Look Out Below

Last week's price action may have broken the stock market's back. For the Nasdaq, the next support level lies at 975

By Mark Arbeter

The market has been trying to hold near its July lows, moving sideways over the last two weeks, but the price action on Friday, Oct. 4, may have broken the market's back. The Nasdaq moved to a new bear market low, while the S&P 500 finished just above its July closing low and has little support left. With support for the major indexes almost nonexistent, things could get ugly in a hurry.

If the S&P 500 were to close below the 776 level, which was the intraday low in July, and also represents a break of the closing low by more than 2%, there is the potential for another cascade-like slide to the next chart support area of 600 to 680. For the Nasdaq, which has already eclipsed its July intraday low and its August closing low, the next piece of chart support lies down at 975. Below that level, there is very little support until the 800 area.

Overall volume continues to favor the bears. During bear markets, there are plenty one- or two-day counter trend rallies that fail. On Tuesday, Oct. 1, the markets rallied sharply (about 4%) but the problem was that volume was only slightly more than average. Many times during the current bear market, price gains have been accompanied by lower-than-average volume, while price declines occur on a pick-up in volume. Major market bottoms usually take place on a huge jump in volume as institutions jump back in with both feet.

The other troubling aspect about volume is that the up/down volume figures continue to exhibit clear distribution (i.e., selling) by institutions, which has been a constant over the last couple of years. Until the distribution ends, and a steady period of accumulation begins, the bear market will continue unabated.

We get the sense that although many investors have thrown in the towel and liquidated their entire portfolios, there are many that are still hanging on. The ones that remain fully invested seem more fearful of missing a powerful rally than protecting the capital they have left. It is also not comforting that many brokerage firms continue to have an overweighted allocation towards equities. The bear market may not end until the majority of market participants truly have a real distaste for stocks.

The major large-cap stocks in the S&P 500 and the Nasdaq continue to exhibit very poor action. Chart patterns of many big caps have either rolled over after tracing out major topping formations, or are close to breaking down.

One stock that we are watching closely is Microsoft (MSFT ), which represents almost 12% of the market cap of the Nasdaq and over 3% of the S&P 500. Microsoft, while well off its high, is once again in danger of further losses. The stock will complete a negative, descending triangle formation if it closes below 40, and there is little chart support below that area. This would certainly weigh heavily on the Nasdaq, and would be a psychological negative for many other stocks.

Along with the many poor chart formations of individual stocks, it is almost shocking how many industry charts are in downtrends. While it is easy to blame the current market woes on the technology, telecom and Internet stocks, there are scores of industry chart patterns that are also in major downtrends. While we used to talk about rotation quite a bit during the glory days, there is no place to hide during the current market phase.

The bear market will end eventually, but we believe it will be from lower levels.

Arbeter is chief technical analyst for Standard & Poor's

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