A Slippery Slope for Stocks

Amid concerns about rising oil prices and interest rates, S&P believes a guarded stance towards equities is justified

By Mark Arbeter

Volatility and market reversals were the story last week, but when all was said and done, markets continued to move in the direction of their intermediate-term trends. Despite the stock market's rally on Wednesday, Mar. 30, off important support, volume was not robust. In addition, the trends in interest rates and oil remain a worry, so we continue to take a cautious stance towards equities.

The S&P 500 traded as low as 1,163.69 on Tuesday, Mar. 29, almost matching the low posted on Jan. 24 of 1,163.75. The index bounced sharply off this chart support level on Wednesday in an attempt to trace out an intermediate-term bottom. Markets as well as individual stocks will frequently bounce off important support levels the first time they are tested, especially when the test is combined with an oversold technical condition. In other words, the ingredients were there for a decent market rally.

In our opinion, the potential trend change must be accompanied by strong demand (trading volume) and also strong internals (price and volume breadth). Trading volume on the NYSE on Wednesday was 1.67 billion shares, and while this was above the 50-day exponential average of 1.56 billion shares, it was below Tuesday's 1.75 billion shares. Price and volume breadth were strong, but without robust trading volumes, we believe the potential for a durable rally are questionable. Consistent levels of volume and strong internals are needed, in our opinion, to get this market off its back.

An extension to the rally looked pretty good in early Friday trading following the weaker than expected payroll numbers for the month of March. The S&P 500 rallied to almost the 1,190 level early on, but reversed and finished lower for the day. The index ran smack into its 50-day exponential moving average and then turned lower. This was the first attempt by the S&P 500 to retake the 50-day, since breaking below this key average on Mar. 16. Additionally, the index ran into a zone of chart resistance that runs from 1,184 up to 1,229, the intraday high on Mar. 7.

After Friday's big reversal to the downside, our expectations for more of an oversold bounce may have been delayed. Daily technical indicators as well as some sentiment indicators have moved to fairly oversold levels, and we think are setting the market up for some kind of bounce in the near-term. In addition, daily momentum indicators are turning higher after getting oversold. The 6-day relative strength index (RSI) on the S&P 500 fell to 19 on Mar. 22, the lowest reading since last August. The 14-day RSI dropped to 33 on Mar. 29, also the most oversold this indicator has been since August.

Meanwhile, the daily stochastic oscillator has turned higher after hitting very oversold levels while the daily moving average convergence/divergence (MACD) is trying to turn after reaching oversold levels. Unfortunately for the bulls, weekly RSI levels have not hit oversold levels, and weekly stochastic and MACD indicators are still on sell signals.

The Nasdaq composite index also fell to support levels on Tuesday and rebounded nicely on Wednesday. The index fell to the 1,970 area, which represented an initial zone of chart support from the highs back in October. In addition, a 50% retracement of the advance from August to early January, provided support at the 1,974 level. The bounce on Wednesday took the index up to near its breakdown point of 2,008, the low in January. The Nasdaq remains below its 50-day and 200-day exponential moving averages, and both are declining. The next zone of support for the Nasdaq lies down in the 1,900 to 1,920 area. A 61.8% retracement of the advance or next Fibonacci support comes in at 1,920.

Like the S&P 500, daily technicals on the Nasdaq moved to oversold levels and daily momentum indicators have turned higher. Unlike the S&P 500, however, the chart condition of the Nasdaq is in weaker shape, and internals with respect to the Nasdaq continue to flash warning signals. Accumulation/distribution models based on the Nasdaq are very weak, indicating a steady dose of selling by institutions. In addition, the chart conditions of many Nasdaq stocks have broken down and in our opinion, are suggesting continued pressure on the index.

One of our worries during much of the year has been the composition of the groups that were doing the best relative to the groups that were underperforming. During the first quarter, the sector that did the best was energy, as measured by the S&P GICS Energy index. The energy sector jumped 17.1% in the quarter, followed by the defensive utility sector, which rose 4.4%. As we have stated many times, these are not sectors that typically lead a durable stock market advance. In addition, oil stocks are strong because oil prices have been strong. The weakest sectors during the quarter included telecom services, which fell 8.6%, information technology, down 7.5%, and financials, down 7%. In many cases, the market does the best when growth and interest sensitive stocks are moving higher.

From a subindustry perspective, many of the leaders were of course from the oil patch. In addition, there was strength in healthcare facilities, drug retail, department stores, personal products, and managed healthcare. The weakest subindustries during the first quarter were Internet retailing and IT consulting. Broad lists of auto subindustries were also weak along with airlines, casinos and gambling, computer storage, multi-line insurance and biotechnology. In our opinion, this is not the kind of strength and weakness that bodes well for the market in the short-to intermediate-term.

Bond yields started off last week heading higher, with the 10-year Treasury note moving above 4.6%. Yields quickly reversed, and hit an intraday low for the week on Friday of 4.4%. The 10-year closed out the week at 4.46%. Technically, 10-year yields are still in a consolidative pattern, after breaking out on Mar. 9. The gap that was created during the breakout was filled on Friday. This gap or absence of trades on a chart from one day to the next was between 4.39% and 4.44%.

We still believe yields are headed higher from an intermediate-to long-term perspective and our next target is up in the 4.7% to 4.9% area. This zone represents chart support from the highs last year. An eventual break of this area, which we are forecasting, would then target the top of the channel that yields have traded in since late-2002, and would take yields to the 5.2% to 5.4% zone. The next 40-week cycle low for yields does not come in until September, so yields have plenty of time to run-up and then reverse into this cycle low.

Crude oil futures also had a wild week, falling as low as $52.50 per barrel on Wednesday before gapping up Thursday and surging Friday to finish at an all-time high of $57.27. On Friday, crude hit $57.70, exceeding the previous intraday high on Mar. 17 by 10 cents. The intermediate and long-term trend for oil prices remains very bullish in our opinion and our next target for crude oil is up in the $63 to $65 zone. Along with the surge in crude oil, unleaded gasoline futures soared to an all-time high on Friday as well. Unleaded gasoline futures have risen from 50 cents per gallon in November, 2001, to over $1.73.

Of course, everyone who has a car already knows this. With our expectation that oil and interest rates are headed higher, we believe a guarded stance towards stocks is justified.

Arbeter, a charterted market technician, is chief technical strategist for Standard & Poor's

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