A Slow Slog Higher for Stocks

S&P thinks market has a little further to run before major indexes run into some key areas of resistance

From Standard & Poor's Equity Research

The major indexes posted decent gains last week after a low-volume pullback in the preceding week. The path of least resistance looks higher for the near-term, in our view. Bond yields fell below key resistance at 4.8%, while crude oil dropped slightly below $70 per barrel.

We believe the stock market has a little further to run before the major indexes run into some key areas of resistance. For the uptrend to continue, it will be very important how the market deals with this overhead supply, in our view. The S&P 500 has moved into a minor area of chart resistance between 1300 and 1326. The cyclical bull market's closing high was 1325.76 on May 5, while the intraday high was 1326.70 on May 8.

On the downside, the index appears well supported. Trendline support, drawn off the recent lows, sits at 1295. Chart support begins in the 1280 to 1290 zone, with more substantial support not too far underneath this range. The 50-day exponential moving average lies at 1280 while the 65-day exponential average and the 200-day simple average come in at 1278.

The S&P 500 is somewhat overbought on a very short-term basis, but is not overbought from an intermediate-term basis. The 6-day relative strength index (RSI) hit 80 recently, which is somewhat overbought. However, the 14-day RSI has only moved as high as 66 since the rally started, and this is not considered overbought. The 14-day RSI has traced out a series of higher highs and higher lows since May, a positive in our view, and is above 50, which we think is another plus.

From a longer-term perspective, the 14-week RSI is sitting in neutral territory, and has plenty of room to move higher before it gets to overbought territory. The worry about the weekly RSI as well as the weekly moving average convergence/divergence is that for the most part, they have traced out a series of lower highs and lower lows during the last couple of years, indicating that momentum is weakening from a longer-term perspective. This is suggesting potential trouble for the equities market down the road, in our view.

The Nasdaq faces a much more difficult road, in our view, as we believe the index sits below a much larger area of overhead supply. Decent short-term resistance sits in the 2200 area from a trendline drawn off the peaks in April and May. There is also minor chart resistance in this zone. A 50% retracement of the correction also lies in this area. But the more substantial piece of resistance begins up near 2233. This is a piece of chart resistance from a bottom of an area that the Nasdaq traded in earlier this year. A 61.8% retracement of the correction sits right above this level at 2237.

The Nasdaq 100 is also faced with a similar piece of overhead. For the QQQ's (Nasdaq 100 Tracking Stock), chart resistance is pretty thick right at the 40 level. Chart support, from the recent reversal pattern, starts at 2164 and runs all the way down to 2020. There is a concentration of moving averages that lie between 2107 and 2175, and they also represent potential supports for the Nasdaq.

For the most part, sentiment got very oversold during the June/July time period, and we believe this set the market up for the latest advance. Bearish sentiment on the American Association of Individual Investors (AAII) poll rose to 57.8%, the highest reading since February 2003, while bullish sentiment fell to 23.9%, the lowest since April 2005. This occurred during the week of July 21, as bearish sentiment overwhelmed bullish sentiment by 33.9 percentage points, the widest spread since February 2003. Bullish sentiment on the Investor's Intelligence (II) poll fell to 35.6% in June, the lowest since October 2002, while bearish sentiment rose to 37.1% in August, the highest since March 2003. During the week of June 23, sentiment was at a standstill with bulls and bears both at 35.6%. This was the first time that bearish sentiment was as high as bullish sentiment since October 2002.

So, we have seen sentiment reach bearish extremes that have preceded major market moves higher. We believe for the market to continue higher, we need an unwinding of this bearish sentiment. In other words, we would like to see the bears throw in the towel and quickly move back to the bullish side of the fence. Unfortunately, that has not happened yet. During the final market low in March, 2003, bullish sentiment fell to 39.8% and bearish sentiment rose to 38.2%. As the market came out of that low, the bears quickly turned bullish and in just 5 weeks, bullish sentiment rose to 51.1% and bearish sentiment fell to 30.3%.

Since June 2006, we have only seen a small uptick in bullish sentiment and a miniscule drop in bearish sentiment. The same thing can be seen in the AAII poll during early 2003. Bullish sentiment exploded from 21.1% to 63% and bearish sentiment plunged from 57.9% to 19% in just 9 weeks. Since the peak in bearish sentiment in July, 2006, in the AAII poll, we only have 5 weeks of subsequent data, but so far, bullish sentiment has only risen to 39.4% and bearish sentiment has only fallen to 37.4%.

Other sentiment indicators are not confirming the AAII or II polls, however, and this may suggest that the market has not completed a longer-term bottom. For instance, the MarketVane poll has shown fairly high levels of bullish sentiment throughout the last couple months, despite the recent weakness in the market. The MarketVane poll hit a high of 73% bulls early this year, and only fell to 55% during the middle of June. During major market lows, this poll will frequently fall to 30% or below. The Consensus poll fell to 40% bulls in mid-July, well above levels usually seen during major lows. For instance, in October 2004, bullish sentiment dropped all the way to 24%. One sentiment indicator that is signaling outright caution is the OEX put/call ratio. As opposed to most other put/call ratios that are used as contrarian indicators, OEX option players are considered to the "smart money", and therefore, their actions have many times been correct. In other words, it is usually bullish when the total put/call ratios are high. However, when the OEX put/call ratio is high, it is considered bearish and a good warning sign. The 15-day OEX put/call ratio hit 1.74 on August 31, the highest this ratio has moved to since August 31, 2000, which just happened to correspond to a major peak in the market. Often, when there are so many opposing forces at work with respect to sentiment, or any other market indicator, the market will stay rangebound until more indicators start to line up together.

The 10-year Treasury bond yield fell to 4.73% this week, the lowest close since March 27. The 10-year yield has now dropped 52 basis points since the end of June, or 46 trade days. This is the steepest drop in yields over a 46-day period since June 2005. Bond yields have clearly broken down and reversed to the downside, in our view, after taking out trendline resistance drawn off the yield lows since June 2005. Long-term trendline support, off the yield lows in 2003 and 2005, comes in around 4.4%. There is also a layer of chart resistance in the 4.4% to 4.6% range. Stepping back, yields have traded in a massive base over the last six years between 3% and 5.5%. Yields also remain in a very long-term downtrend that started in 1981. The recent failure to break strongly above the 5.25% level kept this very long-term trend intact.

Crude oil prices finished last week at $69.19 per barrel, the lowest close since June 20. It is no surprise to us that both bond yields and oil prices are breaking down, as lowered inflationary expectations from the drop in crude prices aid the bond market. Many times, these two markets tend to move together over the long run. It appears that crude oil prices are headed for an important test of the $68 to $68.50 area. A sharp break of this zone of support would end the series of higher highs and higher lows that has been in place since 2003.

Longer-term trendline support comes in at $66, with the bull market trendline (drawn off the lows since the uptrend began) sitting at $62. Weekly momentum is not yet oversold, and we believe this gives more room on the downside for oil prices.

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