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Markets & Finance

A Time for Caution

By Mark Arbeter The Standard & Poor's 500-stock index closed higher for the ninth straight week on Friday, Jan. 23, a fairly rare occurrence. The last time the index was able to accomplish nine straight weeks of closing highs was way back in 1989. The index rose on a weekly basis from June 30 until Sept. 1 of that year, and tacked on 11.24% (weekly basis) during that run. The current advance has produced just over a 10% weekly return.

During the streak in 1989, the market moved to a very overbought position, similar to the situation today. After a mild pullback in '89, the S&P 500 made minor new highs and then went into a fairly lengthy consolidation. This happens to be just what we are looking for at the current time.

Among many things, the action in the Treasury market over the five days ended Jan. 23 could provide the catalyst for a consolidation or pullback in the equity market. There have been two major reversals in the 10-year Treasury note of late, one occurring on Jan. 23 and the other on Jan. 16. Adding more importance to these reversals is where they occurred -- right at critical chart


The closing yield low for the 10-year Treasury back on Oct. 1, 2001, was 3.93%, while the intraday low was 3.91%. On Jan. 16, 2004, , the 10-year Treasury yield fell to an intraday low of 3.92% with the intraday low on Jan. 23 also at 3.92%. This certainly looks like an end to the intermediate-term rally in Treasuries that started when yields were up near 4.7%. The near-term target for yields would be at 4.25% and then 4.4%.

There is important

trendline support up at 4.35% and critical chart support in the 4.4% to 4.5% area. While the very long-term trend in bond yields remains bullish, the near-term action looks bearish within an ongoing bottoming process for yields.

Trading volume, particularly on the Nasdaq, has been very high during January, as it appears investors are throwing money at the market as prices continue their winning streak. Since Jan. 5, which was the official start of normal trading in 2004, Nasdaq volume has been way above average during every session.

While we like to see high volume levels during market capitulations, and rebounds coming out of major corrections or bear markets, we do not like to see consistently high levels after a major price advance. If we just look at times when the market was extended and in a bull market, and then look for times when volume spiked during at least a two-week timeframe, the implications of this combination are not positive.

There was a big thrust in volume during April and May, 1996, after a big run-up in the Nasdaq and it was followed by a more than 13% decline in the index. All of these examples are using weekly declines for ease of comparison. The next time this combination occurred was in January, 1997, and resulted in a 12% pullback. The January, 1999, occurrence was followed by an almost 9% decline. The last one that will be mentioned was in March, 2000, and we all know what happened after that.

As can be seen from the above data, a couple of these volume spurts transpired in January, just like the one this year. This goes hand-in-hand with the historical pattern of the market topping out early in the year and something we have talked about recently. In seven out of the last 14 years, the market put in either a minor or a major peak in January. During two of the 14 years, the peak occurred in February and in 4 other years, the market went into a trading range early in the year.

The S&P 500 hit an intraday high of 1,150.51 last week, extremely close to a key resistance level. One of the potential stopping points for this rally that we have mentioned quite often is a very important Fibonacci retracement of 50% of the bear market, which targets the 1,152.11 level. While it is still too early to tell whether this is the area that will put an end to this rally, it is certainly something to watch closely, considering all the other evidence that a peak may be near. The other significant piece of resistance for the S&P 500 is up in the 1,170 to 1,180 zone. This is where the market crested in both 2001 and 2002 and represents important chart resistance.

Market sentiment remains heavily skewed towards the bullish camp with some investment polls showing historically high levels of positive sentiment. The short-term Consensus poll is at an absurd level of 81% bulls, the highest we have ever seen. Similar readings of 80% were seen in July, 1997, and in April, 1998. In 1997, the market went into a six-month consolidation, and in 1998, stocks paused for two months.

Another concern from the sentiment arena -- more important than the investment polls -- is the recent action of the CBOE put/call ratios. The 10-day CBOE put/call ratio recently fell to 0.63, or the lowest since November, 2001. The 30-day P/C ratio has dropped to 68.9%, the lowest since December, 2001. This clearly shows a move by option investors to the bullish side of the fence. We will note again though that these ratios are still a long way from the levels posted during the peak in the market in 2000.

Another important observation about put/call ratios is that they have been in downtrends since peaking in the fall of 2002, coinciding with the bottom in the stock market. As long as P/C ratios continue their longer-term trend of declining, the bull market will most likely remain intact. Just for historical purposes, P/C ratios fell from late 1994 until early 2000, and then rose until the top in 2002. The long-term movements of these ratios follow the paths of bull and bear markets very well.

We believe that the current intermediate-term advance is nearing an end, with a two to five month consolidation taking hold. Arbeter, a chartered market technician, is chief technical analyst for Standard & Poor's

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