Trend Remains Bearish

A retest of the April lows is in sight as the weakest part of the year approaches

By Mark Arbeter

The major indexes continue to close in on their April lows in slow, grinding fashion. While the indexes are very oversold and could rally in the short-term, we at S&P still expect a test of the recent lows of 1103 on the S&P 500 and 1639 on the Nasdaq sometime during the weak seasonal period of September and October. As of Wednesday, Aug. 22, the Nasdaq has retraced 71.5% of the gains it posted from the low on Apr. 4 to the high on May 22. The Nasdaq 100 is in even worse shape, retracing 84% of its gains during the same time period. The S&P 500 has given back 74% of its rise.

In a strong market, an index or individual stock will typically give back 33% to 50% of its gains, and then resume the uptrend. It remains clear that this is not a healthy market and these recent retracements are just further evidence of this. A retracement over 66% usually suggests that the entire rally will evaporate and that of course equates to a retest of the April lows. If the market can manage to rally in the near-term, it is likely to move up into heavy resistance just overhead and fail. Short-term chart resistance for the S&P 500 starts at 1165 and runs up to 1226. For the NASDAQ, resistance begins in the 1916 to 1923 area and extends to the 2103 to 2129 zone. Any move into these ranges is likely to be met by heavy selling because there was a lot of buying in these zones, and investors will look to cut losses or get out near breakeven.

Short-term rally or not, the trend of the "500" and the Nasdaq remain lower. Both indexes are in downward-sloping channels, setting a series of lower highs and lower lows. The indexes longer term trends and formations are also negative and they remain below both intermediate-term and longer term moving averages and those averages are declining. Over the last couple of weeks, the Moving Average Convergence/Divergence or MACD formations have turned negative. The MACD is a momentum indicator calculated by taking the difference between two moving averages, and then plotting the result against another moving average or signal line. The MACD is a useful tool at turning points in the trend and can also be used to spot divergences and overbought/oversold levels. Looking at both the 12-26 day plotted against a 9-day MA and a 19-39 day plotted against a 16-day signal line, both are currently below their signal line and below zero, implying negative market action ahead. Neither of the MACD's has yet to reach oversold levels, another negative.

Sentiment remains neutral overall, not a good sign with the indexes approaching their April lows. Investors Intelligence poll of newsletter writers is still leaning toward the bullish side. The latest readings were 46.9% bulls and only 30.2% bears, not the kind of readings one would expect near an intermediate-term bottom. One positive sentiment reading is the CBOE Put/Call ratios.

The ratio hit 1.07 last Friday, the first time over 1.00 since April. The 30-day P/C ratio hit 0.75 on Aug. 17, almost reaching the 0.78 level hit in April. However, in October, 1998, the 30-day moved much higher, peaking at 0.88. The Volatility Indexes, which measure option premiums and is a good gauge of fear or lack of, remain at complacent levels. The VIX (volatility of the OEX) is running around 25, well below the 40+ level seen at major bottoms. The VXN (Nasdaq 100) is drifting around 50, well below the readings (+75) seen at bottoms.

Both Nasdaq and NYSE up/down volume models remain bearish, and would need a week or two of strong action to turn positive. This is not likely in the current slow trading environment we are in. Other market internals are in better shape, especially on the NYSE. NYSE breadth remains in an uptrend that started in October '00, and NYSE new lows as a percentage of issues traded are in the 1.5% area, a very favorable reading. New NYSE highs continue to outpace new lows by a wide margin. However, we are not a big fan of many market internals because the data are not market cap weighted like the indexes, and can be distorted by preferred stocks, municipal bond funds and other non-common stocks on the NYSE. We do prefer the up/down volume statistics, because although they are not weighted, volume does have a tendency to go into the larger cap stocks and therefore is a much better internal indicator to measure market action.

We remain on the sidelines, waiting for the market to tell us otherwise. A retest of the lows is in sight as the weakest part of the year approaches.

Arbeter is chief technical analyst for Standard & Poor's

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