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Running Out of Gas

By Mark Arbeter While there has not been a breakdown in prices or any indication that the current rise is over from a chart perspective, stock market momentum is starting to wane, and this raises a caution flag. Besides the weakening momentum, bullish sentiment is rampant and that suggests that expectations for the future have probably gotten ahead of themselves.

The S&P 500 was finally able to close above the 1000 level last week but was unable to make much progress from there and by week's end, was back below 1000. The index remains in a very definable, bullish channel with

resistance up at 1030 and

support at 970.

Chart resistance begins up at 1050 and gets heavy at the 1100 level. Chart support begins at 950 with better chart support at 900. A 50% retracement of the rally since March also comes in at 900. The 50-day exponential

moving average, many times support during an uptrend, lies just below the 950 zone.

One important reason that may be contributing to the pause in the current rally is that the Nasdaq has run right up to a very important, downward-sloping

trendline, and this is acting as resistance. A trendline drawn off the highs in May, 2001, and January, 2002, comes in at the 1670 area and has halted the index over the last two weeks. Despite the fact that the Nasdaq has rallied 32% since its March closing low, and has clearly entered at least a cyclical bull market, one can argue that it still remains in a bearish channel that has existed since 2001.

And while the action in the Nasdaq has most certainly bullish on both an absolute and relative basis, we continue to believe the index is in the middle of a multi-year basing pattern that could extend into 2004 and beyond.

Another reason why the Nasdaq's momentum may be waning is the fact that the index has finally run into the beginning of some decent chart resistance. This resistance begins in the 1700 area and runs straight up to the 2000 to 2250 area.

Further problems for the Nasdaq may come from one of the best-performing industries since the March lows: biotech. The AMEX Biotech index (BTK) has rallied an astounding 57% from its low in March to its recent closing high on June 5, and has been a big contributor to the recent success of the Nasdaq. The BTK, like the Nasdaq, has rallied right up to trendline resistance drawn off the June, 2001, and December, 2001, peaks. The biotech index has also moved into an area of very heavy chart resistance that runs from the low 400 level to the low 600 level.

The semiconductor stocks, another important component of the Nasdaq, have also run into some major resistance levels. The Philadelphia Semiconductor index, or SOX, has peaked recently up at chart resistance in the 400 area. The index has also run into major trendline resistance at 400, with this trendline being the bear market line drawn off the peaks in 2000 and 2002.

One area of our analysis that we continue to worry about is market sentiment. The latest weekly poll numbers from Investor's Intelligence are even more ridiculous than those of the previous week, with 60.2% bulls and only 16.1% bears. As we have said, this is an extreme reading and one that could set the market up for failure. The combinations of the Consensus and Marketvane polls (both short-term in nature) have moved to a sell signal finally, with a reading of over 110%.

Meanwhile, the volatility indexes (VIX, VXN, QQV) continue to drift at very low levels, showing a great deal of complacency towards the market, and are not at levels that are conducive for sharp gains from here.

The one piece of the sentiment puzzle that has supported the market's advance, put/call ratios, is finally approaching low levels that have been associated with decent-sized corrections. For much of the advance off the March lows, CBOE put/calls remained fairly high, actually moving to fairly healthy levels even when the market was rising. This was very bullish, as it suggested that option players did not believe the rally was for real.

Lately, however, put/calls on the CBOE have declined as more and more investors switched to the bullish camp and started buying calls rather than buying protective puts. The 10-day exponential moving average of the CBOE p/c ratio has fallen to 0.68 or the lowest level since last August. Readings below the 0.70 level over the last couple of years have been trouble for the market. The 30-day exponential moving has dropped to 0.75, a level that has also been trouble for the market over the last few years. We will note that during strong bull markets, these moving averages have had to drop even further until the market ran into trouble so it will be interesting what happens from here.

While it is certainly possible that the rally extends from here, the easy gains are behind us and an eye toward the exit is warranted. Arbeter is chief technical analyst for Standard & Poor's

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