Using Charts to Navigate the Market

S&P technical analyst Mark Arbeter sees stocks heading to new highs this summer -- and he explains what signs investors should watch

The worst of the market pullback should be over, and the S&P 500-stock index should be able to post new highs come summer. That's the forecast Mark Arbeter, chief technical analyst and senior investment officer for Standard & Poor's, draws from a study of his charts. (Like BusinessWeek and BusinessWeek Online, Standard & Poor's is owned by The McGraw Hill Companies.)

However, a strong possibility is for weakness in September and October, based on seasonal patterns, Arbeter adds. He also stresses the importance of watching volume. "We still need to see higher levels of overall volume before we can really take off here," he notes. On a technical basis, Arbeter looks favorably on several stock sectors, including oil, biotech, gaming, and commodity-based names in such areas as gold, aluminum, and steel.

These were among the points Arbeter made in an investing chat presented Mar. 30 by BusinessWeek Online and Standard & Poor's on America Online, in replying to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat:

Mark Arbeter is an equity analyst with Standard & Poor's Investment Advisory Services. He has no affiliation with or ownership interest in any company under discussion. S&P's other affiliates may provide services to the companies under discussion.

Q: Mark, do your charts say the market correction is over and we're on the way back up?

A:

I think there's a pretty good chance we saw the worst of the pullback for the S&P 500. I think we saw the low of the pullback for the S&P 500 last week, and we also saw the low for the correction of the Nasdaq last week. We're in the midst of a corrective phase that probably will last another month or so. I think once this consolidative pattern completes itself, probably in April or May, that will allow the S&P 500 to post new recovery highs during the summer months.

Q: Should we sell in May and go away?

A:

I think that if you're nimble, you can start accumulating stocks now, and you'll probably have a good opportunity to take profits in July or August. What I'd be cautious about is historically the weakness seen in the fall months -- September and October -- has a great probability of occurring. And you can't ignore those probabilities. Given that, I'd probably lighten up in the summer months.

Q: Do any stock sectors look better than others from the technical indicators?

A:

Yes. Some of the most positive-looking industry-group charts right now would be the oil stocks, biotech stocks, the gambling stocks, and a broad list of commodity-based stocks, which would include gold, aluminum, and steel stocks.

Q: What do you think the health-care sector is going to do this year?

A:

Health care is a very broad sector. Some of the industries within the it have been performing very well, while other pieces have been lagging behind the overall market. Some of the subindustries within health care that are doing the best on a technical basis would be the medical-device stocks, the biotech stocks, and the HMO stocks. Also the drug-distributor stocks. The main area that has been lagging in health care has been the big pharmaceutical stocks.

Q: Prediction for the Dow at the end of 2004?

A:

For the Dow, I think we can get back up into the 11,500 to 12,000 area by the end of the year. My target for the S&P 500: the 1225 to 1250 area.

Q: Do you look to add to a position on the way up?

A:

The best buy point is when a stock is breaking out to new all-time highs. Another good entry point would be after the initial move up, and you see a pause that moves back to the 50-day moving average on very light volume.

Q: What's your view of market volume in recent days? Is it a positive signal?

A:

We've had a couple of strong price days and sort of average to slightly below average volume. That's something that will have to be addressed as we move forward. That's one of the reasons why I think we might retrace some of our recent gains and possibly do some testing of the recent lows before we see any kind of major upside from the indexes.

What has been positive on the volume side has been the high ratio of advancing volume relative to declining volume. But we still need to see higher levels of overall volume before we can really take off here.

Q: What sell discipline do you use?

A:

There are many signals that one can look for when deciding to sell a stock. As a stock's trend matures, it can do a number of things. The advance will be accompanied by a decrease in volume, which is a negative sign. The slope of the advance can also get very steep, and that's typically a sign that the intermediate move is over. Another negative sign is high volume and little movement in the stock.

A couple of other things to look for would be a break in the price trend and then a break below the 50-day moving average. And probably one of the last things would be when the stock starts heading lower on an increase in volume, in conjunction with the trend break and the break in the 50-day moving average. Those three things would be a pretty good sign that the move is over.

Q: What are the most important things to watch in your charts in this kind of market?

A:

The most important thing is price. The second is volume. Is volume going into an advancing market? And when the market is falling, does volume dry up? Another thing that I watch very closely right now is the breadth of the market based on both price and volume. During the early and middle stages of a bull market, market breadth should remain fairly strong. What you don't want to see is negative divergences with respect to price and market breadth, and so far we have not seen that develop.

Typically, the ends of bull markets are preceded by many negative technical divergences. And one great example would be a peak in market breadth followed then by new recovery highs by the indexes. This negative divergence between breadth and price can sometimes last a fairly long period, but so far none of these negative divergences have cropped up.

Q: How did your technical analysis score in predicting the big market swings of the last several years, vs. other techniques?

A:

Once the market moved into a strong downward trend in 2000, it was clear from looking at many stock patterns and especially the growth area that stocks were in trouble. What's interesting at both market peaks and market bottoms -- and this is the real value of technical analysis -- is that the charts will usually precede a turn in the fundamentals.

At a market peak, stock charts will start to deteriorate while the fundamental news remains positive. At market bottoms, market indexes and individual stocks will turn higher before the fundamentals start to improve. I think technical analysis has compared favorably in recent history over other forms of analysis.

Q: Can you give us any names in the sectors that look strongest to you technically -- oil and others?

A:

Sure. In the oil area, I like Burlington Resources (BR ) and Devon Energy (DVN ). In the biotech area, I like Biogen Idec (BIIB ) and Teva Pharmaceuticals (TEVA ) and Cephalon (CEPH ). In the commodity area, I like Newmont Mining (NEM ) and Alcoa (AA ) and Nucor (NUE ). And in the telecom area, I like Qualcomm (QCOM ). One health-care stock that looks very good right now is Cytyc (CYTC ). And in the communications equipment area, I like Harris (HRS ). In the brokerage area, I like Goldman Sachs (GS ).

Q: How can investors harness technical analysis to best advantage?

A:

The best way to utilize it would be first to educate yourself about the basics of technical analysis. There are some great introductory books out there that are very easy reading. The other way would be to familiarize yourself with basic chart patterns, which would entail using an Internet site and studying stock charts. You don't have to get too engrossed with the hundreds and hundreds of technical indicators that are out there. Just learn how to define when a stock or the market is in an uptrend vs. a downtrend. Is volume supporting the advance?

I tell most people that technical analysis is the simplest form of stock analysis. Basically, you're trying to figure out the supply-demand situation in the market in individual securities. Some of the best authors on technical analysis are Edwards and Magee -- the name of their book is Technical Analysis of Stock Trends. And almost any book written by John Murphy. And also a great way to learn about technical analysis and stock selection is to read Investors Business Daily. And in conjunction with that, William O'Neil's books.

Edited by Jack Dierdorff

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