Something Still Missing
By Mark Arbeter
The stock market went a long way in putting in a potential, intermediate-term low last week, but we will need to see more evidence over the next week or so to give the all-clear sign. The rally on Thursday, Mar. 25, was fairly impressive, but like we have commented in the past, one-day wonders are not enough to turn the medium-term trend higher.
And indeed, there are a couple of key factors that are still missing before we can become comfortable in predicting that it is onward and upward from here. First off, and despite the large rally on Thursday, the major indexes are technically still in a downtrend. In other words, the pattern of lower highs and lower lows is still in force.
Secondly, and fairly obvious since the indexes are still in downtrends, the major indexes have not yet traced out reversal formations typically witnessed during market lows. The most common formation at both minor and major lows is a double bottom. We would expect the Nasdaq to put in a double bottom because it went through a fairly decent correction. The S&P 500, which did not drop all that much from its recent highs, may trace out a sideways consolidation with multiple days of backing and filling before a new leg begins.
Quite simply, we would expect the Nasdaq and the "500" to fall back to the recent lows before any major upside will take place.
The next key component of a market bottom is a series of big days to the upside, that are accompanied by larger than average volume. The typical pattern during a market low is a low volume test of the first reaction low, immediately followed by a surge in both price and volume. The move off the second low would most likely push the indexes above the trading ranges seen during the bottoming process, and then set them up for a move back to the highs put in during January and February.
There are other components of a market bottom such as re-capturing the 50-day exponential moving average and breaking the bearish trendline that has contained the indexes since their highs. These two components are usually satisfied as the indexes breakout of their most recent trading ranges seen during the course of the bottom.
The other limiting factor to a sharp move higher from here over the near-term is that the major indexes, as well as many stocks, have a decent amount of overhead resistance to work through. This is likely to put a ceiling on the market over the weeks' ahead.
For instance, the S&P 500 will hit resistance at many levels just overhead. There is fairly important trendline resistance up in the 1,120 area. This trendline supported prices from May, 2003, until mid-March, and now represents key resistance. Intermediate-term chart resistance begins at 1,122, which is also where the 50-day exponential moving average lies. The zone of chart resistance that starts at 1,122 was formed during the January to early March consolidation and runs up to the recovery highs of 1,160. A 50% retracement of the recent decline in the S&P 500 and an additional piece of resistance comes in at 1,124.
Key support for the "500" lies at the recent closing low of 1,091. The next piece of support comes from the 150-day exponential moving average at 1,080. A 23.6% retracement of the advance targets the 1,074 level with chart support beginning at 1,075. We had mentioned recently that a measured move, based on the width of the January to March consolidation, gave a downside target of 1,095 for the S&P 500, and with this week's closing low of 1,091.33, this target has been fulfilled.
In our last column, we talked about the volume dynamics of an intermediate-term advance and took a look at the 10-day moving average of advancing volume divided by declining volume on the Nasdaq. To give a quick review, this ratio will rise sharply during the early stages of an advance, to at least 2.0, if not over 3.0. This usually marks the top for this ratio as institutions come back into the market in force.
As the up move gets more mature, this ratio will put in a series of lower highs. Eventually, there is just not enough fuel to push stocks higher and the indexes roll over, allowing the whole process to start over. This ratio will frequently dip below 1.0, sometimes approaching 0.5 as the correction deepens.
This indicator peaked back in March, 2003, when the intermediate-term advance took hold. It then put in a series of lower highs. Just recently, this ratio fell to a fairly oversold level of 0.78. Since that time, the ratio has traced out a pattern of minor new highs and new lows. With the extremely strong up/down volume on Thursday of almost 17:1, the 10-day shot up to a strong reading of 3.1:1. This is typical of an early stage Nasdaq advance.
Sentiment polls are finally starting to give up some of the extreme bullishness, which is a good sign, and we think will allow the market to complete a bottom. Investors Intelligence poll of newsletter writers has seen a drop in bulls to 45.4% during the latest week, the first reading below 50% in an incredible 46 weeks. Bearish sentiment has risen to 23.2%. While these numbers are not the kind normally witnessed at market lows, they are a step in the right direction.
CBOE put/call ratios have risen to healthy levels of late. The 10-day and 30-day exponential moving averages of the CBOE p/c's recently moved to the highest levels in over a year.
Arbeter, a chartered market technician, is chief technical analyst for Standard & Poor's