Seasonal Sweet Spot

Though sentiment and some internal market measures are extremely overbought, the wind is at the market's back

By Mark Arbeter

After a two-week consolidation in the second half of November, the major indexes all broke out once again. As we enter December, another seasonally strong month, price momentum and volume remain positive, and we believe this will allow for further gains. However, sentiment and some internal market measures are extremely overbought so there could be a pause or pullback sometime during the month.

As we have said, the market is right in the sweet spot as far as seasonals are concerned. Historically, the best three months of the year to be invested in the stock market are November, December, and January. Incredibly, the S&P 500 has risen 15 out of the last 17 Decembers, so it is hard to bet against the market during this time of year, especially with the wind at the market's back.

Market breadth or participation remains very positive, with the NYSE advance/decline (A/D) line and the Nasdaq A/D line both in new recovery high territory. Looking a bit deeper, sector strength remains broad with positive chart conditions in the energy, industrial, material, utility, telecom, and consumer discretionary areas. The financial area is neutral, but there's plenty of strength within the sub-industries. While there is continued weakness or underperformance in consumer staples, health care, and technology, certain areas within these three sectors are also performing rather well.

Along with the strong breadth statistics, we are witnessing an impressive level of stocks hitting 52-week highs on both the NYSE and the Nasdaq. NYSE new highs as a percentage of issues traded hit almost 14% recently, with almost 10% of issues traded on the Nasdaq hitting new 52-week highs. These levels are the highest since the beginning of the year. The new high list is littered with a broad group of sub-industries including financial, medical, business services, telecom, retail, insurance, building, leisure, transportation, software, and chemicals. The old adage that a rising tide lifts all boats certainly describes this market very well.

The S&P 500 ran up above the 1190 level on Friday and hit its highest level since August, 2001. Looking at the market with a longer-term perspective, there is a good block of chart resistance that starts at 1200 and runs clear up to the all-time highs. Our intermediate-term target remains 1253, arrived at with both a chart measuring technique and Fibonacci retracement analysis.

From an overbought/oversold perspective, we find that the S&P 500 has already reached overbought conditions on this run on a daily basis, but has yet to reach overbought levels on a weekly basis. In our opinion, this should allow for more upside as we move into the New Year. On a shorter-term basis, chart support lies in the 1170 to 1184 area, with more important, intermediate-term support down between 1150 and 1160.

Towards the end of the week, the Nasdaq moved up near its high for the year, but was unable to finish at a new 2004 high. Back on Jan. 26, the Nasdaq closed at 2153.83. We believe the Nasdaq will put this level behind it in the near-term and forge its way to our next target up in the 2500 to 2600 zone. Chart resistance, from back in 2001, is up between 2250 and 2328, with the next layer starting at 2300 and running up to 2900. Chart support begins in the 2075 area and is thick down to the 2000 zone.

Our concerns about the market are short-term in nature and we believe we could witness a quick pullback sometime during the month. This, in our view, would be a big positive because it may alleviate some of the sentiment and internal extremes that exist currently.

While sentiment polls have been overbought and tilted towards the bullish camp for quite sometime now, we are seeing this condition roll over into the options market. Put/call ratios on the CBOE, after holding fairly high during the middle of the year, have dropped rather sharply and now are at levels that have caused the market some short-term trouble in the past. Both the 10-day CBOE put/call ratio and the 30-day have fallen to their lowest levels since the beginning of the year.

Another measurement of sentiment, investment polls, are at bullish extremes, and we view this as negative from a contrarian point-of-view. When combining two short-term sentiment polls, MarketVane and Consensus, we are clearly near the upper limits of bullish sentiment. When taken together, bullish sentiment recently hit 144%, the highest since early January when the market was peaking. The last time prior to January of this year that this kind of bullish extreme was seen was way back in 1998. While the market has been able to go higher in the past with high levels of bullish sentiment, we think that these heavily skewed sentiment readings will eventually catch up with the market.

The Treasury bond market reversed sharply Friday following the weaker than expected nonfarm payrolls report, but we believe the trend in interest rates is still higher. The 10-year Treasury yield fell back Friday and tested the breakout point of 4.25% (intraday low was 4.23%) and then ticked back up and finished near 4.27%. In many markets, this action of testing the breakout point is quite common, and as long as the individual market stays above the breakout point, the trend remains the same and the breakout is still in force. We see the 10-year yield rising back to the highs posted earlier in the year up between 4.6% and 4.8%.

Crude oil prices continued to plunge as some speculative froth got taken out of the market. Prices fell back to the mid-$42 per barrel area, and are at their lowest level since late August/early September. Crude oil fell to important trendline support, drawn off the lows in September 2003 and June 2004. While oil prices could continue to weaken over the intermediate-term, it would take a close below $36 to turn the long-term trend in oil from bullish to bearish. There is a trendline drawn off the 2001 and 2003 lows that represents critical long-term support for the market.

Arbeter is chief technical analyst for Standard & Poor's

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