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A Tired Market

By Mark Arbeter While the Dow Jones industrial average and Nasdaq composite index broke out to new recovery highs this past week, the S&P 500 continued to drift within the confines of a two-month price consolidation. The Nasdaq has benefited from a big move into semiconductor stocks while the DJIA has been propelled by strength in cyclical stocks.

But the "500" can't seem to break out on positive news -- and won't break down on negative news. It must be August.

The DJIA broke out of its two-month trading range on Monday, Aug. 18, with a fairly large gain. This is just what you want to see on a price break. However, volume was well below average on the NYSE, exactly what you don't want to see. This certainly does not inspire a lot of confidence for huge gains from here.

With its close above the 9,320 level, the DJIA made a new recovery high. The next area of chart

resistance for the DJIA starts at 9,500 and runs up to and above the 10,000 level. Trendline resistance, drawn off the January, 2000, peak in the DJIA, and also touched in September, 2000, and March, 2002, comes in near the 9,850 zone. This resistance line is also known as the bear market trendline for the DJIA, as it has contained prices for the most part since the peak in 2000. The S&P 500 and the Nasdaq have already taken out their respective bear market lines.

A real negative for the market and the DJIA would be if the index pulled back into its recent base, or back below 9,320, as this would suggest a failed breakout. Failed breakouts, either up or down, can many times lead to a change in the markets' trend.

The Nasdaq also broke to a new recovery high last week, and on the plus side, volume was a bit better than average. The Nasdaq ran up above trendline resistance on Friday and then pulled back sharply. This line of resistance is drawn off the August and November, 2002, peaks. Trendline

support for the Nasdaq lies at 1,700 with chart support also at 1,700 and then 1,600. The 50-day exponential

moving average comes in at 1,680 and is also considered support.

The DJIA has benefited from a rotation into cyclical stocks and out of consumer non-durable stocks of late. Many cyclical stocks have broken out to the upside, and this has certainly pushed the DJIA higher and suggests that investors believe economic growth will continue to accelerate into the end of the year.

The Nasdaq has been helped by a rotation out of biotechs, as that group has paused, and into semiconductor stocks. The Philadelphia Semiconductor Index broke strongly to a new recovery high last week, hitting its highest level since last June. We have not talked about rotation for quite some time, but if this market is going to have legs from here, it is critical that money flows from group to group, as we have seen since March, and not out of the market all together. Rotation is a vital component of any bull market, and while a lot of things change over the years, the song remains the same with respect to money flows.

Unfortunately, there is not much to update on the S&P 500, as it is still drifting within a 2-month plus trading range. During the week, the "500" rose to an intraday high of 1,011, and failed once again. This sets up the possibility that the index is in the process of tracing out a triple top. To confirm a breakdown in the S&P 500, the index would need to close below the 960 level for at least two days.

One glaring weakness in the market internals is the decrease in the number of new highs on both the NYSE and the Nasdaq over the last couple of months. The recent peak in new 52-week highs on the NYSE was 581 on June 6. On July 8, new highs fell to 348 and the most recent peak in highs was on Thursday, Aug. 21, at 225. A similar pattern can be seen on the Nasdaq, with 408 highs on June 6, 390 new highs on July 8 and 310 new highs on Aug. 21. This shows deterioration in the market's internal strength, as fewer and fewer stocks are able to continue to push higher. In other words, the market is getting tired.

Sentiment, which we have been worried about for a month or so, remains obscenely bullish. Investor's Intelligence poll of newsletter writers is showing 55.1% bulls and only 18.4% bears. Bullish sentiment has remained above 50% for 16 straight weeks while bearish sentiment has been below 21% for the last 12 weeks. The VIX or volatility index fell to another new low for the current move, closing at 19.23 on Tuesday, the lowest since August, 2000. As we mentioned before, a close on the VIX above 25 would most likely signal that a correction is finally here. In early August, during the latest pullback, the VIX rose above 25 on an intraday basis, but never closed above this level.

Our market call for a correction two weeks ago was obviously premature, and while the recent rally could extend itself, the low volume breakouts, deteriorating internals, and negative seasonal price patterns leave us cautious. Arbeter is chief technical analyst for Standard & Poor's

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