A Brighter Picture

Price and volume measures show an improving tone for the market. But there are still some major obstacles ahead for stocks

By Mark Arbeter

Price and volume measures on the major indexes continue to show improvement and it appears that the path of least resistance is higher. There has been some decent follow through buying since the surge on May 8, and this is something that has been absent of late. However, any type of advance over the intermediate-term is likely to be staggered in nature due to the heavy overhead supply that the major indexes face.

The S&P 500, after bottoming out in the 1050 area, has for the first time in months, traced out a series of higher highs and higher lows. In the process, the index has broken above the downward sloping trendline that has existed since the top in March. This trend reversal in prices has carried the S&P back above the breakdown point (resistance) of 1074 and back into the sideways consolidation that has existed since the beginning of December. The latest price action has extended the trading range of the "500" to 1049 to 1177. The next resistance area for the index runs from 1103 to 1130, and we would consider a break above the 1130 level as bullish on a short-term basis. However, resistance is thick all the way back to the top of the trading range so gains from here will probably be labored.

The Nasdaq continues to trade in a downtrend, and has failed to break above two important bearish trendlines. The first, drawn off the highs in March and April, comes in at 1750. The 50-day exponential moving average also is near the 1750 level. The more important downward sloping trendline for the index, drawn off the January and March peaks, is in the 1775 area. A break above this longer trendline would reverse the bearish price action on an intermediate-term basis and set the Nasdaq up for a test of the most recent high in April in the 1830 area. Eclipsing the 1830 level would bullish short-term and probably set the index up for a run to trendline resistance (drawn off the May, 2001 high and the January, 2002 high) near 1970.

Besides all the resistance from the myriad of bearish trendlines, chart resistance is very thick all the way up to 2100, with further chart resistance all the way up to the low 2300 area. This illustrates some of the many roadblocks for the Nasdaq in the months ahead.

Up/down volume measures on the Nasdaq and the NYSE have improved to neutral from bearish, and will turn bullish with a couple more days of strong volume breadth. The constant pattern of distribution by institutions has subsided, and the beginnings of a change to accumulation are currently being seen. This is a must for higher index prices. This week, it will be important for the volume breadth to break its recent downtrend on the Nasdaq and we would also like to see confirmation from the 6-and 10-day summation of up/down volume. If there is more follow-through this week, the intermediate-term trend of the major indexes will turn bullish, with the Nasdaq most likely leading the way higher. If this occurs, rotation out of the hottest sectors of the market, basically small- and mid-cap issues, and back into the beaten up techs will mostly likely be seen.

A healthier stock market will also lead to some intermarket rotation, with money coming out of long-term Treasuries and into stocks. Since mid-1998, stocks and bonds have become disconnected from historical trends. That is, when bond yields have risen since mid-1998, stocks have also moved higher, and when yields have fallen, stocks have done the same. Some of this intermarket action during the last four years can be explained by the events during the fall of 1998 and by September 11. Both of these time periods created huge uncertainty about the U.S. economy and therefore led to lower yields (weak economy, safe haven buying) and weaker stock prices (lower corporate EPS expectations). Of late, bond yields have started to rise, during which time there has been an improvement in stock prices. This trend is likely to continue in the near-term, however, we know this disconnect will not go on indefinitely.

Sentiment remains a mixed bag with short-term investment polls at their most oversold levels (low bullish sentiment, which is positive) in months and Investor's Intelligence (intermediate-term poll of newsletter writers) overbought or way too bullish. The MarketVane poll is showing only 20% bulls, the lowest since the market bottom in September, 2001. The Consensus poll is at 21% bulls, the lowest level of bullishness since the market bottom in April, 2001. Both these polls are certainly a positive for the market.

However, Investor's Intelligence is still showing 52.1% bulls and only 29.8% bears. Amazingly, this poll has barely budged over the last 10 weeks, a period of weak index performance. During that time, bullishness has ranged from 51.6% to 54.8% and bearishness has moved from 28.4% to 30.2%. All the more incredible, the major averages have been in major downtrends for over two years and yet newsletter writers remain bullish.

The tone of the market has improved, suggesting the worst is over for the near-term. However, any attempt for a rally over the intermediate-term will be met by a huge supply of stock overhead -- and this will prevent a major, uninterrupted move to the upside.

Arbeter is chief technical analyst for Standard & Poor's

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