Crossroads

The current correction across the major indices is in keeping with corrections we have seen throughout this year, which have measured from roughly 4 - 8%. Market participants could therefore not be faulted for expecting an upside resolution. In fact, a significant higher volume gain this week could end the correction and reestablish the uptrend.

There is an argument to be made for bull market continuation. Poor news last week, especially in Friday’s jobs report, only led to higher prices. Earnings season has gone well, although sales growth was not encouraging. And many leading stocks continue to hold up well in their uptrends. Several are breaking impressively to 52 week highs. Over the weekend the G20 essentially relented to Treasury Secretary Geithner in backing the continuation of stimulus measures and as we go to press weak dollar plays are flying and stock market futures indicate another attempt at market follow through is underway.

And yet the markets begin the new week at a crossroads. While we must be on guard for a bullish resolution the bulk of the evidence weighs in favor of a deepening correction.

We’ll focus on the NASDAQ in our analysis but our comments are equally applicable to the S&P 500.

A weekly chart of the NASDAQ shows a clear shift in volume patterns over the last seven weeks. Whereas earlier in the rally there was robust upside volume interspersed with lighter volume declines, of late the opposite is true, with the market selling off on heavy volume and bouncing on light volume. Last week was a case in point with impressive weekly gains marred by below average volume.

The daily shows us the development of a Head and Shoulders top. This pattern is most often successful when upside volume dries up as the pattern progresses. That is clearly the case so far.

A negative resolution might not occur immediately. There could yet be further upside in this oversold bounce in the market. But unless upside volume mars the pattern we could well end up with significantly lower prices later this month.