By Mark Arbeter
The major stock market indexes were as cold as the weather in the northeastern U.S. last week, dropping three out of four days, and reversing the nice gains of early January. Over the past two weeks, the S&P 500, the Nasdaq and the Dow Jones industrial average have all fallen about 7%. If that is not enough, on Friday the S&P 500 broke critical support, and the index appears headed for a test of the July and October lows.
After drifting sideways for the last three months, the S&P 500 and the Dow Jones industrial average broke out of their consolidative patterns with a vengeance on Jan. 24 and it looks like a resumption of the downtrend has begun. About the only positive Friday, albeit minor, was the fact that volume was not particularly heavy.
Nonetheless, the price action and chart formations look terrible, and many stocks broke down along with the averages. The Nasdaq did not break below the lower end of its trading range but that will most likely occur this week.
Now that the "500" has taken out the critical support level of 870, major support is located down at the July and October lows of 775 to 800. For the DJIA, which had support at 8250, its summer and fall lows are in the 7200 to 7500 area. Near-term support for the Nasdaq lies at 1319 and once that is taken out, support is seen at the July lows of 1200 and the October bottom of 1100.
If there is an extremely negative headline (related to a possible U.S.-Iraq armed conflict, for instance) then the speed of the descent should be quite rapid. However, there is the possibility that the markets will form another narrow, downward sloping channel and the move lower could be rather deliberate, a chart pattern that has been witnessed many times during the last three years.
The action of the largest capitalization issues in the S&P 500 has certainly not been pretty. The top four stocks in the S&P 500 by market cap - Microsoft (MSFT ), General Electric (GE ), Exxon Mobil (XOM ), and Wal-Mart (WMT ) -- have all rolled over and dropped below their respective trading ranges. Just these four stocks represent 11.6% of the total S&P 500 performance. Microsoft makes up 11.4% of the Nasdaq by itself.
A look at the next seven largest stocks of the "500" from a technical perspective, which if added to the four listed above make up about 25% of the index, does not give us the picture of a healthy market. While these seven stocks remain range-bound, there most recent action is certainly negative, and suggests the possibility that they will also break down and once again test their major lows.
Our indicators that measure accumulation and distribution have turned bearish once again, exhibiting a definite increase in selling by institutions over the past week. Overall volume remains lackluster, as indecision among bulls and bears is extremely high. Continued low levels of volume favor the bearish case for stocks, as strong volume is the weapon of the bulls.
The typical seasonal strength during November, December and January is not playing out too well this year. Although the market rose nicely in November, the next two months have not been kind to market bulls. This is certainly worrisome because this three-month period is usually the strongest period of the year. This illustrates why it is more important to watch the trend of the market along with its internals as the primary focus of predicting the market. In fact, over the last three years, the months of December and January have not been great months for the S&P 500.
One indicator that we watch closely but have not mentioned in a while is the moving average convergence/divergence or MACD. The MACD is a trend-following momentum indicator and is calculated by taking the difference between two moving averages and laying another moving average (signal line) on top. The typical time periods used are 12- and 26-month periods with a 9-period signal line. When the MACD is below zero and then crosses above the signal line and the zero level, a buy signal is given. Sell signals are just the opposite.
Other interpretations of the MACD can also be used such as looking for positive and negative divergences; extreme overbought and oversold conditions, trendline breaks, and something we just discovered, watching the range of the MACD. On the daily chart, the MACD of the "500" has given off negative divergences recently, has crossed below the signal line accompanied by a cross below the zero line and has broken trendline support that has existed since July.
On the weekly chart, we have not seen these negatives on the MACD as of yet. However, what is interesting is that the range of the weekly MACD has not risen above the zero line since late in October, 2000. This is somewhat similar to our analysis of relative strength or RSI. During the bear market, stocks have not been able to exhibit enough strength to break the pattern of weakness in many technical indicators from a longer-term basis. There are zones in which the MACD and RSI will travel during bull and bear market periods. It appears that the weekly MACD, for the most part, will remain above zero during bull markets but stay below zero during bear markets.
Sentiment is certainly hampering the attempt by the market to transition from a bearish trend to a bullish trend. Every time we have rallied during the bear market, market sentiment has moved very quickly to the bullish camp. This goes along with our feeling that many investors believe a return to the glory days is here and that investors are more afraid of missing a move to the upside than are worried about protecting their assets from further downside. Until that psychology changes, there is probably little hope that a sustainable advance can take shape.
During the last month, a period of flat prices at best, CBOE put/call ratios have slid to negative levels as call activity has risen relative to put activity. Over the last couple of months, also a period of unexciting action, Investor's Intelligence poll has generally shown about 50% bulls and less than 30% bears. We might understand these sentiment readings back in the late 1990s, but not after three years of falling prices and in a short-term period of sideways action.
Arbeter is chief technical analyst for Standard & Poor's