An Unconvincing Rally

The market needs strong trading volume to accompany price gains -- and that has been sorely lacking in recent sessions

By Mark Arbeter

The stock market started the New Year with quite a bang from a price perspective but once again, total volume was very suspect. The fact that institutions did not embrace the price strength leaves the market wanting and we still believe susceptible to further losses.

On Monday and Tuesday, the S&P 500, Dow Jones industrial average and NYSE all tested the bottom of their respective ranges on very light volume, and then exploded on Thursday. The Nasdaq got close to testing the bottom of its recent consolidative zone, and the early-week volume was also very light. Given the fact that the market has run out of selling pressure, at least short-term, a successful test was not a big surprise.

However, a low-volume test of support only implies that the market is in a position to bounce, and not out of danger. The market needs strong volume on price gains and that has been a sorely missed ingredient for the bulls. If the major indexes again fall to the bottom of their recent ranges and volume starts to pick up, then an extension of the trading range will likely occur.

Key support levels for the major indexes remain the same. The S&P 500 has chart support in the 870 to 876 area while a 50% retracement of the October to late November rally comes in at 860. Chart support for the Nasdaq lies at 1319 with a 50% retracement of its recent rally nearby at 1315. If these levels are taken out on average to above-average volume, the "500" will likely fall to near the lows seen during July and October of between 770 and 840. This is also an area where strong buying was seen and therefore remains a critical zone. The Nasdaq could decline down to the 1200 to 1300 range or the lows seen during July.

Chart patterns of the major indexes and many individual stocks remain negative. As we have pointed out, the S&P, DJIA, and NYSE failed to complete their respective reversal formations, as they did not take out the interim price highs of August. If history is a guide, and a new bull market had started, these indexes would have quickly taken out these highs in the process of completing bullish, double bottom patterns. What may be developing now because of these failures are intermediate-term, double tops with the first high in August and the second high in late November/early December.

To complete or confirm these negative patterns, the lows in July and October will have to be taken out, something we are not calling for at this point. Shorter term, since about the middle of October, the indexes have also traced out potential negative head-and-shoulder formations. To complete these patterns, the recent trading range lows, cited above, would have to be broken.

Although overall volume has been very light of late, and certainly not surprising because of the holidays, there remains a clear pattern of mild distribution by institutions. If a new bull market were underway, large price gains would be accompanied by higher than average volume as well as strong up/down volume statistics. That is not occurring, which leads us to believe more basing activity will be seen with the indexes continuing to travel sideways in a fairly wide range.

Another concern remains market sentiment readings. Investor's Intelligence poll of newsletter writers is still showing about twice as many bulls as bears. This wide spread has preceded trouble in the past. Put/call ratios have also declined and are approaching bearish levels on a 10- and 30-day basis. This bullishness continues to be a mystery to us considering the poor market performance over the last three years. When the market can finally climb without a large and quick shift to the bullish camp, we will feel much more comfortable taking a more constructive stance.

In the very short-term, the market could drift a bit higher but we remain very cautious over the intermediate-term.

Arbeter is chief technical analyst for Standard & Poor's

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