Is the Worst Over for Stocks?

A growing number of signs suggest the market has successfully tested the September lows

By Mark Arbeter

The market is in the important process of testing the price levels seen during the September, 2001, lows, and there have been an increasing number of signs that point to a successful test. However, with the amount of overhead supply facing many stocks, as well as a slowing trading environment as we move deeper into the summer, the potential rebound will not likely lift the spirits of investors.

There are many key areas of support for the major indexes, represented by both closing and intraday lows and also by previous zones of heavy buying after the lows were in. For the S&P 500, major buying was seen in the 966 to 1000 area. The closing low on the S&P 500 on Sept. 21, 2001, was 965.80 and the intraday low was 944.75. A major low in October, 1998 for the "500" was 957.28, so the mid-900 level on the index is critical.

The Nasdaq saw major buying in September between 1473 and 1581. The closing low in September was 1423.19 and the print low was 1387.06. The closing low in October, 1998, was 1419.10 for the Nasdaq while the print low was 1357.10. One important item to remember during a price test is that the Nasdaq will often close below the initial low by 3% to 5%. Anything more than 5% would be considered a failure, with additional downside likely.

The chart patterns or price trends on both the S&P 500 and the Nasdaq remain in bearish configurations. The "500" has traced out a series of lower highs and lower price lows since the Mar. 19, 2002, high while the downtrend for the Nasdaq has been in affect since the intraday high on Jan. 9, 2002.

While the major indexes have so far held above the September lows, the same cannot be said for many other indexes. The Nasdaq 100 slid to a closing low on Tuesday and was more than 76% below its March, 2000 peak. The NDX also fell to its lowest closing level since Jan. 30, 1998. The Amex Biotech, Amex Pharmaceutical, Dow Jones Utility, and the CBOE Software indexes have all busted below September's lows.

One positive technical development that we are finally seeing comes from the sentiment indicators we monitor. While the short-term investment polls (Consensus, MarketVane) have been oversold for weeks and have moved to levels not seen since the lows in the spring of 2001, there has been a big lag in the CBOE put/call ratios and the Investors Intelligence newsletter poll. There have been four daily readings of over 1.00 for the CBOE put/calls, the most +1.00 readings since the five seen during September, 2001. Looking at the CBOE equity-only put/call ratio, we have had extreme daily readings above 0.80 for five of the last seven days. This is most extreme readings on the equity-only p/c's since the seven out of nine days last September. Also, put volume has finally increased to above average levels which is important to validate these high put/call readings.

The Investors Intelligence poll has finally started to exhibit more fear towards the market after remaining overbought for many months. Bullish sentiment on the II poll fell to 42.9% bulls, the lowest level since early November, 2001. Bearish sentiment increased to 34.7%, the highest level since early October, 2001. In April, bulls were as high as 54.8% and bears were as low as 28.4%. The decline in bullishness in the last two weeks has been fairly substantial, dropping from 53% to 42.9%. That is the largest two-week drop in the percentage of bulls since August, 1997. However, we would like to see bulls/bears fall to 1.00 (currently 1.24) or below; exhibiting the usual pessimism seen at major market lows.

There is some anecdotal evidence that the market is approaching an intermediate-term low as well. Talking with brokers (customers) during the past week, many have said that clients have been throwing in the towel of late, selling their entire stock portfolios because they could not take any more pain. The other anecdotal indication that a low may be near is that the current tone of news is completely opposite from the flow of news at the market top in early 2000. There is a laundry list of terrible news cited for not investing in the stock market at the current time. During the boom times, all the news seemed to support over-investing in the stock market.

While these are certainly not scientific observations, you wonder how much more terrible news is coming, and even if there is more, the market may have fully discounted the worst.

Longer term, a four-year cycle, which has been very accurate, suggests that a major low is due this year. Combining this with the fact that the final low of most bear markets have occurred during the August to December time period, we believe the final low will be seen in the third or fourth quarter. Almost every year there is weakness in the fall months (September and October) that may be extended this year from the potential heavy tax-loss selling. While there may be a trading opportunity during the summer, the best launching point for a durable, intermediate-term rally probably won't occur until later this year.

Arbeter is chief technical analyst for Standard & Poor's

Before it's here, it's on the Bloomberg Terminal. LEARN MORE