More Pain Ahead for Stocks?

The major indexes have failed to break through key resistance levels -- an overriding negative for the market

By Mark Arbeter

The failure by the major indexes over the last couple of weeks at important trendline resistance areas is the overriding negative for the market at this point and may imply some more basing and testing action over the next 2 to 4 weeks. While some technology stocks appear to be putting in a bottom, many still lack reversal formations so commonly seen at major turning points.

We believe volume has been lackluster on both sides of the market (both up and down days) and will probably be necessary to fuel a sustainable advance. In many market reversals, trading volume plays a key ingredient as institutions come rushing back into stocks.

The rally on Friday, Oct. 1, pushed the major indexes back up to important resistance zones that are marked by both bearish trendlines and heavy chart resistance. The S&P 500 faces trendline resistance from a downward sloping line in the 1,132 area. The index is in the midst of heavy chart resistance that runs from 1,080 up to the top of the trading range at 1,160. Trendline resistance for the Dow Jones industrial average comes in at 10,335 and 10,440. Chart resistance for the index is heavy between 10,000 and 10,740.

The Nasdaq broke above one key bearish trendline on Oct. 1 that was at 1,910. Two other important downward sloping lines come in at 2,000 and 2,020. Chart resistance for the Nasdaq is thick from 1,900 up to 2,150. We believe a concerted push higher by the major indexes through the above-mentioned trendlines will go a long way in finally turning the market around, but until then, the major trend continues to be lower.

In some of our recent commentaries, we talked about the dichotomy between the advance/decline lines on the NYSE and the Nasdaq. The NYSE A/D line pushed to a new recovery high in mid-August and has made a series of higher highs ever since. The Nasdaq A/D line has remained in a well-defined downtrend since January. However, with the strength in the Nasdaq on Oct. 1, the A/D line is showing signs of bottoming out.

In our opinion, the broad strength exhibited by the NYSE is encouraging and probably puts a floor underneath the blue chip indexes, but we still believe that leadership from the growth area will be needed in order to propel the market to robust gains on an intermediate-term basis.

Volume on both the NYSE and the Nasdaq picked up toward the end of last week, and it could be a sign that institutions are slowly coming back into the market. In our opinion, that would be a constructive sign for the market. Historically, sustainable market advances start with a surge in trading, with advancing volume dominating declining volume. For the most part, volume has tailed off since peaking in the beginning of the year.

One worry continues to be the action of the volatility indexes. The VXO or volatility index of the S&P 100 (OEX) hit its lowest level of the year on Oct. 1 and is back to levels last seen in 1995 and early 1996. The VXN or volatility of the Nasdaq got very close to the lowest level of the year and is also back to levels last printed in 1995. Volatility indexes measure option premium levels and when they are low, it shows that there is a lot of complacency in the marketplace and that investors do not expect much price volatility. During the last year, when the volatility indexes have moved to new lows, a correction or pullback has occurred.

Oil prices oscillated around the $50-per barrel area almost all week, and while there may be times of profit taking, the long-term trend in this market is higher. Our feeling is that oil prices near $50 will keep a lid on the equity markets. We believe a strong close over the $50 level would be technically bullish for oil and signal another leg higher, possibly towards the $55 to $60 zone.

Oil wasn't the only commodity to attract investor's attention this week as gold futures surged to their highest level since April, closing above the $420 level. Gold futures are now close to challenging the recovery highs just above the $430 level set back in January and March. A break of the $430 resistance level would target the $460 to $480 zone during the next intermediate-term advance, in our opinion. Coinciding with gold's break higher was a breakdown in the U.S. Dollar index. The index broke below an important trendline that has supported prices since February and we think the greenback is now in danger of testing its bear market lows down near 85.

The bond market, in our opinion, is very toppy, and could be subject to some profit taking. The yield on the 10-year Treasury bond has been unable to break multiple pieces of resistance in the 3.9% to 4.1% area, and with the market being very overbought, we believe yields could back up from here. Key near-term support for the 10-year is at 4.25% to 4.4%.

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