Reaching a Critical Point

While the near-term trend is firmly bullish, the major indexes are nearing heavy resistance

By Mark Arbeter

The market's near-term trend is firmly bullish as investors are once again buying dips. More importantly, stocks have been able to climb in the face of plenty of less-than-positive economic news. While many have embraced the recent strength, we would like to see the major indexes break above stiff resistance that lies just ahead for confirmation that the worst is behind us.

On Friday, May 2, the major indexes broke out to new recovery highs on fairly heavy volume. The S&P 500 shot out of its short-term consolidation pattern and closed at its highest level since finishing at 931.66 on Jan. 14. The S&P 500 has traced out a series of lower highs and it would be very bullish if the index can start breaking through some of these previous highs. The closing high prior to January's occurred on Nov. 27 at 938.87 with the intraday high during that time at 954.32 on Dec. 2. The highest close for the S&P 500 during the nine-month trading range was on Aug. 22 at 962.70. As we have said numerous times, to break the back of the bear market, a strong breakout above the top of the current trading range will be needed.

The Nasdaq, which has been the most impressive of the major indexes since the bottom in October, broke out to its highest close since June, 2002. On an intraday basis, the Nasdaq was higher on Dec. 2, hitting 1521.44. The next level of chart resistance for the Nasdaq comes in at 1620, which were the lows printed in April, 2001. Trendline resistance, drawn off the highs in May, 2001, and January, 2002 lies up at 1700. With the Nasdaq already above its recent consolidation, and therefore has less near-term resistance to deal with, we would expect continued outperformance from the index.

There are a whole host of indexes that are nearing the top of their trading ranges. Of major importance to the Nasdaq's performance is the chart action of the biotech and semiconductor groups. The Amex Biotech index (BTK) has been in a sideways consolidation since July and has run up to the top of its trading range. A break above the high set in August, 2002, near the 400 level would be very bullish, and act as confirmation for the strength seen in the Nasdaq. The Philly Semiconductor index (SOX) has been in a basing pattern since October and since February has traced out a series of higher lows. The SOX index would have to close above the November, 2002, high around 380 to break out.

A critical area of importance for the overall market is the action of the financial stocks. Historically, financial stocks have led the major indexes both at bottoms and at tops. The recent action is more coincident, as the lows of the NYSE Finance index and the Dow Jones Utility index occurred at the same time as those of the major indexes. The NYSE Finance index, like many indexes, has traced out a sideways consolidation since July and is within about 2% of breaking above its nine-month trading range. The DJ Utility index has not acted as well as many other indexes and remains about 3% below its January high and 12% below its August high.

The small and mid-cap stocks have not been left out of the latest rally and are also closing in on their respective trading range peaks. The small-cap Russell 2000 is within 1% of its August closing high while the S&P Midcap 400 is only 4% from its August high.

With all these indexes doing so well, it is no wonder that the advance has been pretty broad and that can be seen in the impressive action of the NYSE advance-decline line. The up/down volume statistics have also been pretty positive and our volume breadth models are in bullish configurations. The rally is being accompanied by higher volume on advancing days while down days are occurring on lower volume. Volume since the March low however, has not been overwhelming, something usually seen at the beginning of a major bull market.

Sentiment is giving off mixed signals. CBOE put/call ratios have been pretty high of late, a positive. There have been a couple days when the market has had a good day and the put/calls have been fairly high, something we have not seen during the entire bear market, and it shows that option investors do not believe in the current advance.

However, other sentiment measures have moved to overbought levels and in some cases, to extreme levels. The Consensus poll is showing the highest level of bulls since early January, 2002, right at a market peak. The AAII poll is at an extreme area with 63% bulls and only 19% bears. The volatility indexes for the Nasdaq (VXN) and the Nasdaq 100 (QQV) have moved to very low levels, showing a high degree of complacency. The VIX or volatility index on the S&P 500 has also moved down near the 20 level, an area that has represented trouble for the market over the past five years.

The market's price action is undeniably bullish and suggests further price gains over the near-term. However, with many indexes still in basing patterns, and with the lack of long-term evidence (which we have talked about in the past and will review next week) that a new secular bull market has started, we will wait for further signs before taking a more aggressive stance.

Arbeter is chief technical analyst for Standard & Poor's

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