3 Charts Warn of a Pullback by Mid-December

Editor's note: In the past year, one expert has used market pullbacks similar to the one John is predicting to capture huge returns in a matter of days. These include 62.4% in nine days, 33.8% in four days and 18.5% in a single day. As you read John's report, consider how this strategy could help you get positioned for the next market sell-off.

Stocks took a breather this past week following three consecutive weekly gains in the major indices. The decline was led by the tech-heavy Nasdaq 100 (-2.7%) and small-cap Russell 200 (-2.4%), which were both leaders on the way up.

One catalyst for last week's decline was yet another failed attempt by the Nasdaq 100 to remain above its March 2000 tech bubble high, which it has been negotiating since August. I'll talk about this in more detail later in the report.

From a sector standpoint, all sectors of the S&P 500 ended in negative territory for the week except financials, energy, materials and industrials. Much, if not all of this, was related to the recent spike in long-term interest rates, which has boosted financial stocks while driving investors into hard assets as a hedge against what many believe to be emerging inflation pressures.

This big migration into the financial sector to capitalize on the rise in interest rates can be seen in Asbury Research's asset flow metric below. The biggest inflows in assets in sector-related ETFs over the past one-week, one-month and three-months periods have all been into financials. As long as this continues, financials should outperform the market.

The What, Where and When of the Next Market Pullback

As I have been stating for most of the year, my overall outlook on the market is positive. My initial upside target in the bellwether Dow Jones Industrial Average is 20,400, which is 6.4% above Friday's close.

However, the next few weeks may be tough sledding for the market for a number of reasons. 

The What: Market Volatility Forecasts a Decline

The first chart, one which Market Outlook readers are undoubtedly very familiar with by now, shows that the Volatility S&P 500 (VIX) spent most of the past two weeks hovering just above 12, a historically low level that indicates an extreme in investor complacency.

The low VIX serves as a contrary indicator, as previous complacent extremes have closely coincided with every near-term peak in the S&P 500 since April. So, as I have been saying for some time, as long as the VIX is residing near 12, near-term downside risk in the stock market exceeds upside potential.

The Where: Watch the Tech Bubble Highs

Another potentially negative factor to be aware of this week is overhead resistance in the market-leading Nasdaq 100 at 4,816 -- the March 2000 tech bubble high -- which the index has tested repeatedly since August.

The Nasdaq tried to stay above this key level just last week but failed once again. The index peaked at 4,897 on Nov. 29 before collapsing into Friday's closing level of 4,739. 

If continued weakness breaks support near 4,657 from the Sept. 12 and Nov. 4 lows, it would clear the way for a deeper decline to major support at 4,601 (the 200-day moving average) to 4,574 (April 19 high).

The When: Seasonality Suggests Between Now and Mid-Month

As for the when, seasonality is a negative factor for the next two weeks. The next chart breaks down the fourth-quarter seasonal pattern in the S&P 500 into 13 weekly increments. 

Historically, the final week of November is the seasonally strongest of the entire fourth quarter, after which the index tends to weaken during the first two weeks of December before finishing out the month on a strong note.

To wrap up the what, where and when: Low volatility suggests a near-term market pullback is likely before stocks go much higher. This pullback will probably start around major resistance at 4,816 in the Nasdaq 100. And it will probably occur during these first two weeks of December, right before the well-known Santa Claus rally typically pushes the market higher into year end. 

You may recall that at the end of last year, the S&P 500 peaked on Dec. 29, and the charts are telling us to expect a similar situation this year.

Oil Fuels a Rebound in Commodities 

In recent issues, I've discussed the PowerShares DB Commodity Tracking ETF's (NYSE: DBClate-September breakout from three months of investor indecision, along with a subsequent retest of its 200-day moving average. I said the 200-day moving average must hold as support to confirm the major bullish trend change that originated in April.

DBC has not only held the 200-day moving average as support, it has rallied to retest its June high at $15.59, which now becomes important overhead resistance. This rally was largely due to the recent jump in oil prices, as 53% of the fund's holdings are in oil-related assets.

A sustained rise above $15.59 would constitute an important breakout that would clear the way to the next overhead resistance level at $16.71, which is 7% above Friday's close.

Putting It All Together 

Bullish chart patterns with unmet upside targets in a number of key stock indices, including the Dow industrials, suggest more overall strength in the stock market through early to mid-2017. However, historically low volatility, the Nasdaq 100's most recent failed attempt to remain above formidable overhead resistance at 4,816, and seasonal weakness in the S&P 500 during the first half of December all warn of a near-term pullback.

Bigger picture, if oil prices -- and commodity prices in general -- continue their recent rise, it will support my intermediate-term forecast for more stock market strength amid improving global economic conditions into 2017.

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