A Plethora of Mixed Signals

With technical conditions still mixed, we at S&P remain somewhat cautious towards the market until the current trading range breaks

By Mark Arbeter

The stock market suffered its first decent-sized weekly loss since the beginning of October, with the S&P 500 falling about 3% and the Nasdaq dropping about 4%. While the losses were moderate relative to the gains the market has posted off the October lows, some caution is warranted, although there have not been enough technical signs to point to anything major at this point.

As we pointed out a couple of weeks ago, the market is giving off a plethora of mixed signals and that has not changed. The major indexes are in the process of tracing out major reversal formations for the first time since 1998. The bond market, which continues to move in the opposite direction as stocks, is in the process of tracing out a bearish reversal pattern, signaling a potential boost to the stock market. The seasonals are positive as we are in the best time of year historically for the market.

The market is also entering the third year of the election cycle and that has been favorable for stocks as well. A four-year cycle low was due in late 2002 and this cycle has been remarkably accurate in timing the stock market over many decades.

On the flip side, the major indexes have not yet completed their reversal formations, and until that occurs, we will remain cautious. The indexes are still in long-term downtrends because they have yet to take out their respective bear market downtrend lines that have kept a lid on prices since the top in 2000.

There remains a heavy load of overhead supply on the major indexes and many individual issues. There has not been any type of new leadership from growth stocks that can take this market appreciably higher. In the shorter term, many Nasdaq stocks are very extended, have run into formidable resistance, and many have yet to trace out major reversal patterns. Finally, after each rally during the bear market, sentiment quickly moves to a bullish extreme, something that should not occur at the beginning of a new bull market, especially after the carnage that we have witnessed.

Shorter term, the current advance has flattened out and the action has become very choppy. While Monday's action (strong opening, weak close) was bearish, while Friday's action (weak opening followed by nice reversal) was somewhat bullish. The weekly action using a candlestick chart was not positive because it was an outside week or in candlestick terms, the market traced out a bearish engulfing line. This weekly candlestick goes higher than the week before, but also finishes lower than the previous week. After a significant uptrend, this weekly candlestick can act as an intermediate-term reversal pattern.

The key levels of support and resistance for the S&P 500 remain the same. On the upside, the index must see a close above the 963 level to complete the ongoing double bottom reversal formation. On the downside, support is seen at the recent closing lows of 907 and 876.

The Nasdaq, which continues to act stronger than the S&P 500, is very extended. Many Nasdaq stocks have moved up to areas of formidable resistance. This, in combination with the fact that many stocks have risen 50% to 100% or more, could create some pressure on the index in the near-term. Also, many Nasdaq stocks have yet to trace out major reversal formations, which suggests more basing activity could be seen.

Our up/down models on the NYSE and the Nasdaq have moved into neutral configurations after being bullish since mid-October. There have been some signs of minor distribution, but so far, not enough to suggest anything major to the downside.

Sentiment has moved to bullish extremes on a number of investment polls and this certainly bears watching. Investor's Intelligence is currently showing 51.1% bulls and only 25% bears. This is the highest percent of bulls since May, 2002. Also, bulls/bears has risen to 2.04, the highest ratio since January, 2002. Historically, when bullish sentiment is double bearish sentiment, the market goes sideways at best, and many times goes lower in the intermediate-term. The American Association of Individual Investors poll is up to 51% bulls and only 17% bears. This is the fewest percentage of bears since May, 2002.

We remain somewhat cautious towards the market until the current trading range breaks. With the short-term direction of the market neutral, the intermediate-term bullish, and the longer term still bearish, calling the market right now is like giving directions during a blizzard.

Arbeter is chief technical analyst for Standard & Poor's

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