A Rough Week, but Stocks Hold On

But caution remains in order as the market is still susceptible to a downside breakout

By Mark D. Arbeter

The S&P 500 and the Nasdaq saw some technical deterioration last week, but the damage was limited to an expansion of the 7-week trading range. The rapid mid-week upside reversal and accompanying high put/call ratios suggest that a short-term low is in place.

However, the continued downside probing near the bottom of the trading range, and the heavy distribution by institutions of late, still leave the market susceptible to a downside breakout.

The S&P 500 closed below important support of 1114.50 on Tuesday, then fell as far as 1081.66 during the day on Wednesday before reversing sharply. We have been saying that to confirm a downside break, we had to see two consecutive closes below 1114.50 by at least 1%. Because the market reversed on Wednesday, this did not occur. It is very interesting to note that the S&P 500 reversed extremely close to the intraday low it saw in March 2001 at 1081.19. The market made an important bottom in the Spring of 2001 and was testing this area on September 10, right before the attacks. Therefore, the 1080 area has become an important support zone.

If the conditions for a downside breakout do occur, the "500" is likely to trade into the 1054 to 1111 area once again. This support was created by the sideways consolidation that occurred in October. A typical retracement of 50% of the rally since Sept. 21 comes in at 1060. Another way to measure the potential decline is to add the width of the recent sideways consolidation and subtract that from the bottom of the range. This measuring technique would give us a target of 1052, right in line with the other projections.

The Nasdaq also fell below important support during the week, closing below the 1918.50 level on Tuesday. But, just like the "500", the Nasdaq did not meet the criteria for a downside breakout because the it did not close 2% to 3% below support for 2 straight trading sessions. If this criteria is finally met, the Nasdaq does not have good chart support until the 1628 to 1776 area. A 50% retracement of the move since September targets the 1743 level while the measuring technique used above for the "500" comes in at 1738. Volume measures on both the Nasdaq and the NYSE remain in bearish configurations as defined by our up/down volume models. This indicates fairly heavy distribution by institutions since early in January, not something that raises our confidence about the short-term direction of the market. Because of the negative volume measures, the chance for a downside market break remains real.

Important leadership from growth stocks has disappeared as money has rotated back into defensive issues as well as value stocks. The new high list is littered with stocks with defensive characteristics such as food and beverage, small banks and financials, insurance, utility and medical stocks. This also does not breed a lot of confidence as investors have moved into areas of the market that they deem as safe.

Sentiment remains a mixed bag with shorter-term indicators moving to bearish extremes while longer-term measures remain on the bullish side. The total CBOE put/call ratio hit 1.05 on Tuesday, the highest level since September. The equity-only put/call was also very high that day. But longer term measures of sentiment remain stubbornly slanted towards the bullish camp. Investors Intelligence poll of newsletter writers refuse to give in from their bullish stance, with 51.6% bulls and only 26.8% bears.

We continue to be cautious as there is a real chance that the market will see additional downside action in the near-term. Our intermediate-term call of a wide sideways trading range also remains unchanged.

Arbeter is chief technical analyst for Standard & Poor's