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When Resistance Becomes Support

S&P 500 Index

Earlier in the rally, I wrote about 1370 being a resistance area for the market – we finally broke through it in late February, but the rally ran out of steam the past couple of weeks and the market pulled back.

As you can see on the chart above, I’ve drawn a line around 1370 to make it easier to spot this level. So far, this pullback has been a textbook example of an “orderly” correction – around a 5% pullback to a support level.

One of my axioms is my Rule of Three. Whenever a market breaks support or resistance, it has to do so by either a passage of three days time on the other side of the resistance or support level, or it has to do so by 3%. If you look back at the late February breaking of resistance, it was unable to sustain it for three days, so it pulled back a couple percent. Then in early March, it successfully passed the Rule of Three and the market headed up another 5%-ish.

After the end of March, a lot of investors began to take profits on the big run higher in the first quarter. Then Europe started to come back into the news and the Fed released some minutes that said they weren’t going to immediately do another round of QE stimulus. This caused investors to sell stocks further, pulling the market back 5%-ish to support.

If you look at the graph closely, you will see that we have flirted with breaking support but haven’t been able to sustain three days below 1370. Then something comes along and acts as a catalyst to revive investor enthusiasm: Apple’s earnings. If the largest company in the index can increase its earnings 97% year-over-year, maybe things really aren’t as bad as the talking heads on TV want you to believe (in reality, most of them likely had short positions and were trying to scare the market into a fall so they could profit from it).

So far, earnings season has been pretty good. There have been some isolated cases of disappointment – like Conoco Phillips missing their estimates in a major way due to the falling price of natural gas – but for the most part things have been good – just look at Caterpillar which announced today that it had its best quarter EVER (and in one of those market anomalies that is nearly inexplicable, the stocks lost 4% on this news, so we bought it).

With what appears to be a successful test of support and the beginning of another leg higher in this rally, we began to put the cash we have on hand from selling near the recent top back into the market. The CAT purchase was just one we made today – most were focused on the large cap exporters – but, alas, I didn’t buy my nemesis, Apple. After such a large move overnight and today, investment basics say that it will pull back as short-term traders sell to capture their unlikely profit.

But, I’ve been wrong on Apple a lot. I started researching it today and I have a handful of clients that already own it with at $78 cost basis. I bought a starter position for them because they had the cash available and figured that if it pulled back we’d make sales for everyone and fill out a full position – sadly, the stock never looked back from that level. The unfortunate thing is that the standard analysis that gives me a buy level just doesn’t work with this company – it is too successful and popular to ever pull back enough to make it a value stock – whatever will be, will be with this one.

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