recovery. Rather, I would see it as a healthy correction, bringing stock valuations back down to more reasonable levels, and as a strong buying opportunity with significant upside potential to follow over the coming 12 to 24 months.

Craig Allen, CFA, CFP, CIMA, is president of Montecito Private Asset Management LLC and founder of Dump That Debt. He has been managing assets for foundations, corporations and high-net worth individuals for more than 20 years and is a Chartered Financial Analyst (CFA charter holder), a Certified Financial Planner (CFP) and holds the Certified Investment Management Analyst (CIMA) certification. He blogs at Finance With Craig Allen and can be contacted at .(JavaScript must be enabled to view this email address) or 805.898.1400. Click here to read previous columns or follow him on Twitter: @MPAMCraig. The opinions expressed are his own.

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