Holding the Line

This is not a strong stock market yet, but the Nasdaq and S&P 500 did hold at key support levels last week -- a positive sign

By Mark D. Arbeter

Last week was both positive and negative for the markets. The major indexes fell right through their respective breakout points (Nasdaq: 2233, S&P 500: 1273) without much of a pause. In a strong market, stocks and indexes frequently break out to new highs, pullback and test their breakout levels, and then resume their advance.

Well, this is not a strong stock market yet, but the positive is that the indexes did hold at their recent congestion zones marked by 1996 to 2233 for the Nasdaq and 1192 to 1275 on the S&P 500. These support areas were created by the sideways action that started in mid-April.

The recent pullback was fully expected because the major indexes had run up into the lower levels of major resistance. This resistance runs from 2250 to 2892 on the Nasdaq and 1275 to 1383 for the S&P 500. This overhead supply was formed during the January rally and will probably contain the market's upside for the near-to intermediate term.

We at Standard & Poor's still expect any advance to be labored but also think the downside is limited as well as the Federal Reserve tries to jump-start the economy.

One positive aspect of the recent decline was that it alleviated a very overbought, short-term condition of the major indexes. However, another example of a strong market is its ability to get very overbought, and then not pull back much. This frequently occurs during the initial stage of an advance in a powerful bull market. The bear market was so severe this time that it will take time to repair the chart damage of many stocks and indexes.

A surprising negative which has occurred during the rise off the March/April lows is the dramatic shift in some of the sentiment polls. The American Association of Individual Investors poll has seen a sharp increase in the percentage of bulls, rising from 28% bulls to 62% bulls in just nine weeks. The Consensus poll has been even more dramatic, surging to 66% bulls (the highest reading since Jan. 1999) from just 10% eight weeks ago.

This quick shift in bullish sentiment, especially considering what has transpired over the last year, is disconcerting and suggests that certain groups of investors believe that the good times are back.

Despite the late-week gains in the Treasury market, chart patterns remain negative. The 10-year Treasury yield could decline back to the 5.20% to 5.3% area which is where both chart resistance and trendline resistance exist. Once this yield decline ends and the 10-year busts support at 5.5%, yields will move to the next support area of 5.6% to 5.8% on their way to 6% or above.

With the heavy overhead supply limiting the upside, and the Fed's aggressive monetary policy providing a floor below, we continue to see a rangebound market over the next couple of months.

Arbeter is Chief Technical Analyst for Standard & Poor's

Before it's here, it's on the Bloomberg Terminal.