By Mark Arbeter
The stock market has taken a breather following the major indexes' run-up to important resistance levels last week. The indexes are also facing a short-term overbought condition that has often led to a pause in rallies in the past.
We believe the stock market is poised to take another run at new cyclical bull market highs in this seasonally strong period. Gold prices broke to the upside again, and are trading at the highest level since 1988, while bonds rallied sharply.
The S&P 500 ran into trendline resistance up at 1238 early last week before pulling back. This trendline is drawn off the highs from August and September. In addition, the index is bumping up against chart resistance that runs up to the cyclical bull market high of 1245. The intra-week pullback was very small, as the index did not even fall back to its 10-day simple moving average. Near-term chart support begins at 1230 and runs down to the 1200 zone.
Overhead resistance, above the 1245 level, comes in at 1253. The 1253 level represents a 61.8% retracement of the bear market. Fibonacci retracement, in our view, has been very accurate in predicting support and resistance levels since the bear market bottom in October 2002. Trendline resistance, drawn off the highs from earlier this year comes in at 1260.
Besides bumping up against some key resistance levels, the S&P 500 has moved to a fairly overbought condition on a short-term basis. The 6-day relative strength index (RSI) recently hit 78, its most overbought condition since June. The 14-day RSI is at the 60 level and is not yet considered overbought. The daily stochastics oscillator (14, 5, 5) is very overbought, and is also suggesting the possibility of an additional pause in the recent rally. The 10-day rate-of-change (ROC) of the S&P 500 recently rose over 4%, considered an overbought condition, and the highest ROC reading since last November.
The Nasdaq has gotten very close to its cyclical bull market peak -- its Aug. 2 closing high of 2218.15. Once this level is taken, the next key level in our view is up at 2230. This comes from trendline resistance drawn off the highs over the last couple of years. In our view, this is a critical piece of resistance for the Nasdaq as it has contained prices since the beginning of 2004. If the index can take out this formidable piece of resistance, the next area of overhead is up at 2340, the high from back in 2001. This level also represents the beginning of a lot of accumulation from back in 1999, just before the Nasdaq took off on its historic run to 5048.62. Like the S&P 500, the daily stochastic oscillator and 6-day RSI based on the Nasdaq are in overbought territory but intermediate-term momentum indicators are not yet overbought.
There appears to have been a fairly quick shift in market sentiment over the last two to four weeks as investors have embraced the market's strength. Investor's Intelligence poll of newsletter writers is currently showing 53.1% bulls and 22.9% bears. This is the lowest percentage of bearish sentiment since early August and it is also the widest spread between bullish and bearish sentiment since that same time period. Over the last two weeks, bullish sentiment has jumped by 6.7 percentage points, the largest 2-week jump since June, 2004.
The American Association of Individual Investors (AAII) poll has also moved quickly to the bullish camp with 58.6% bulls and 23% bears. This is the highest level of bullish sentiment since December 2004, right before a correction. Just two weeks ago, the AAII poll was showing only 32.1% bulls and 46.2% bears. Bullish sentiment on the AAII poll over the last two weeks has increased 26.5 percentage points, the largest rise since April 2004.
Put/call ratios on the CBOE have dived sharply over the last month as option investors have moved quickly out of the bearish camp. The 10-day CBOE put/call ratio has fallen from 1.11 on October 13 to 0.82 on November 11. The 30-day CBOE put/call has dropped from 1.02 on October 12 to 0.89 on November 16. From a ROC perspective, these are the fastest drops in the put/call ratio over a 25-day period since November 2004. While these rapid moves from bearish to bullish sentiment is part of the process of putting in a bottom and then moving higher, we are concerned about the speed in which investors seem to be moving to the bullish camp.
Gold prices have broken out again and are trading at their highest level since December 1987. Gold has been in a bull market since March, 2001 and has risen almost 90% since that bottom. Prior to this advance, gold had been in a bear market after peaking at $850/ounce in January, 1980. Historically, gold has been a hedge against inflation and often moves in the opposite direction vs. stocks. The next major piece of resistance for gold is up at the $500 level. There is chart resistance at $500 as well as psychological resistance. The $500 area was major resistance for gold back in 1987 and 1983. This week, the XAU gold index broke out to its highest level since 1996. While we do not make gold price forecasts, the trend is very strong and a break above $500 would be very bullish on a long-term perspective, in our view.
Treasury bond yields fell back below the 4.5% level last week, and in the process, broke through trendline resistance that has been in place since early September. Daily momentum indicators have turned bullish, suggesting that the rally has some room to run. Chart resistance begins in the 4.4% zone and that was the yield high from back in August. Fibonacci retracement resistance lies between 4.42% and 4.25%. We believe that after the rally runs its course, the 10-year Treasury will push higher and approach the 5% area late this year or early next year.
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As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations and 11.0% with sell recommendations.
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Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's