By Mark Arbeter
A strong market rebound on Wednesday, Aug. 31, failed to garner any follow-through buying so we believe more testing of the recent lows is in store. Nonetheless, the resiliency of the market last week cannot be ignored, in our view. The bullish spin for the week was that with the hurricane devastation and soaring fuel prices, the Federal Reserve might not push the federal funds rate up as high as many were expecting.
Giving credence to a less hawkish Fed last week was the sharp drop in many short-term market rates. The fed funds futures rate fell 50 basis points to 3.00%, taking out a rising trendline that had been in place since June, 2004. The 1-year Treasury bill fell from a high of 3.95% the prior week to 3.78% on Thursday, Sept. 1, while the 2-year Treasury bill dropped to 3.83% on Thursday from 4.06% the preceding week. While the move in short rates may be temporary, in our view it hints that there may be some relief from the Fed following hikes in the funds rate since June, 2004.
In our opinion, part of the bounce last week was due to technical factors. The S&P 500 had moved into an area where multiple pieces of support came in, and in addition, the index was also oversold on a daily basis. The S&P 500 has a very concentrated area of support between 1183 and 1205. Chart support, from the small consolidation in June and July, occurred within these two levels. The 150-day exponential moving average is at 1199; the 200-day simple lies at 1196 with the 200-day exponential average at 1190.
A 38.2% retracement of the rally from April to early August targets the 1204 level while a 50% retracement of the recent rally targets 1191. Intermediate-term trendline support, drawn off the August, 2004, and April, 2005, lows, comes in around the 1190 area. Additionally, the index hit the lower Bollinger Band, which many times acts as a support.
The strong rally on Wednesday, followed by small gains on Thursday, took the S&P 500 right up to initial resistance. The trendline drawn off the recent peaks since early August comes in at 1222, right about where the index closed at on Thursday. There is also minor chart resistance in that zone. The middle Bollinger Band, which is a 20-day simple moving average, also lies at 1222.
However, with the lack of strong follow-through buying on Thursday and Friday, it appears that some more testing of the recent lows will be needed before another attempt higher can be made. We are still wary that the recent lows will hold, but a light volume test would do wonders in turning the current trend higher, in our view. Therefore, we think the action over this week and next will be very important from an intermediate-term perspective.
Daily momentum indicators have improved with the stochastics indicator issuing a buy signal. The daily moving average convergence/divergence (MACD) indicator has reversed its downtrend, but has yet to issue a buy signal. Weekly momentum indicators are still in bearish configurations, and this keeps us cautious for now. The weekly stochastics indicator has rolled over from an overbought condition, and is on a sell signal. The weekly MACD is also on a sell signal, having traced out multiple negative divergences since the beginning of 2004. The daily relative strength index (RSI) has moved to a fairly oversold condition, while the weekly RSI is in neutral territory, but has also traced out a series of lower highs, while prices were hitting higher highs.
Crude oil prices were all over the place last week, and in our opinion, the market still looks very toppy and susceptible to a correction. After finishing last week at $66.13 per barrel, crude spiked to $70.85 on Tuesday, Aug. 31. Prices then got hammered on Friday, Sept. 2, falling $1.90 to $67.57. Initial support comes from a trendline drawn off the May, July, and August lows and that comes in at $66. With the extreme upside move since May when crude oil was $47, and with the market being so overbought on both a daily and weekly basis, we see the potential for additional downside once trendline support gives way. More substantial support lies down in the $50 to $60 area. That being said, we think that any correction in prices will only represent a counter-trend move within a long-term bull market.
As far as fuel prices were concerned, the real story last week was not crude oil but the huge moves in gasoline, diesel, and natural gas prices. These markets are more relevant to the average consumer as we need these types of fuel to fill our cars, trucks, and to heat our houses. Regular gasoline prices rose from $1.96 per gallon to $2.71 last week while diesel prices surged to $2.28 per gallon from $1.87. Natural gas prices jumped from $9.85 per million BTU to $12.65. Needless to say, some consumer discretionary subindustries had a tough week, with retailing, hotel, casino, and restaurant stocks getting hit pretty hard. On the flip side of that, oil stocks were very strong last week.
Bond yields continued to fall last week, with the 10-year Treasury falling to 4.03% from the Aug. 26 close of 4.19%. For a very brief time on Thursday, September 1, the 10-year yield fell below 4%. There are a couple of key areas of resistance that are very close, with the first being chart resistance in the 3.8% to 3.9% zone. In addition, trendline and chart resistance lies down in the 3.7% area. We do not expect yields to fall below the 3.7% area, as the 40-week cycle low for bonds is due during the third full week of September.
Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's