The stock market continued its hot streak, vaulting higher for the third straight week of 2012 and the fourth straight week dating through last year. The recent rally has carried many of the index ETFs past significant resistance levels and could bode well for the early part of 2012. However, the market is already overbought and could be vulnerable to a pullback soon. There are some individual equities that are starting to experience selling, which could signal that market participants are getting more aggressive in protecting gains. Google, Inc. (Nasdaq:GOOG), for instance, sold off over 50 points on Friday following a disappointing earnings report.
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The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, had a very solid follow-through week as it extended itself from its October highs. SPY is starting to get in position to challenge its 52-week highs, although a breakout is highly unlikely without some consolidation. The longer-term picture certainly improved this week, but SPY is very vulnerable to a pullback right now. The market followed a similar pattern for much of last year, where it would slowly drift higher before a sudden correction. While there could certainly be more near-term upside, traders should really be on guard at this point. The $128 area would be a likely area for support moving forward, unless a violent pullback occurs. In that case, the $125 level may attract buyers. (For related reading on ETFs, see 6 Popular ETF Types For Your Portfolio.)
The DJ Industrial Average, as represented by the Diamonds Trust, Series 1 (NYSE:DIA) ETF, had a very strong week as well. It closed at its highs for the week on the heels of solid earnings reports from some of its components. DIA is also in a position to test its 52-week highs near $128, and in fact, it is almost there. At this point, that level may act as a magnet as participants begin to expect the test. However, much like SPY, it would be dangerous to assume a breakout without some consolidation or pullback. It is very difficult for a breakout to succeed when there are so many market participants sitting on profits. Typically, investors will flee on the first sign of weakness in order to protect quick gains. The $122 level remains a key area to watch on any weakness. (For related reading, see 3 Reasons Not To Trade Range Breakouts.)
The Bottom Line
While the markets have made some clear progress so far in 2012, they are starting to get very vulnerable to a pullback. The markets are overbought on many measures and many individual stocks are extended. Chasing breakouts is rarely a successful strategy and this market has punished this behavior consistently over the past several months. However, the recent strength may be leading to a character change in the markets and if the markets can consolidate in a healthy manner, it may set the stage for more upside in the coming months. All the index ETFs have now set higher highs and higher lows, so until this pattern reverses, it can be assumed that healthy pullbacks will be buyable. (For related reading, see ETFs Vs. Index Funds: Quantifying The Differences.)
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