A Period of Consolidation

S&P's forecast calls for the major indexes to be in a trading range environment until late in the year

By Mark Arbeter

The S&P 500 remains locked in a 5-week trading range within the confines of an intermediate-term uptrend. With volume patterns still constructive, it is our belief that the "500" will break out to a new recovery high in the near term. However, taking into consideration a weakening seasonal backdrop along with an extreme level of bullish sentiment, our intermediate-term forecast continues to be a trading range environment until late in the year.

The current 5-week range for the S&P 500 has been 1010 to 1015 on the upside and 962 to 974 on the downside. Trendline support, drawn off the secondary lows in late March, and successfully tested on July 1 and July 10, is at 988. Another piece of support for the S&P 500, the 50-day exponential moving average, lies at 965. Chart support below these levels comes in at 950. Both chart resistance and trendline resistance lie at 1050 and 1070, which should cap the upside over the summer months.

The Nasdaq, which has been outperforming the S&P 500 since October, broke out to a new recovery high on July 7. During last week, the index paused after it ran up to a trendline drawn off the peaks in August and early December, 2002. Like the S&P 500, the Nasdaq remains in a nice bullish channel with trendline support from this channel at 1660 and trendline resistance up at 1800. The Nasdaq has moved into a wide area of chart resistance that runs from 1700 to 2000. Chart support for the index lies at the recent breakout point of 1680 with additional chart support at 1600. The 50-day exponential moving average, also considered support, comes in just below the 1600 level.

Volume patterns remain positive on both the NYSE and the Nasdaq, despite the ongoing consolidative action of some of the major indexes. The Nasdaq's breakout was accompanied by a nice pick-up in volume, although volume was a bit less than the previous price breakout. Recent accumulation/distribution data remains in bullish configurations, suggesting that the Nasdaq could extend its recent gains while the "500" could break out to new recovery highs. Pullbacks remain shallow and have occurred on a decrease in volume. Market internals continue to exhibit healthy trends with positive readings from market breadth and new high/new low data.

Many chart patterns of the large caps still look constructive, with many breaking out of very long bases to 52-week highs. But the real action has been in small- and mid-cap stocks, with explosive moves in many issues. It is interesting to note that these stocks look terrific when looking at 1-year, daily charts. But, when viewed from a longer-term perspective using a 5-year weekly chart, many are still in long-term downtrends and are likely to be hurt by a massive amount of overhead supply and by profit taking.

What is different between many large and small stocks is that the larger cap issues have been basing for years, while many of the smaller issues made their primary lows this year or late last year. This suggests the smaller issues will probably need more consolidative trade sometime later this year, as these stocks complete their bases.

A look at the Russell 2000 small-cap index confirms what were seeing with many smaller issues. The index has exploded from its secondary low in March, but still remains below a key long-term trendline. The bear market trendline for the Russell 2000, which is drawn off the peaks of the last couple of years, comes in at 475, or right where the index has recently run out of gas. An internal trendline, drawn off the highs in September, 2000, June, 2001, and January, 2002, also comes in just below the 475 area. The "2000" has also advanced into an area of very thick chart resistance that runs from 450 up to 525. With major trendline and chart resistance facing the Russell 2000 and many small stocks, some caution is advised in this capitalization area.

The biggest overriding technical negative for the market remains the overwhelming bullish sentiment. All the investment polls we monitor (Investors's Intelligence, American Association of Individual Investors, Consensus, and MarketVane) have all moved to dangerously bullish levels within the last month. This in conjunction with the low levels on the volatility indexes (VIX, VXN, QQV) likely suggest that the easy gains for the current run are behind us and that any upside from here will probably be limited to single-digit returns from the most recent highs.

The Treasury bond market has just gone through a very nasty selloff, with yields on the 10-year note backing up from near 3% to almost 3.8%. There is a thick zone of chart support that runs from 3.55% all the way up to about 4.25%. Intermediate-term trendline support, drawn off the peak in yields in December, 2002, and March, 2003, comes in at 3.875%. A break of this trendline support would confirm an intermediate-term trend change for the Treasury market, and in our opinion, would be bullish for stocks, as it would probably end fears of deflation and give an indication that bond investors believe the economy is finally picking up some steam.

Arbeter is chief technical analyst for Standard & Poor's

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