A Show of Support
By Mark Arbeter
The equity market finally stabilized last week, and the technical outlook has improved from a short-term perspective. The primary stock market indexes ran into some fairly strong support areas, and when you consider that many short-term technical indicators were in pretty oversold territory, the turnaround was certainly not surprising. However, we remain concerned from an intermediate-term standpoint and are not convinced that a strong floor has been traced out.
The Nasdaq remains in a very definable downtrend, having traced out a series of lower lows and lower highs since peaking out at 2,154 on Jan. 26. The index ran smack into trendline support last week, drawn off the lows posted in March and May. Along with hitting this support, the index had moved to a very oversold condition on a short-term basis, with the 6-day Relative Strength Index (RSI) falling to about 14 in the middle of July. This is the most oversold this technical indicator has been since September, 2001. The 14-day RSI fell to 30, very near the levels it posted during the March and May declines. The 100-day rate-of-change (ROC) dropped to -10% in July, the weakest performance over this timeframe since the bear market. In total, the index was set for a counter-trend rally.
However, with the Nasdaq off about 12% from its recovery high, and with the correction taking a fair amount of time, overhead resistance is heavy. This supply is likely to prevent any major upside over the intermediate-term, and even if the recent lows represent the worst for the correction, these lows will likely be tested sometime down the road.
Besides chart resistance, which is pretty heavy from 1,890 all the way up to 2,100, other potential rally stoppers lay overhead for the Nasdaq. The 50-day exponential moving average lies at 1,942 while the 200-day exponential moving average comes in at 1,929. Both of these moving averages represent resistance, and as we pointed out a couple weeks ago, a negative moving average crossover is looking more likely with each passing day. The last time the 50-day crossed below the 200-day was way back in October, 2,000. This simple crossover system has been bullish since May, 2003. Additionally, there is trendline resistance up at 1,965 and 2,035. A 50% retracement of the decline off the June 30 peak targets the 1,943 level.
The S&P 500 fell right to the bottom of its 6-month trading on Monday, July 26, and was able to bounce slightly off this chart support. The closing low on July 26 was 1,084.07, while the closing low during May was 1,084.10. Who says the market doesn't respect former price lows? At the low on Monday, the S&P 500 had pulled back 6.4%, so there is not as much chart resistance as compared to the Nasdaq. Chart resistance runs from 1,100 up to the highs of the consolidation in the 1,160 area. The 50-day exponential moving average is at 1,113 and a 50% retracement of the decline since June 23 targets 1,114. The 150-day exponential moving average comes in at 1,106, with trendline resistance at this point as well. Trendline resistance also lies at 1,140.
As we have mentioned, the market action over the last couple of months is more reminiscent of a bear market than a bull market. The many companies that have posted stronger than expected June-quarter results have gotten hit pretty hard. This is exactly what happened in 2000 and part of 2001. The declines in the indexes are interrupted occasionally by short-covering rallies that fail to generate any follow-through.
The plethora of oversold readings over the last couple of months, both on an internal basis and a price basis, have led to only short-term recoveries. Many stocks that were holding up well on a technical basis have broken down, providing few places to hide. In fact, leadership of late is only being seen in oil and steel stocks as well as some defensive areas of the market. These are not the sectors of the market that can lead the market out of its doldrums.
Another concern has been the constant signs of selling by institutions. We have witnessed many days of price weakness accompanied by higher than average volume, and this is certainly not a positive sign. All of our accumulation/distribution models remain in bearish configurations. The advance/decline line of the up/down volume on the Nasdaq moved to a new correction low, confirming the price low seen in July. Until institutions step up to the plate from the demand side, the market slide is likely to continue.
Despite the fairly weak market environment, sentiment has failed to correct from overly bullish levels. The Investor's Intelligence poll of newsletter writers is showing 51.1% bulls and only 22.3% bears. MarketVane's poll of advisors and traders is still slanted toward the bullish side with 59% of its participants positive on the market. The volatility index or VXO, which measures fear in the options market, is way below the highs posted during the sell-offs in March and May. The VXO jumped about 50% during those two pullbacks, and at many market bottoms, the VXO jumps even more than 50%. During the latest decline, the VXO only rose about 30%. Complacency during price weakness with respect to options, and outright bullishness on the investment polls in the face of weakening technicals is not a positive in our view.
Not all readings in sentiment land paint a bullish outlook. The American Association of Individual Investors (AAII) poll has backed way off from its extreme bullish posture. While the latest figures have not swung to the bearish side, it is a step in the right direction. Put/call ratios did reach fairly extreme levels in May and June, and have backed off quite a bit. This combination usually leads to rallies in the market. At the end of July, Odd-Lot Short Sales on the NYSE spiked to near the levels posted during the pullbacks in March and May. Spikes in short sales by individual investors have worked pretty well at calling intermediate-term lows in the market over the past couple of years.
Overall, the weight of the evidence remains negative from technical standpoint and we still believe there is a good chance that the most recent lows are in jeopardy.
Arbeter, a chartered market technician, is chief technical analyst for Standard & Poor's