Turning Up the Volume
By Mark Arbeter
The major indexes continued their trek higher to new recovery highs last week despite some disappointing late-week economic news on the job front. The market continues to be buffeted by relatively low Treasury yields, expectations for a strong December-quarter earnings season, strong seasonal flows into equities, the continued grind lower by the U.S. dollar, the lack of alternative investments, and short covering, especially in Nasdaq stocks.
Investors, and more importantly, institutions, came back to stocks in a big way after the holidays. Volume on the Nasdaq was consistently strong, with the figure for Thursday, Jan. 8, the highest since June 6, 2003. Activity on the NYSE was just as impressive during the week. NYSE trading volume on Thursday was the highest since Nov. 21, 2002.
The negative that can be taken away from the strong volume levels is that a lot of it was in single-digit stocks, many in the telecom area, so we suspect that the dollar trading volume is not what it used to be. Another potential negative is that markets tend to top out on high volume levels, but we don't think the run is over.
The S&P 500 and the Nasdaq are currently slicing through fairly heavy zones of resistance levels like a hot knife through butter. The S&P 500 is in a zone of chart resistance that runs all the way up to 1,177. We think that area will represent the maximum for the current intermediate-term advance. More likely, the "500" will run up to the 1,152 area, which would represent an important Fibonacci retracement of 50% of the bear market.
Another piece of important resistance for the "500", and one that might contribute to a consolidation, is the trendline off of the January, 2003, and June, 2003, peaks. The index closed exactly at this resistance of 1,132 on Thursday. This trendline could be a decent obstacle in the near-to intermediate term because it has contained prices for the last year.
The Nasdaq has chart resistance up to the 2,328 level after breaking out above the 2,000 zone. The index busted right through potential Fibonacci resistance at 2,070, or a 23.6% retracement of the bear market. The next important Fibo retracement (38.2%) comes in way up at 2,617. Psychological resistance, represented by a 100% advance from the bottom in October, 2002, lies at 2,228. The Nasdaq, after underforming the S&P 500 from early November to mid-December, has once again taken over a leadership role.
One of the reasons the Nasdaq continues to surprise on the upside is the high levels of short interest in many Nasdaq stocks as well as on the Nasdaq 100, or QQQ's. There was a huge build-up of shorts on the more speculative issues during the bear market, and the bears just won't give in. That shows that there still has not been a capitulation to the bullish camp when it concerns the Nasdaq, and until there is, prices are likely to go higher and be well supported.
The short interest on the QQQ's was 192 million on Mar. 14, 2003 or right near the last bottom for the index. Since that time, the Nasdaq has soared but short interest has gradually increased. The latest monthly figure shows short interest on the QQQ's at 350 million on Dec. 15. It would take almost four days of average trading volume for the bears to cover their short positions. So the bears have not covered during the tremendous run by the Nasdaq but have in fact increased their bearish positions on the index.
One potential concern for the equities market is the extreme overbought condition of the major indexes. In fact, we are at overbought levels that have historically caused the indexes to go into at least a consolidation of about a couple months. A period of backing and filling would be very healthy for the market right now. On the flip side, a near-term blow-off to the upside would steal gains from the rest of the year, and probably lead to a more extended consolidative period of perhaps nine to 12 months.
One way to measure how overbought the market is by examining the relative strength index or RSI. This is a momentum oscillator that ranges from 0 to 100, but in most cases is confined to the 20 to 80 zone. The 14-day RSI on the S&P 500 hit 79 on Thursday and the very short-term 6-day RSI rose to almost 90. For both the 6-day and the 14-day, this is the highest RSI reading since late 1998. The 14-week RSI rose to 76 on Thursday, the highest overbought reading since August, 1997. After the 8/97 occurrence, the market traded sideways for five months with a fairly good-sized correction in the middle. During 1998, the market went higher but then drifted into a two-month trading range.
Another indicator we like, which has worked very well at predicting at least a pause in the market, is down/up volume on the Nasdaq. When the 10-day ratio of declining volume to advancing volume on the Nasdaq falls down near 0.5, the index has tended to pause or exhibit some minor weakness. On Thursday, this measure was at 0.63, the lowest level since mid-October, and when the index went flat for about two months.
Commodity prices continued to rise, with oil, gold and the CRB Index posting new recovery highs. In fact, gold and the CRB Index have surged to their highest levels since the 1980s. Meanwhile, the main contributor to the surge in commodities, the U.S. dollar, fell to the lowest levels since early 1996. The bond market surged on Friday, Jan. 9, pushing the 10-year Treasury yield down to near the 4% level, or the lowest yield since early October. The 10-year Treasury also broke out of a 4-month symmetrical triangle, which has bullish implications.
One caveat: There is a ton of resistance in the 4% area, so before calling for another extended run in bonds, we would like to see a strong break back below 4%. That seems odd with all the stimulus being thrown at the economy, but stranger things have happened.
Arbeter is chief technical analyst for Standard & Poor's