On the Comeback Trail

S&P still believes the major indexes will post new recovery highs sometime in the first half of 2005

By Mark Arbeter

The S&P 500 index put in a decent performance last week, continuing its rebound off strong support in the 1,160 area. While the short-term trend had turned bearish during January, the intermediate-term price trend remained bullish. Although we are still cautious for the near-term as we have not seen robust volume levels on the upside, we still believe the major indexes will post new recovery highs sometime in the first half of 2005.

Over the last week, the leading Exchange Traded Funds (ETFs) have come from Latin America, Energy, Small Cap Growth, Utilities, and Natural Resources. Individual stocks breaking out to 52-week highs come from a broad area of subindustries including homebuilding, metal products, oil & gas drilling, oil & gas refining, machinery, steel, consumer products, utilities, nursing homes, medical products, and leisure products.

As we have commented on many times, one of the key drivers of a bull market is rotation in and out of different groups. Money stays in the market as institutions move quickly to catch the latest momentum plays. Bear markets are characterized by money leaving the market completely, as alternative investments are looked upon more attractively than equities.

The price trend for the S&P 500 is positive from an intermediate-term perspective. However, we are getting mixed signals from many momentum indicators based on the S&P's price action. From a weekly view, the moving average convergence/divergence and the weekly stochastic indicators are still in bearish configurations after rolling over. The weekly MACD also put in a lower low while the "500" moved to new highs, and therefore has traced out a negative divergence. The weekly stochastic oscillator rolled over after getting very overbought, adding to the significance of the signal.

While the weeklies are bearish, the daily momentum indicators have turned positive and are not yet in overbought territory. If the daily momentum indicators move to an overbought position and rollover, and at the same time, the weeklies remain bearish, we believe that could be a prescription for further losses.

In our view, the key support level for the S&P 500 is down at 1,160. This level or area is significant for a number of reasons. First, it represents the top of the consolidation from back in 2004, and therefore is also the key breakout point for the index. As talked about many times, an individual stock or index will frequently test the breakout point, before resuming its advance. Two additional pieces of support also come in around the 1,160 level, and they are the 80-day exponential moving average and a Fibonacci retracement of 38.2% of the advance since October.

On the upside, there is little chart resistance for the S&P 500. The previous closing high on Jan. 18 was at 1,195.98 while the closing high in December was 1,213.55 and the intraday high in December was 1217.90.

Below 1,160, there is plenty of support for the S&P 500. A 50% retracement of the advance since October targets the 1,154 level. The 150-day exponential moving average lies at 1,153 while the 200-day exponential moving average comes in at 1,141. The peaks in October, June and April are also potential support levels and they are all in the 1,140 to 1,150 zone.

As we look back for reasons for the pullback in January, we have discovered a key technical explanation for the weakness. Like many times with market analysis, errors or missed opportunities entail going back to the drawing board. Fibonacci analysis is great for giving very reliable upside and downside price targets. Once the market broke out from the 2004 consolidation, an initial Fibonacci target of 161.8% of the width of the consolidation could have been used for rally stopper. The width of the consolidation was 94.53 points.

Multiplying this width by 1.618 gives us 153 points. Adding this to the bottom of the consolidation at 1063.23 gives an initial Fibonacci target of 1,216.18. The intraday high during the rally in December was 1217.90. If the S&P 500 can get through this level, the next Fibonacci target using this type of analysis would be 1311. Multiplying the width of the consolidation by 2.618, and then adding it to the bottom of the consolidation will arrive at this target. While our upside projection for the S&P 500 remains 1,253, we believe another 50 or 60 points would not be out of the question.

The Nasdaq is in a little weaker position from a technical perspective than the S&P 500. The index spent much of the week filling a price gap created by the drop on Jan. 20. Key short-term resistance levels for the Nasdaq are just overhead. The 50-day exponential moving average lies at 2,076 while the previous price high from Jan. 18 was 2,106. If the Nasdaq can break above the 2,106 level, the last remaining piece of short-term resistance would be up at the 2,180 zone or the highs from December.

The bond market broke out on Friday, Feb. 4, and we now believe yields on the 10-year Treasury note are heading for important resistance in the 3.9% area. This area has provided stiff resistance in the past and therefore is important from an intermediate-term perspective. The 10-year yield bottomed out at 3.94% in October, 2004, 3.96% in September, 2004, 3.92% in January, 2004, and 3.91% in October, 2003.

On Friday, the 10-year broke out of a small symmetrical triangle that had been in place since October. More importantly, the 10-year took out intermediate-term trendline resistance drawn off the yield lows in March and October, 2004. If the 10-year can break below 3.9%, the next piece of chart resistance lies in the 3.6% to 3.7% area. This was the yield low from back in March, 2004.

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

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