The Pause that Refreshes

If the S&P 500 nears its August high, it would be in a natural spot for a minor pullback -- which could then set it up for a true breakout to the upside

By Mark Arbeter

The S&P 500 continues to march higher in a slow, deliberate fashion. The price pattern of the "500" indicates that institutions are not falling over each other to accumulate stocks -- as most breakouts have failed to develop any kind of momentum -- but are using any kind of weakness to add to their positions. This is in sharp contrast to the Nasdaq, which continues its torrid pace higher. While the Nasdaq has already blown past its August high, the S&P 500 is slowly closing in on this important level of resistance up at 963.

Once the index gets up in the vicinity of the August high, this would be a natural spot for a minor pullback. The pause in the market at this point would be healthy if it occurs on lighter-than-average trading volume. If this scenario plays out, the "500" would then be in a position to truly break out to higher ground, completing the double bottom reversal formation that started with the first low in July.

We would like to see the breakout accompanied by heavier-than-average volume, and strong up/down volume figures. If we can get this break, then the "500" could have a clear shot at running up to the 1050 area as there is very little resistance until that point.

A completion of the major double bottom reversal formation will go a long way toward putting the bear market to rest, as it would be the first major bullish reversal formation since the double bottom in 1998. It would also set up the first series of higher highs on the S&P 500 since early 2000. The final hurdle in the transition from bear market to bull market will be a break above the major downtrend line that has been in existence since 2000 and this comes in at about 1000. This bear market trendline has been a ceiling for the "500" and must be taken out to officially call for a major trend change.

Trading volume continues to support the argument for higher prices with strong volume accompanying price gains and lower volume seen during price weakness and consolidative price patterns. Accumulation by institutions remains heavy, especially in the Nasdaq. All of our volume breadth models remain in bullish configurations.

The bond market is in danger of breaking to new yield highs for the current move, and a close above 4.25% for the 10-year Treasury note would have bearish implications for bonds in the near term. This would be the highest yield since August and set the stage for a move to the 4.5% to 4.75% area. At this point, what's bad for bonds is good for stocks. Both asset classes have moved in opposite directions since 1998. Bonds have been a safe-haven play (a bet against stocks) and have benefited from weakness in the economy. With bond yields now headed higher, investors are moving back into stocks on the bet that economic conditions will improve, driving earnings higher.

Sentiment continues to turn more bullish as stock prices rise. Put/call ratios are declining and bullish sentiment on investment polls is rising. While most of the sentiment indicators we monitor are not yet flashing danger signals, the Investor's Intelligence poll has once again moved to an area of concern. Just a week ago, bullish newsletter writers doubled bearish newsletter writers. This has been a ratio that has either caused the market to pause or worse, go into a full-fledged correction. The one time that this did not work was coming out of the 1998 low.

This poll is also showing only about 25% bears, a historically low level, and an area that has caused the market some problems. While sentiment indicators are secondary to price and volume, the increase in bullishness bears watching.

Arbeter is chief technical analyst for Standard & Poor's

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