Stocks: What the Charts Say

Mark Arbeter, S&P's chief technical analyst, sees the market in the process of bottoming out, though it could test its lows soon

A bit of a short-term bounce is possible in the stock market and possibly "a pretty decent yearend rally." That's what the charts tell Mark Arbeter, chief technical analyst for Standard & Poor's, who nonetheless expects the market to test its August lows sometime in September and October.

From a technician's viewpoint, the market areas that look best to Arbeter include oil, steel, chemicals, telecom, utilities, transportation, and some financials. At the other extreme, the weakest are technology, the airlines, and food distributors and grocery chains.

Within tech, Arbeter would wait for the sector "to put in some kind of reversal formation before getting too aggressive." He sees semiconductor equipment as the weakest segment of tech, but he expects to see better times for the area later this year. And according to his charts, semiconductor maker Cree (CREE ) looks attractive, and he says some software stocks have broken out to 52-week highs.

These were a few of the points Arbeter made in an investing chat presented Sept. 14 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Mark Arbeter is a Standard & Poor's Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."

Q: Mark, what does the market look like now from the viewpoint of technical analysis?

A:

Technically, the market is still in an intermediate-term decline. The major indexes are still on a pattern of lower highs and lower lows. But I think the market is in the process of bottoming out on an intermediate-term basis. We had quite a washout in many stocks -- the technicals got fairly oversold in August, and some sentiment indicators moved to extreme levels normally seen at an intermediate-term low.

Short-term, I think the market will move a little bit higher. Sometime during September or October, the markets will move back down and test the lows that we saw in August. If that test is successful, then we could have a pretty decent yearend rally.

Q: How much influence do you think the uncertainties over the election, Iraq, and terrorism are having?

A:

All these are probably keeping a lid on the market at the current time. It's possible that once we get through the election period that that lid will be removed from the market and that we'll be able to rally from there.

Q: Do you find that the technical charts reflect the course of the economy? Uncertainties there, too, of course.

A:

Absolutely. The technicals will usually lead the economy. And, in fact, they're a component of the leading indicator report that comes out every month. This is especially true at major tops and major bottoms. The stock market will usually turn higher before the economic news becomes bullish and also before the corporate news becomes bearish. At major tops, the market will usually turn lower before any sign of economic deterioration or weakening in corporate profits.

Q: Do any sectors or stocks look better now on the charts?

A:

Yes. The sectors that look the best right now include oil stocks, steel, chemicals, telecom, utilities, and transportation, and some financials look pretty good.

Q: To what do you attribute that?

A:

For some of these it's probably saying that the corporate backdrop that these industries are in is improving. Some of the strength in some of these industries is probably tied to a move to more conservative stocks, and certainly the strength in oil can be tied to the big rise in oil prices.

Some of the strength also in the basic materials stocks might suggest that demand, possibly from China, will be very strong. Some strength in the telecom and utility stocks might be due to investors looking to decent dividend yields in these uncertain times.

Q: Do you see any hope for a revival among the tech stocks?

A:

Yes. The Nasdaq and many technology stocks moved to very oversold conditions in mid-August. We've seen a decent bounce so far. I think they're in the process of basing out -- and we could see better times toward the end of the year for this area.

Q: Any particular portions of tech, or specific names?

A:

In the semiconductor area, Creelooks attractive on a technical basis. Some of the software stocks have recently broken out to new 52-week highs. But, for the most part, I would wait for the technology group as a whole to put in some kind of reversal formation before getting too aggressive with technology.

Q: To what extent, if any, do you mix fundamental analysis with the technical discipline?

A:

One way to do that is if you're an aggressive investor and you're looking for William O'Neil-type stocks [O'Neil is chief of Investor's Daily]. In that scenario you want to combine a strong chart with strong fundamentals. You're looking for stocks with high relative strength that are breaking out to new all-time highs in conjunction with strong sales and earnings growth. During a strong market period, stocks with these characteristics will tend to outperform.

Ironically, even though you're looking at the fundamentals, you're less concerned about p-e ratios and more concerned with how the stock is acting and how strongly or how fast the company is growing.

Q: Can you point us to any stocks that look especially good in the areas you said were doing better?

A:

In the oil sector, Occidental Petroleum (OXY ), Apache (APA ), and Devon Energy (DVN ) look attractive. In the telecom area, Verizon (VZ ) looks good, as well as Qualcomm (QCOM ) and Alltel (AT ). In the financial area, Bank of America (BAC ) looks attractive. In the steel area, Nucor (NUE ) seems good. In the chemical area, it's IMC Global (IGL ) and FMC (FMC ) on a technical basis. And in the transportation area, Burlington Northern (BNI ) is acting very well.

Qualcomm has probably been one of the better performers this year. It just recently moved to another new all-time high.... Technically, they just have everything going for them. When a stock can act fairly strong in a lousy market environment, such as the way QCOM has acted, that's a very bullish sign. For instance, when the market in technology stocks was heading sharply lower during July and August, QCOM basically moved sideways, very close to its all-time high. Then, when the market environment improved, the stock broke out once again and has been rising ever since.

Q: Does anything in the current charts surprise you, from a historical perspective, perhaps?

A:

Not really. Historically, after you've gone through a major bubble, the major indexes tend to recover somewhat and then move into big sideways consolidations that can last many years. And so far, this is exactly what's occurring.

Q: So what are the weakest sectors or stocks?

A:

The weakest sector, say, over the last three to six months, has certainly been the technology area, and more specifically, the semiconductor-equipment stocks. One of the other groups that continues to act very poorly is airline stocks. Certainly this can be explained by the big rise in oil prices. The other groups that are not acting too well are the food distributors and the grocery-store chains.

Q: How can the average investor make best use of technical analysis?

A:

First thing that the average investor has to do is get educated -- learn how to read a chart, learn how to determine what type of market phase we're in, follow the markets on a daily basis. And plenty of excellent books and Web sites can assist the average investor. Once this knowledge is gained, probably the most valuable aspect of technical analysis is the timing of individual stocks.

We as technicians are not so much concerned with what a company does, but the action of the chart. The big advantage with technical analysis is that major trends will begin and end prior to a turn in the fundamentals. Another big advantage of technical analysis is the use of strict sell disciplines. When used properly, these sell disciplines are a great way of cutting the losses that seem to plague the average investor.

Q: So an alert chart watcher can get tips on when to buy or sell?

A:

Absolutely. Probably the best setup to buy a stock using a chart is to find a stock that has been in an uptrend and is currently basing or moving sideways. When and if the stock breaks out to a new all-time high and on heavy volume, in a good market that's a good time to buy a stock.

On the flip side, if a stock has had a big run and it loses momentum and it starts breaking through some key moving averages such as the 50-day moving average, and you start to see the stock decline on a pickup in volume, those are some of the warning signs to get out or sell your position.

Q: What insights does technical analysis give on stock valuations?

A:

I don't really look at valuations. What I do look at that might tell me a stock is getting ahead of itself is the slope of the advance. Many times after a big move in a stock, the slope of the advance will get very, very steep -- basically, the stock is going straight up. That would be a warning sign to me that the stock is overbought and that it might be time to either sell or lighten up on my position.

Q: Did the charts prefigure the bursting of the tech bubble?

A:

Absolutely. Many technology stocks rolled over in 2000, well before the fundamental backdrop on these individual issues started to deteriorate. Many of these highfliers gave many technical warning signs that a major breakdown was coming.

Q: So does your analysis tell us this is a time to buy (very carefully) or to sit it out?

A:

I would prefer to remain on the sidelines until the major indexes have put in reversal formations. I would certainly be looking at charts of individual stocks, especially those that are breaking out to either new 52-week highs or to all-time highs. If one was inclined to, you could certainly start to buy these stocks on a selective basis. But the stocks that have gotten beat up, I think you're going to have to have some patience with.

Q: At the other extreme, what's a sure sign you should sell?

A:

There are many different sell signals. Certainly, if a stock has moved up quite a bit and its slope gets very steep, that would be a sign to get out. If a stock is in an uptrend and fails to go to a new high and then starts putting in lower lows, that would be another sign to sell. Another sign would be a stock that's acting very, very well and has a huge rush of volume into it -- that would be a sign of a top.

Another sign would be if a stock saw a huge amount of volume but was unable to continue its uptrend -- that would be a sign that institutions are selling into the strength. A couple more signs would be that it's always dangerous when a stock breaks both its 50-day and 200-day moving averages. Another sign would be if a stock fails to move higher on better-than-expected news.

Edited by Jack Dierdorff

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