A Lump of Coal for Stocks?

If support levels give way, the much-anticipated Santa Claus rally could be in danger

By Mark Arbeter

The major indexes showed little movement last week, and after two down weeks, there were no indications that the recent decline that started in early December is complete. Since the recent peak in both the S&P 500 and the Nasdaq, the indexes did fall to their lowest levels during the week, extending the recent trading range to the downside. While there was not a "material breach" of chart support, that could be just around the corner.

The S&P 500 and the Nasdaq appear to be rolling over again and if support levels give way, the much anticipated Santa Claus rally could be in danger. Key chart support for the S&P 500 is 876 or the closing low during the middle of November. A second level of support lies at 860, which is a 50% retracement of the recent rally. Both these levels lie within the price range of 841 to 881 seen on the big volume day of Oct. 15. There was a good deal of buying done in this price range and if the bulls want to make a stand, this is the zone they would do it in.

In conjunction with the poor action of the major stock market indexes, there are two other related concerns. Many important industry charts are acting rather poorly, confirming the weakness in the major averages. Secondly, many of the other markets such as gold, oil, and commodity benchmarks like the CRB index are performing quite well, while the dollar index continues its bearish action. This combination of intermarket action certainly does not inspire a lot of confidence about the U.S. stock market.

The Philadelphia Semiconductor index (SOX) is breaking down or failing after tracing out what appeared to be a very bullish head-and-shoulders reversal pattern. The success of this index is obviously very important to the direction of the Nasdaq.

Another important component of the Nasdaq, the biotech group, is also putting in a less-than-stellar performance. The AMEX Biotech index failed to complete a bullish, double bottom, reversal formation, and it looks like more basing action will be required before it is ready to really turn higher. Some of the other indexes that have failed to complete reversal formations include the Russell 2000, the DJIA Utilities, the DJIA Transports, and the NYSE Finance.

While some stock-related indexes remain in the doldrums, there have been very bullish chart patterns emerging in the commodity indexes. The Commodity Research Bureau (CRB) index completed a very bullish double bottom during the past couple of weeks. The first low of this formation occurred in 1999, with the second low in late 2001. The CRB index also took out a bearish trendline drawn off the 1980 high, breaking a 22-year downtrend. Aiding the rise in the CRB has been the strength in both gold and oil. Gold recently broke out to its highest level since 1997, while crude oil has shot back above $30.

If all this is not enough to send you scurrying to the hills, the U.S. dollar index has traced out a massive top over the last couple of years and just recently fell below important support, to its lowest level since early 2000. The dollar index also broke a very important trendline drawn off the April, 1995 low. If the strength in these commodity indexes continues alongside a deteriorating dollar, the outlook for the stock market does not look pretty. It is starting to look a bit reminiscent of the 1970s, where stocks marked time while other markets garnered investors' attention.

Overall market volume during the last couple of weeks has been extremely light. There has been unwillingness by investors to get aggressive as stocks rise and a definite aversion to jump on the short side when stocks are heading lower. However, the underlying character of the volume has been decidedly bearish. All of our up/down volume models are now firmly negative, and they have been very predictive over the last couple of years.

While nothing works all the time, and we will wait until support levels are taken out, we would remain very cautious. In what is normally a strong time of year for stocks, institutions are certainly not taking a bullish position in stocks.

Arbeter is chief technical analyst for Standard & Poor's

Before it's here, it's on the Bloomberg Terminal.