A Key Move for the S&P 500

The index has broken out of its trading range -- and appears headed for further losses

By Mark Arbeter

Note: Technical Market Insight will not be published on Aug. 16. It will return on Aug. 23.

The S&P 500 finally broke out of its more than 6-month trading range last week and appears headed for further losses. The much weaker than expected July nonfarm payrolls report on Friday, Aug. 6, caught the market by surprise and sent the 500 to its lowest level since mid-December, 2003. The Nasdaq dropped to levels not seen since August, 2003.

The late-week breakdown by the S&P 500 took it firmly below critical intermediate-term chart support in the 1,080 area. This level was the floor during the long consolidation and the break of this floor should be considered an important technical breakdown. The S&P 500 is now down 8.1% from its February 11 closing high, and while this is certainly an unpleasant drop, it is much less than many other indexes.

Many technical breakdowns, especially with individual stocks, are accompanied with a surge in trading volume. The volume figures for the NYSE and the Nasdaq were about average on Friday and may give the bulls some ammunition that this is just a minor breakdown and that the indexes are nearing a bottom. However, many market bottoms occur in the face of capitulation-type volumes, not average levels.

As we have said in our recent comments, a strong break below the 1,080 support zone for the 500 would give us an initial technical target of 1,010. This mechanical objective is arrived at by subtracting the width of the 6-month consolidation, which was 74 points, from the bottom of the trading range at 1,084. The next significant Fibonacci retracement of 38.2% of the advance since March, 2003, would target the 1,021 level. Intermediate-to long-term chart support also begins in the 1,010 zone and runs down to 950. The 950 area is immensely important because it represented the top of the trading range during bear markets bottoming process during 2002 and 2003. Additionally, the September, 2001, low was also in the 950 region.

The Nasdaq is quickly approaching bear market territory, with its 17.5% decline off the January, 2004, high. The index, along with many of its growth related components, has led the overall market to the downside, after blowing away many other indexes and stocks during the bull market off the October, 2002, bottom. The index remains in a very clear and definable downtrend, with a series of lower highs and lower lows being traced out since the top in January.

The technicals deteriorated even further on Friday as the Nasdaq broke below this downward sloping channel. This trendline break, in conjunction with the S&P 500's break, may be a precursor to further price acceleration to the downside. While this may leave a bad taste in the mouths of investors, the faster the market drops, the quicker that we get a market bottom. Slow, deliberate declines (typical bear market action), is the other alternative, and we feel this is a far worse scenario.

Over the last couple of weeks, we talked about the possibility of a very negative moving average crossover with respect to the Nasdaq. Well, with Friday's decline, it finally happened. The 50-day exponential moving average crossed below the 200-day exponential moving average, giving an important moving average crossover sell signal. The last time the 50-day crossed below the 200-day was way back in October, 2000. This simple crossover system has been bullish since May, 2003. Since 1990, these crossover signals have been fairly rare, and while not perfect, they have tended to give pretty good buy and sell signals.

Support levels for the Nasdaq are not as evident or strong as they are on the broader based S&P 500. This is typical because the Nasdaq tends to advance much faster than the "500" during bull markets and therefore there is not as many areas where there is a concentrated area of trading. Minor chart support for the index lies between 1,600 and 1,800, but more substantial chart support does not start until 1,500 or the top of the range set during the bottoming process in 2002 and 2003. A 50% retracement of the move off the March, 2003, bottom would target the 1,713 level. For informational purposes, a 20% decline (bear market definition) from the January, 2004 peak would equate to a decline down to 1,723.

Since peaking out at 4.87% on June 14, the yield on the 10-year Treasury note has benefited quite a bit from the weakness in stocks. This was more than evident following the payroll numbers on Friday as the 10-year note rose sharply in price, pushing the yield all the way down to 4.21%, or the lowest level since April. As mentioned before, chart support is thick between 3.9% and 4.4%, while a 61.8% retracement of the advance from March targets the 4.13% level. While we don't expect yields to drop much below 4%, it would certainly be possible if stocks continued their downward trek.

On a historical basis, the stock market has an uncanny ability to put in major lows during the months of September and October. If we get a sharp break during August and put in a decent bottom, we would expect a test of that low sometime in the September-October timeframe. This is the easiest scenario to predict and gives us decent trading opportunities. The other possibility, mentioned above, is that the market continues to erode slowly in true bear market fashion. This environment is obviously best viewed from the sidelines for the longer term investor and played on the short side by the active trader.

Arbeter is chief technical analyst for Standard & Poor's

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