A Sea Change for Stocks

S&P believes that a long overdue consolidation or pullback is underway

By Mark Arbeter

The streak of nine straight weeks of higher closes for the S&P 500 index finally came to end last week, and we believe that a long overdue consolidation or pullback has commenced. It is our opinion that the consolidation or trading range for the "500" will be bounded by 1,080 on the downside and 1,155 on the upside -- and will last for two to five months.

While the majority of Wall Street is blaming the latest weakness on the change in the Federal Reserves' policy statement, the market has been looking for a reason to sell off. We think the change in the policy statement was somewhat expected despite the reaction by the stock market. The bond market had turned the corner over the last two weeks and yields were headed higher before the FOMC decision.

The U.S. dollar, which will benefit from higher interest rates, was also headed higher before the announcement. Gold, which seems to be running counter to the dollar, peaked in the middle of January, also signaling that a sea change was at hand. As can be seen, the impact of a less accommodative Fed is far-reaching, but will take time to turn the longer-term trend of many of these related markets.

The main reason for our belief that the damage will be limited in scope is the condition or construction of the charts of the major indexes. There is plenty of good support beneath the market, which should contain prices. Initial chart support for the S&P 500 lies at 1,130 and the first minor trendline, drawn off the November and December lows, is at 1,118.

Of more importance for the intermediate-term trend of the market is the 50-day exponential moving average, which lies at 1,102, and trendline support drawn off the March, 2003, and November and December lows at 1,110. Intermediate-term chart support as well as trendline support off the May, August, September, and November lows comes in at 1,080.

Longer-term support from the 150-day exponential moving average is at 1,047. A mild Fibonacci retracement of 23.6% of the advance since March, and potential support targets the 1,072 level. As we have pointed out numerous times, resistance for the S&P 500 is heavy from 1,150 to 1,177, and should continue to limit the upside.

For the Nasdaq composite index, a lot of support is located very close together and therefore this area takes on greater significance. The 50-day exponential moving average, which has supported prices since April, 2003, comes in at 2,025. Trendline support, from the lows in August and December, lies at 2,005, while the lower Bollinger Band comes in at 2,012. Pretty decent chart support is at 1,990 and then 1,900. A 23.6% retracement of the advance since October lies at 1,908.

There were some clear signs of distribution this past week, especially on the Nasdaq, as institutions dumped some recent winners. The total declining volume on the Nasdaq during Tuesday, Wednesday, and Thursday was the highest three-day total since September, 2001. As we said in our last column, there had been a ton of volume going into Nasdaq stocks during January, and the Fed stopped that in its tracks.

On a more relative basis, the three-day moving average of declining volume to increasing volume rose to 2.92, the highest since mid-November. While three days of heavy selling is not of real significance from a longer-term perspective, it is another piece of evidence that the intermediate-term trend may have turned from bullish to neutral.

We have certainly talked a lot about how overbought the stock market is of late and have dusted off a measure we have not talked about in quite some time. Taking the difference between a 10-week exponential moving average and a 40-week exponential moving average on both the Nasdaq and the S&P 500 shows how far or extended the intermediate-term trend is ahead of the longer-term trend.

The recent difference between these two moving averages on the Nasdaq hit a very high 11.1%. This is the highest reading since early 2000. If we look at similar readings, and ignore the "Bubble Years", a definite pattern emerges. Readings of this magnitude occurred in 1986, 1991, 1992, 1995, and in 1997-98. After each time, the Nasdaq either paused or went into a minor correction. Similar results can be seen when looking at the S&P 500 and the difference between these two averages, but it is of course a little less dramatic.

As we already said, the Fed's policy statement change and the potential for future rate hikes are far-reaching. Of all the markets, the currency and bond markets could be most affected in the near-term. We see little affect on the stock market near-term because rates are so low, so any small increase is likely to have a muted response from equity investors.

The Treasury market leads the Federal Reserve, and in many cases, by a long period. The 10-year Treasury yield bottomed out last June 13, over seven months ago. This was certainly an indication among bond investors that they have been expecting a tightening in monetary policy.

The dollar, however, is still firmly entrenched in a long-term bear market, but the seeds may have been planted for some type of long-term bottom being traced out this year. If we are correct about the bond and dollar markets, it is likely that the torrid run in gold prices is over. Remember that a turn in these markets is likely to take time.

Arbeter, a chartered market technician, is chief technical analyst for Standard & Poor's

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