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Time for a Turnaround?

From Standard & Poor's Equity Research

The major stock market indexes ran into decent areas of overhead resistance early last week, and then succumbed to some profit taking and consolidative action during the holiday-shortened week. Bond yields continued to be very choppy while crude oil made a marginal new high before backing off.

The S&P 500 index ran up to the 1280 level on Monday, July 3, and then drifted a bit lower by the end of the week. There is a zone of chart resistance in the 1245 to 1291 range and we thought the index would pause or do some backing and filling once this area was reached.

In addition to this overhead supply, there is a host of key moving averages in this range as well as important retracement levels that sometimes act as resistance. The S&P 500 has broken back above its 200-day exponential moving average at 1262 and the 50-day exponential average lies at 1268. These averages now represent potential support for the index. The 80-day average sits at 1284 and represents potential resistance. The next key retracement level is 61.8% of the recent correction, which targets the 1286 level.

The "500" looks to be tracing out a potential, bullish head-and-shoulders (H&S) reversal pattern. The left shoulder was formed in May, while the head took shape in June. The index may be working on the right shoulder currently which could take the "500" back down near the levels of the left shoulder in the 1245 to 1260 zone. If that pullback occurs on lighter than average volume, and the S&P 500 then breaks above the neckline that may be forming, it would signal a bullish price reversal in our view.

The Nasdaq remains in poorer technical shape than the S&P 500 and the small cap indexes as it continues to trade below many of its key moving averages. The rally on July 2 took the index right up to its 50-day exponential average, which now lies at 2186, and the Nasdaq failed to get through this piece of resistance. The index has since fallen back to decent chart support between 2140 and 2155. The 200-day simple and exponential, and the 80-day exponential averages all lie between 2210 and 2228, and we believe represent key resistance levels for the index. Chart resistance comes in between 2136 and 2234, and this is from the consolidation in late May and early June. A 38.2% retracement of the correction targets the 2184 level and a 50% retracement comes in at 2220.

The U.K.'s FTSE 100 Index, which sometimes leads the U.S. indexes, has completed a bullish, double bottom reversal formation, and we see additional gains from here. With the close above the previous high of 5791, the index confirmed that the bottoming process was complete, and is set to potentially run back near the recovery highs last seen in April and early May, in our view. Taking the width of the double bottom and adding this to the breakout point of 5791 targets the 6075 level. The FTSE has retraced over 50% of the correction, and the next Fibonacci retracement of 61.8% sits just above current prices at 5894. Overhead chart resistance lies up in the 5936 to 6133 area.

With the recent price strength, the FTSE has climbed back above all its key intermediate- and long-term moving averages. The 14-week relative strength index has bounced sharply off of bull market support while the weekly MACD looks like it is bottoming out. While a test of the recent breakout point is a possibility, we do expect further gains in the index.

Market sentiment, after getting very bearish, is starting to turn around, and that could be a positive, in our view. After moving to extremely high levels, the CBOE total put/call ratio has started to back off, as investors take profits in their put options and start to buy call options. The 10-day and 5-day averages of CBOE P/C ratios have both traced out double tops and are starting to head lower. They both have broken below rising trendlines that have been in place since early May. The same action can be seen in the equity-only P/C ratios, although they did not move to extreme oversold levels that the overall P/C ratios did.

Some of the investment polls are also showing a move away from extreme levels of bearishness and towards a more constructive view of the market. For instance, the American Association of Individual Investors poll has shown a rebound in bullish sentiment to 38.6% from 26.2% over the last 3 weeks while bearish sentiment has dropped to 39.8% from a recent reading of 55%.

Crude oil prices closed at a marginal all-time high on Wednesday, July 5, finishing at $75.19 per barrel, just 2 cents above the previous all-time high posted on Apr. 21. Prices then backed up on Friday and finished the week at $74.09. With the strong break above trendline resistance, crude has broken a string of lower highs, and we believe this completes the recent correction. If the crude market can break strongly above the recent highs, a breakout will be confirmed, and then we think we could see prices headed up to at least the $80 level. Trendline resistance, drawn off the peaks over the last couple of years comes in at $80. The width of the latest consolidation/correction was $7.00, adding this to the potential breakout point of $75 gives us a potential measured move up to the $82 area.

One worry about oil prices, in our view, is that even if crude can climb to $80 or above, it is unlikely that weekly momentum indicators will confirm this move. This would set up some glaring weekly divergences down the road, and may signal that either a major correction will be seen, or a possible longer-term top.

We have had a tough time predicting what bond yields are going to do of late, as the market has gotten very choppy. The 10-year Treasury yield has once again traced out a series of lower yield highs and lower lows, since peaking out at 5.25% on June 28. There is heavy chart support up in the 5.25% to 5.50% range, and the lower part of this range has acted as a ceiling for bond yields over the past couple of months.

Chart resistance sits in the 4.9% to 5.2% zone while trendline resistance comes in at 5.05%. Longer-term trendline resistance, off the yields lows since June 2005, is all the way down at 4.7%.

One big positive for bonds, in our view, is that both daily and weekly momentum indicators are tracing out negative divergences with respect to yields, and may suggest that a rally in bonds is near and that yields have peaked or are close to peaking for the intermediate-term term.

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