The stock market is likely to perform "in a sideways fashion" this summer but reach a bottom later in the year, according to Mark Arbeter, chief technical analyst and senior investment officer for Standard & Poor's. Bear markets typically end sometime between August and December, he points out.
Arbeter observes that this market decline is largely company-specific, although technology and telecom are major losers. The indicator he's watching most closely at the moment is investor sentiment, though he's also alert to put/call ratios and volatility indexes.
In selecting stocks, he likes to see a name that is strong by both technical and fundamental measures. That combination shows up best right now in health care (except for pharmaceuticals) and in gold and steel stocks.
These comments were among many Arbeter made in a chat presented June 27 by BusinessWeek Online on America Online, in the course of responding to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Mark, despite the WorldCom (WCOME ) shock, the market managed to climb today. From your standpoint, what's going on -- and more to the point, where are we going?
A: Well, right now, we're in the process of testing the price lows seen during September, 2001. It's too early to tell whether this is the final bottom, but I think we are seeing good indications that we are really close to a bottom, which I suspect will occur either this week or next week.
Unfortunately, because of the time period that we're in right now, moving into July and August, which are the slowest trading months of the year, I think the market, at best, will trade in a sideways fashion during the summer. And then the final low will probably occur in the third or fourth quarter of this year. Typically, bear markets end during the time period of August through December, so that's when I'm looking for the final low.
Q: What indicators are you watching most closely now? Is sentiment important right now?
A: That's probably the most important indicator at this point. I'm watching many different sentiment indicators, and I'm looking for extreme levels of bearishness among these sentiment indicators. The ones I'm looking at very closely include sentiment polls, such as Investor's Intelligence. I'm also looking at put/call ratios, and I'm watching the volatility indexes.
Q: I think the S&P is still overvalued by 8%. Is that true from a technical standpoint?
A: That's a fundamental question. We don't look at "overvalued" or "undervalued" situations as technical analysts. We look at prices, price trends. We look to see if the market is overbought or oversold, we watch sentiment very closely, we watch other markets (such as the bond market and the dollar). We look at internal indicators -- such as up/down volume and advancing issues vs. declining issues. And we also look at probably the most basic form of technical analysis...the chart patterns of the major indexes and major components, or stocks, of those indexes.
Q: What caused the market to rise in face of the WorldCom debacle?
A: Well, I think at the time of the WorldCom news, the market that day moved down to September's price lows, which were also the lows seen in October, 1998. At these levels -- 950 for the S&P and around 1,400 for the Nasdaq -- both in 1998 and 2001 we saw a period where institutions came back into the market to bid prices higher.
That's where we can expect, as technicians, additional buying to come in off the sidelines. And we can also expect investors who are short to come in and cover their shorts, which adds demand for stocks and pushes prices higher. During this whole process, the market has gotten very oversold, and it was due for a bounce.
Also, the news that seems to be herding the market at this point is mostly company-specific.... There are weaknesses in technology and in telecom, and in certain other areas that have come to the forefront just recently, that have hurt a lot of major stocks within the indexes. However, we're not seeing, in my opinion, reasons for people to liquidate their entire portfolio. Those reasons might be, say, rising inflation, high interest rates, global meltdown in the economy. Most of the bad news has been either company-specific or industry-specific.
Q: Is there any special sector you like? Sectors that look best to a technician? Or is it company-specific, as you just said?
A: One of the sectors that I like the most right now is health care, if you exclude the pharmaceutical companies. Within health care, I like the HMOs, I like the dental supply companies, I like the hospitals, and I like the diagnostic companies. I also like some consumer-nondurable stocks, as well as gold stocks and steel stocks.
Q: Mark, what about small stocks? How is the Russell 2000 looking these days?
A:The chart formation on the Russell 2000, on a short-term basis, is bearish. It topped out in the middle of April and has put in a series of lower lows and lower highs. It will be very important that the Russell holds to the 450 area, which is about a 50% retracement of the move seen in September, 2001. My guess is that because of the weakening in the dollar, eventually money will move back into those stocks that benefit from a weaker U.S. currency, which will be large-cap issues that do a lot of business overseas. This is probably a real negative for small caps, because they do most of their business domestically.
From an intermediate-term perspective, the Russell 2000 may be tracing out a head-and-shoulders top formation, which is a bearish reversal formation. If that formation completes itself, I think the Russell could probably retrace all the way back to its September lows, which were back in the sub-400 area.
Q: Do you think data-storage companies will recover first in technology? Is that group or any other in tech showing any signs of life now?
A:I would probably expect the next technology run to begin with strength in semiconductor stocks and semiconductor-equipment stocks. However, at this time, there are no technology sectors that are performing well on a technical basis.... What I'll look for, and have yet to see, is a whole host of new technology stocks putting in nice price patterns and breaking out to new all-time highs. But as of yet, we have seen no indication as to where this new technology leadership will come from.
Q: Do you follow QCOM (Qualcomm) at all?
A: On a short-term basis, the stock looks like it's trying to bottom out in the mid-20s area. Intermediate-term, the stock is in a downtrend. We have seen a series of lower highs and lower lows. If the stock were to break below 25, on an increase in volume, things could get kind of ugly because there's very little support below 25 until you get all the way down to about 10. So I'd be real careful with this one.
Q: Any new but relatively unknown technical indicators being developed by analysts that you can comment on?
A:There's a lot of work being done with neural networks. That's fairly new, in the last five years or so. These are models that adapt to changes in the market, but it's way beyond what I do. I think it's important to keep things simple. The textbooks that I've read from the '30s, '40s, and '50s talk about the same chart formations that we see today. The great thing about technical analysis is that people's emotions run from fear to greed, no matter what decade we're in. And these get reflected in the chart patterns of individual issues and indexes.
Q: Is this the Nasdaq's bottom?
A: I still believe that the final price low for the Nasdaq and the S&P will be later this year. You cannot predict a price low in the market until after the fact -- the reason being that you have to see a two-week period of strong accumulation by institutions after you've hit your low. What that says is that institutions are comfortable coming back into the market, and their accumulation...will lead to the next bull market.
Q: Mark, do you include any input from fundamental analysis in coming to your conclusions?
A: Yes, I do. In picking individual stocks, I like to see not only strong technicals but also companies that are growing strongly from a revenue standpoint, as well as in earnings per share. I like to see companies with high margins. I also like to see the industry that the company is in doing well -- not just one company doing well, but a whole group of them. Typically, when you combine fundamental analysis and technical analysis, and fundamentals and technical are both strong, that's where you see the greatest price winners during a bull market.
Q: What's the major problem with the chart formations of many of the tech stocks?
A:The overriding problem with most technology stocks is that they're so far off their all-time highs, and there are so many investors who still own these stocks at much higher prices, that whenever these stocks rally, they will be hit by a supply of stock that was bought at higher prices. As an example, you buy a stock at $20. It falls to $10, it rallies back to $15 or $20. All those people who bought at $20, and held through that 50% decline, will look to break even when the stock gets back to $20. That's where the supply of stock comes from.
Now, if you think about the major techs, many have fallen from 100 or above. They may have fallen to 50, moved sideways, then maybe dropped to 20, but each time the stocks run back up to resistance levels, they'll be hit with supply, which will drive the stocks lower again.
Q: Why not buy now at very low prices for the long term? And do you see any stocks where technical and fundamental indicators are both strong now? The point you like to see!
A:I think if you have a very long-term perspective on the market, and your expectations have been ramped down, now is probably a good time to come back into the market in a very diversified way. As for the second question, right now stocks with the strongest fundamentals and technicals include some of the health-care groups I mentioned before: the HMOs, hospitals, and diagnostic companies. Steel stocks, gold stocks. That's where you're seeing the best combination of technicals and fundamentals at this time.
Q: Mark, what are the important levels to watch for the Nasdaq and S&P 500 indexes?
A: For the S&P 500, the 950 area is very important. I wouldn't be worried unless we saw a close 2% below the 950 area. You have to give the indexes a little room. For the Nasdaq, the 1,375-1,400 area is very important, and I would not be concerned unless the Nasdaq closed 5% below that area. If that were to occur with both indexes, then I think you could see another down leg. It's interesting, but the second low for the Nasdaq does frequently undercut the first price low, which really sends sentiment to bearish extremes, and usually marks a major bear-market low.
Q: And finally, any prediction for how the S&P and Nasdaq will close the year?
A:I think the S&P 500 has a good shot at closing in the 1,100 area, and I think the Nasdaq could approach the 1,800-to-1,900 area by the end of the year.
Edited by Jack Dierdorff