By Mark Arbeter
Last week was certainly a fascinating time for the markets, with bond yields plunging and then reversing sharply to the upside on Friday despite a weak payrolls report. In addition, crude oil prices rose sharply while the U.S. dollar added to its recent gains.
So where does that leave stocks? Although the major indexes have been in a fairly strong rally, the advance or price momentum is slowing. We attribute this decelerating momentum to a couple of technical factors. The S&P 500 and the Nasdaq have both run into areas of important chart resistance and we continue to believe that the indexes will have to pull back before they can bust through these key levels and take a run at the cyclical, bull market peaks. The indexes are also very overbought on a daily or short-term basis from both a price and internal perspective. Moreover, volume during the rally has been less than robust, and therefore, we think that the market will need a pause or pullback to recharge its batteries.
Currently, the most interesting index to analyze from our perspective is the Nasdaq. The Nasdaq had advanced (as of Thursday, June 2) 193.62 points, or 10.2% since the bottom on Apr. 28. This is the strongest 24-day period for the Nasdaq since last November. What has caught our attention is the apparent failure at the 2,100 area once again. Not only did this zone provide a ceiling for the index in January, February, and March of this year, but it also led to a pause in the rally in mid-November of last year. Looking further back on the charts, the 2,100 area was also a ceiling for the Nasdaq during its countertrend, bear market rally into the January, 2002 high.
Why the 2,100 level? We believe one reason is that there was a lot of accumulation in this area early in 2004 as well as in late 2004. The institutions and individual investors that acquired stocks in this area were for the most part off in their timing. As the market rallies back near 2,100, these holders of stocks, having sat through some tough times, are probably more than willing to dump their holdings now that they have broken even. This supply, in our opinion, has created at least a temporary ceiling for the Nasdaq.
There were three separate weeks over the not-to-distant past when there was evidence of fairly heavy accumulation in and around 2,100. The most recent was the week ending December 3, 2004, when trading volume on the Nasdaq was 11 billion shares and the index ranged in price between 2,090 and 2,164. Moving back to the beginning of 2004, there were two consecutive weeks of heavy accumulation. During the week of Jan. 9, 12 billion shares traded hands during a strong week that ranged between 2,021 and 2,113. The following week saw 11.7 billion shares trade between 2,080 and 2,140. To add significance to this analysis, the two weeks in early 2004 represented the two highest trading periods for the entire year of 2004. The other that occurred in December, 2004, was the sixth highest week of volume in 2004.
Because these weeks were strong from a price perspective, we surmise that a lot of the volume was due to accumulation by institutions and individual investors. Because their timing was not great, we can project that anyone left holding stocks that were acquired during these periods is probably more than happy to sell into rallies every time the Nasdaq approaches the 2100 level. By the way, the intraday high on Wednesday of last week was 2,095.54 and the intra-day peak on Thursday was 2,097.80.
One of our main concerns about the current rally is the lack of robust volume levels as well as the lack of strong up/down volume figures. The characteristics we look for to gauge whether a rally can build into a sustainable uptrend are a price thrust accompanied by strong absolute volume levels, and robust levels of advancing volume relative to declining volume. So far, we have seen a strong price performance, but we think that volume continues to suggest that the rally will not turn into a sustainable trend to the upside.
To measure the strength of the move from a volume standpoint, we like to look at the 10-day ratio of up/down volume on the Nasdaq. The most recent comparison takes us back to the rally off the August, 2004, lows. During the initial stages of that advance, the 10-day ratio of up/down volume on the Nasdaq hit 2.9, a fairly healthy ratio. The latest advance off the May lows has only pushed this ratio to 2.3. The rally off the October, 2002, bear market low pushed this ratio to an extremely high level of 4.1, while the rally off the March, 2003, low moved this ratio to a very strong reading of 3.7. Clearly, the volume thrust we would like to see is not there, and suggests to us that this is a rally in an aging bull market.
The 10-year Treasury yield plunged below 4% last week, dropping as low as 3.8% during the early part of Friday's session. The reversal on Friday from 3.8% to 3.98% was significant and we think could represent a turning point for yields. As we have mentioned many times, there is quite a bit of chart support in the 3.9% area. This zone acted as support in 2002, 2003, 2004, and 2005. Combine this support zone with the very overbought condition, and you have the ingredients for a major reversal in yields. The 14-day relative strength index, or RSI, is at its most overbought condition since June 2003, right when yields bottomed out. If bond yields do turn around, initial chart resistance lies up in the 4.25% area.
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Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's