From Standard & Poor's Equity Research
After a very tough start last week, the stock market regained its footing and put on a decent showing. There was a successful test of the recent lows, but we do see more tests over the next couple of weeks. Treasury yields pulled back just under 5%, while oil ran up near important resistance.
On Tuesday, May 30, the S&P 500 closed at 1259.84, successfully testing the May 23 closing low of 1256.58. The key to a successful test of support, in our view, is lower volume during the test. This demonstrates, in our opinion, that selling pressure is easing as the index tests support. NYSE volume on May 22 was 2.04 billion shares, and volume on May 24, when the S&P 500 hit its lowest point during the pullback on an intraday basis, spiked to 2.25 billion shares.
When the S&P 500 tested the lows on May 30, volume dropped sharply, coming in at only 1.54 billion shares. Sharply lower volume on the Nasdaq was also seen during the retest. Nasdaq volume was 2.3 billion shares on May 22, 2.7 billion shares on May 24, and only 1.8 billion shares on May 30. Nasdaq volume on May 24 was the highest since December 7, 2004 so it's possible that this represented a capitulation.
In addition to a sharp decline in trading volume during the retest, there was also some improved price momentum and internal data that suggested to us that at least a short-term bottom was in. The peak in downside momentum with respect to the 6-day relative strength index (RSI) occurred on May 18 when this indicator fell to 14.1. Since that day, the 6-day RSI has traced out a series of higher highs and higher lows. The 14-day RSI put in a double bottom on May 18 and May 23 around 29.
Downside volume on the NYSE in relation to upside volume peaked on May 17 at 9.01. During the May 30 retest, this ratio fell to 8.02. NYSE new lows, divided by NYSE issues traded, peaked at 6.2% on May 17. During the retest, NYSE lows/issues fell to 3.1%. On the Nasdaq, new lows peaked at 4.5% on May 22 and fell to 1.78% on May 30.
So while we believe the stock market has put in a short-term low, we do see more volatile action over the next couple of weeks as prices do some more downside testing. With the degree of the latest pullback as well as the quickness of the retreat, we think it will take at least 2 weeks from the initial low before an intermediate-term bottom is in.
We have been looking for an initial rally to carry the S&P 500 up to the 1290 area. We hit 1290.68 on an intraday basis on Friday, so we think the majority of the initial rally off the first low is near completion. If we are close in our forecast, we still believe the probability is high that the initial lows will be tested in the 1245 to 1260 zone over the next couple of weeks. We believe another successful test would set the market up for a decent move into the summer. If we do get a rally in the summer, it could very well mark the top for the bull market, in our view.
We focused on the 1290 level as a potential short-term peak for the S&P 500 for a couple of reasons. First, there is a fair amount of chart resistance in the 1285 to 1310 zone. Secondly, there are numerous intermediate-term moving averages that lie near the 1290 level. These include the 50-day and 65-day exponential moving averages as well as the 80-day simple average. Often, when an index or individual stock breaks substantially below these key, moving averages, the first rebound back to these averages fails. When the market is above these moving averages, they often provide support during an advancing market. When the market drops below these averages, they then become resistance. Thirdly, a 50% retracement of the pullback lies in the 1290 area.
While we have focused on the record CBOE put/call ratios of late, other sentiment indicators have slowly shown a pickup in fear, a prerequisite, in our view, for an intermediate-term bottom. The Investor's Intelligence poll of newsletter writers is showing 42.6% bulls and 29.8% bears. This is the lowest percentage of bullish sentiment and the highest percentage of bearish sentiment since early March. The American Association of Individual Investor's (AAII) poll is showing only 33% bulls and 45.5% bears. This is the lowest percentage of bullish sentiment and the highest percentage of bearish sentiment since the last major intermediate-term bottom in October 2005.
There have been some extreme readings with respect to the ISE Sentiment Index (ISEE) of late. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often-specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.
When the ISEE is over 100, more customers have opened long call options than put options. When the ISEE is below 100, more customers have opened long put options than call options. On Wednesday, May 31, this sentiment reading fell to 89, the lowest since September 1, 2004. The reading on Thursday was 97. Since the middle of 2003, readings below 90 have been quite rare. We did get very low readings in May and August 2004. The May timeframe represented a short-term bottom, while the August time period represented an intermediate-term bottom.
We think bond yields have finally peaked from an intermediate-term perspective, as yields broke through trendline resistance on Friday drawn off the mid-January lows. The 10-year Treasury finished the week with a yield of 4.99%, the lowest since April 26. It appears that the 10-year has traced out a topping pattern, in our view, and could see some further downside action. The 10-year is currently testing resistance from the 50-day exponential moving average with the next piece of resistance in the 4.7% to 4.8% zone. Intermediate-term trendline resistance, off the June 2005 yield lows, comes in around 4.7%. A 38.2% retracement of the yield rally from June, 2005, to the recent peak in mid-May also targets the 4.7% level. The bond market had gotten fairly overbought in April, with respect to yields, and has put in some negative divergences ever since.
Crude oil prices rose a bit last week and are very close to breaking out to the upside, in our view. Trendline resistance, drawn off the peaks since April 21, sits up at $72.60. With oils' close at $72.33 on Friday, the market is getting very close to breaking the series of lower highs. The latest pullback in oil, from $75 to $68 has alleviated a very overbought condition on the daily charts. In addition, the pullback represented a 38.2% retracement of the rally from November until April. The daily MACD has turned higher while the weekly MACD is still working on a series of higher highs and higher lows.
While we were looking for a correction down into the low $60s, a strong break above the trendline mentioned above would put our forecast in doubt. It is interesting to note that the oil indexes that we follow did correct all the way back to their lower, long-term channel lines. Key, intermediate-term support continues to be at $68, in our opinion.