Bears Call the Tune

Opening strength in the major indexes has been met with selling. A day where stocks open to the downside might actually help

By Paul Cherney

The Nasdaq composite index closed below 2,025 on Jan. 24. This has increased the chances for a test of the next layer of support for the index at 1,981-1,900. The S&P 500 has been pretty steady, but if the Nasdaq starts to drop hard, it will represent a weight on the S&P 500. These markets are short-term oversold and ripe for a rebound. But...

What we have been seeing in the marketplace has been higher opens that do not attract buying follow-through. I think the higher opening prices are just bears covering shorts (taking short-sided profits). The higher opening prices do not attract buyers, they attract sellers. I think those sellers are fence-sitters who are happy to sell into small advances that offer them prices that are higher than the recent lows.

I think we might have to see a day when selling dominates the opening of a session. A session that opens with selling might put the fear of a plunge into the hearts of the fence-sitters. The fear being that they won't get any better prices to exit long positions than the ones they are seeing on the screen at the moment. An opening like this could create a shakeout, forcing the fence-sitting sellers to abandon hope for a rebound and compelling them to deliver shares into a falling market.

That might relieve the overhead of sellers just hoping for prices higher than the previous day's lows and give the markets a little breathing room for a short-term rebound or relief lift.

Longer-term measures of accumulation versus distribution remain at levels suggesting that the markets are still in a distribution mode, and until that changes, lifts in price are usually only short-term phenomenon. This is exactly the opposite of the technical condition that was in place for November and December of 2004 when I would include words to the effect: "declines in price are usually short in duration and shallow in depth". But now, these measures are starting to reach the edges of envelopes of normalcy and the possibility of a relief rebound in prices is building. The markets are ripe for a relief rebound (that would probably fail to attract sufficient follow-through buying to initiate a protracted trend higher). But at this time, there simply has not been enough technical evidence of aggressive buying to tilt the scales to favor a sustained trend higher.

There is a negative bias in place as long as the CBOE volatility index, or VXO, remains above 13.88. It would be an intraday positive, though, if the VXO could move under 14.42. The chances for a panicked period of selling have increased and this would represent a shakeout if it occurred near the open of trade. If the VXO jumps above 14.96, that might coincide with aggressive, capitulation style selling (short-term). But, the index would have to reverse and head lower to suggest that short-term selling pressures might be giving way to a short-covering rally of a day or two.

We have not seen truly panicked selling yet, just persistent and orderly distribution.

The S&P 500 is at a thin line of support at 1,169-1,160.52. It would not be healthy for bulls to see a close under 1,160; that would create an oversold condition that should compel a short-covering rebound, but in my view of the chart and the current technical conditions, a rebound could easily run out of momentum and turn over. That would increase downside risk for a test of the next layer of support under 1,160.52, which is 1,142.05-1,090.19.

At this time, if there is a rebound in prices, I would have to see compelling evidence of strong buying demand to expect anything more than just a one- to three-day lift in prices.

Short-term measures are oversold and a rebound this week would be natural, but it would take a close in the S&P 500 over 1,195.98 or a close in the Nasdaq above 2,106.19 to increase confidence in expectations for a small leg higher (doubtful). It would require price breaks above resistances (S&P 500 1,195.98, Nasdaq 2,106.19) on good volume to extinguish intermediate-term measures that the current state of distribution is fading.

S&P 500 immediate resistance is 1,174-1,182.52, then 1,185-1,195.98, then 1,205-1,209.53. There is more formidable resistance from July of 2001. The older the resistance, the less precise you can be, but here is the read from the 60-minute charts from July and August of 2001: resistance is 1,215-1,226.27.

Nasdaq resistances are 2,032-2,056 and 2,045-2,065, which makes 2,032-2,045 a focus of resistance. Resistances are stacked at 2,072-2,116 with a well-defined ledge of resistance at 2,086-2,103.

Anytime resistance is exceeded it must be treated as support until broken. Anytime supports are broken they must be treated as resistance until exceeded.

Cherney is chief market analyst for Standard & Poor's

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