Ready for a Retreat?
By Mark Arbeter
The stock market added to its recent gains last week but we think there are numerous signs that the rally is extended and that we may see a pullback in the near term. If we do see a small correction, and it occurs on light volume, we believe the rally will take the indexes back to or above the highs seen earlier this year. However, from a longer-term perspective, we do not see a strong, sustainable advance developing as we move into the summer months.
The major stock market indexes have all moved into areas of chart resistance and this is one of the reasons that we see some contraction in prices over the near term. The S&P 500 has pushed up into an area of chart resistance between 1,190 and the Mar. 7 closing high of 1,225. In addition, long-term trendline resistance comes in at 1,210. This trendline is drawn off the March, 2003, and August and October, 2004 lows. This trendline acted as support during the last couple of years, but was broken in April. Trendlines that are broken to the downside become technical resistance.
If we are correct in our projection that prices will pull back in the near term, we believe that there are levels immediately below the index that will provide a floor. Chart support lies in the 1,180 to 1,190 area. The 50-day exponential moving average lies at 1,177 and the 150-day exponential moving average is at 1,171. In addition, a trendline drawn off the lows in April and May lies at 1,170.
The Nasdaq has rallied into an area of chart resistance between 2,020 and 2,100. Long-term trendline resistance, drawn off the March, 2003, and August, 2004, lows, lies at 2,110. This trendline was former support. We see plenty of support just below for the Nasdaq as well. Chart support comes in between 1,990 and 2,020. The 50-day, 80-day, and 200-day exponential moving averages are all sitting near the 2,000 level, so we believe this represents a strong area of support. Trendline support, off the recent lows, lies at the 2,040 level.
Volume on the NYSE and the Nasdaq during the latest rally has been less than inspiring, in our opinion, and is an important reason why we believe there will be a pullback and that the current rally will not develop into a long-term, sustainable uptrend. Since the May 13 low, the S&P 500 has advanced on seven out of nine days. During those seven positive days, volume on the NYSE has been below the 50-day average six times.
A similar picture can be seen with respect to the Nasdaq. Since the May 12 bottom, the Nasdaq has moved higher on nine out of 10 days. Only two of those days have occurred on higher-than-average volume. While we cannot argue too vigorously about higher prices, it is our belief that they are occurring due to a lack of selling pressure and not from robust levels of institutional demand. Strong demand and volume levels are the hallmark of most vibrant bull markets, and light volume at this stage of the cyclical bull market is a sign of age and not vitality, in our opinion.
One of our favorite shorter-term gauges to determine whether the Nasdaq is overbought on a volume basis, and that a pause or pullback may be near, is the 10-day ratio of down volume vs. up volume. This ratio generally oscillates between 0.5 and 3. When the ratio moves down towards 0.5, it indicates that there is very little declining volume relative to advancing volume. Our interpretation of this, based on what has happened in the past, is that the Nasdaq appears to be extremely overbought with respect to the last 10 days of volume action, and that a pause or pullback in the rally is not far behind. On Tuesday May 26, this ratio hit 0.55, which represents a fairly extreme overbought condition by this measure.
Another internal indicator that measures whether the Nasdaq is overbought or oversold is the 5-day summation of TRIN on the Nasdaq. TRIN is simply the ratio of Nasdaq advances over decliners, over the ratio of Nasdaq advancing volume over declining volume. The TRIN or ARMS Index shows whether volume is flowing into advancing or declining stocks. If more volume is flowing into advancing stocks, then the TRIN will be less than 1.0, and if more volume is flowing into declining stocks, then the TRIN will be greater than 1.0.
While it is typically more bullish for the TRIN to be less than one, the indicator can serve its purpose as a reading of whether the market is overbought or oversold. On Tuesday, the 5-day summation of Nasdaq TRIN fell to 2.87, the lowest since last December. Readings below three represent overbought levels and many times in the past have led to pullbacks in the Nasdaq.
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Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's