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Stronger Signals for Stocks

By Mark Arbeter The S&P 500 continues to close in on a critical

resistance area while more and more indexes break out from their recent consolidations. While we believe a pullback/correction is not far off, a potential breakout by the "500" is taking on a greater probability and will have positive implications for the market on a longer-term basis.

The uptrend continues off the March lows and it looks like there is still enough strength left for the S&P 500 to run up and challenge the closing highs seen last August at 963 which would be considered chart resistance. The other piece of key resistance also comes near the 963 area and is the bear market trendline drawn off the peaks in the index over the last couple of years.

If the market does get up into this zone, we would then expect some type of retracement, perhaps back to the 900 area because the market is so extended. There is good chart

support near 900, and a decline to this level would represent a common fibonacci retracement of 38.2%. A secondary area of support lies in the 865 to 875 zone where chart support and a 50% retracement of the advance lies.

If the S&P 500 blasts right through the 963 area, the index could run a bit because there is an absence of chart resistance until the 1050 zone and that chart resistance runs up to 1175 and is pretty thick. There may be some buy-stops just above the top of the S&P's 10-month range that could provide some initial thrust to a potential breakout.

During the past week, some important indexes broke out of their recent basing patterns, adding to the bullish argument for stocks. An important component of the Nasdaq, biotech stocks, broke out to new recovery highs as the AMEX Biotech Index (BTK) took out its 10-month high after closing above the 400 level. In the financial area, the NYSE Finance Index and the Amex Broker/Dealer each posted a recovery high this week. Staying in the interest-sensitive area, the DJ Utility index broke out of a 7-month base today and is within striking distance of taking out its bear market trendline drawn off the peaks over the last couple of years.

Moving over to the small-cap arena, the Russell 2000 has also broken out of its 10-month inverse

head-and-shoulders pattern and looks poised for further gains. With so many indexes at new recovery highs, can the S&P 500 be far behind?

Looking at long-term momentum indicators, we see further bullish evidence emerging. The monthly moving average convergence/divergence indicator or MACD has turned positive on the S&P 500, crossing above its signal line for the first time since 1999. More importantly this time, it is occurring from a deeply oversold territory. The weekly MACD is also in a positive configuration, above the signal line and just recently, crossing above the zero line, giving further confirmation of the latest move. This is the first cross above zero for the weekly MACD since late 1998. The weekly MACD also broke above a down-sloping bearish trendline drawn off its peak in 1999.

While we have yet to see the price gains and absolute momentum usually seen during the beginning of a major bull market, and therefore have not pushed the Relative Strength Index (14-day) to an extreme overbought reading also seen at the start of something major to the upside, there has been definite improvement in the RSI readings on both a daily and a weekly basis.

The 14-week RSI has recently moved to its highest level in the last couple of years and has also broken above a down-sloping trendline that has held the RSI in check since 1997. During the start of many major bull markets, the 14-day and 14-week RSI will rise to the 80 level, exhibiting an extreme overbought condition and a lot of price strength. So far, the market has not been able to accomplish that with the 14-day RSI at 66 and the 14-week RSI at 61, but it certainly could happen.

After all these bullish observations, one only has to look at sentiment to come back down to earth. Remember, sometimes near an intermediate or long-term peak in the market, things will look brightest, and this gets reflected in these investment polls. The opposite occurs at major market lows. Investor's Intelligence readings for the latest week are 54.4% bulls and only 23.9% bears, extreme overbought readings. The American Association of Individual Investors poll is showing 52.8% bulls and only 18.4%, also an extreme reading. We get the sense that a lot of the potential ammunition for this particular run has been used up, and that should limit gains from here.

One other sentiment tool that is flashing caution is the volatility indexes. The VIX or volatility of the S&P 100 has declined down to 21, the lowest level since last May. When the VIX has declined to 20 or below over the last couple of years, it has meant trouble for the market. The VXN or volatility index on the Nasdaq, has fallen to 31, the lowest level in almost five years. These volatility indexes measure option premiums and indicate that premiums are very low on a historical basis and show a great deal of complacency in the marketplace.

While the recent price strength has to be respected, the sentiment indicators suggest the gains from here will be limited. Arbeter is chief technical analyst for Standard & Poor's

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