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An Impressive Showing

By Mark D. Arbeter The market, after a much needed pause earlier last week, broke to new recovery highs in impressive fashion. Despite the massive uncertainty, stocks have been able to retrace all their losses since the Sept. 10 close. Price action, market internals, and sentiment all suggest further gains lie ahead.

Since the rally began, the market has not had to deal with very much chart resistance, because the decline which started Sept. 17 was very steep. Now that the market has regained those losses, chart resistance will start to test the strength of this move.

Near-term resistance for the S&P 500, which comes from buying done during the Spring lows, runs from 1080 to 1150. Above there, chart resistance becomes very thick, because of the sideways consolidation from June to August which runs from 1150 to 1240. Chart resistance for the Nasdaq, also fromthe Spring lows, runs from 1700 to 1850. The heavier chart resistance comes in at 1920 and stretches all the way to above 2300.

There are some very short term bullish observations that can be made at this point, which support our view that this rally may have some legs. We have seen days where the market opens lower due to some negative headline(s) only to come back during the day and finish on a strong note. Fear levels are certainly still elevated despite the recent price action. On Tuesday, the indexes closed moderately lower but the CBOE put/call ratio moved to a healthy level of 0.97, indicating that option players were once again moving into protective put options.

In previous technical comments, I have mentioned that many intermediate-term advances begin with evidence of strong accumulation by institutions. This can be witnessed by a series of strong volume breadth measures. During the rally so far, the Nasdaq and the NYSE have seen a couple of days where up/down volume ratios have exceeded 5:1. These indexes have also shown 10-day measures of up/down volume over 2:1. If the market were going to fail once again, there would be good signs of distribution by institutions or high levels of down/up volume.

Since 1996, rallies have failed on the Nasdaq when there is a day of down/up volume of over 6:1 and a 10-day measure of over 2:1. On the NYSE, rallies have failed when the down/up volume ratio rises above 4.5:1 and the 10-day moves over 2:1. As long as these levels of distribution are not seen during the beginning of an advance, the market will be able to hold its own. If we do get these levels, a full retest of the September lows would probably be seen.

Sentiment polls, after registering high levels of bearishness, are beginning to move back to the bullish camp. During the market lows in September, Investors Intelligence poll of newsletter writers moved to its most bearish position (33.7% bulls, 42.1% bears) since the bear market lows in 1998. The latest readings are 39.2% bulls and 34% bears. While some may worry that newsletter writers are turning bullish too fast, historically this is actually a positive during the beginning of a new advance.

During the bottoming process, we like to see bearish sentiment exceed bullish sentiment. When a new rally begins after a correction or bear market, it has been positive when bullish sentiment increases and surpasses bearish sentiment. This occured after the bottoms in 1998, 1997, 1994, 1990 and 1987. As long as optimism does not return to extreme levels, and we all remember those days, the market should be in decent shape.

In the near-term, some pause in the recent rally is certainly a possibility as the indexes begin to run into some real resistance. Another potential short-term problem is that mutual funds may once again lighten up on their losers before the end of their fiscal year on Oct. 31. Beyond that, we continue to believe that the surprises will be on the upside as we move into a very favorable seasonal time period. Arbeter is chief technical analyst for Standard & Poor's

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