Caution Flags for the Markets

The Nasdaq is the first major index to show signs of a short-term technical breakdown

By Mark Arbeter

Last week, the stock market was basically flat despite a fair amount of daily volatility as neither the bulls nor the bears could take control of the market. The bond market continued its major reversal, in our opinion, and crude oil futures held up near $55 per barrel. We still believe the stock market is in the process of tracing out a short-term top and would remain cautious for the next couple of weeks.

We believe the Nasdaq is the first major index to show signs of a short-term technical breakdown. While the S&P 500 and the Dow Jones Industrials have traded in a sideways formation recently, the Nasdaq looks to us like it is rolling over. Because the Nasdaq has led the rally since the lows in April, we do expect the index to pull back more than the other indices.

As we have mentioned over the last couple of weeks, there is a brick wall at the 2100 level for the Nasdaq. The latest failure at that point was the fifth time this year, as the index was unable to break above that level in January, twice in February, March and now June. While the Nasdaq has run into formidable resistance overhead, there appears to be a solid floor underneath. Chart support lies in the 2020 level and represents the peak in index in April and the lows for the Nasdaq earlier in the year. There is a convergence of moving averages in the 2020 zone that is quite remarkable and somewhat rare.

The 50-day exponential, 80-day exponential, 200-day exponential, and the 200-day simple moving averages are packed extremely tight and all lie between 2014 and 2022. In addition, a 38.2% retracement of the advance since the intra-day low on Apr. 29 would target the 2018 level. The more pieces of resistance at one level, the more significant that area becomes.

A decline to the 2020 level would represent only a 4% pull back and, in our opinion, set the Nasdaq up for another run at 2100. We believe the next move higher will finally put 2100 to rest, placing the Nasdaq in position to challenge its cyclical, bull market peak up in the 2200 zone. One of the reasons for our short-term caution but intermediate-term optimism is the current configuration of momentum indicators. The daily stochastics indicator on the Nasdaq has rolled over from an extremely overbought condition, signaling that a pull back had arrived.

The daily MACD indicator has also rolled over and given a short-term sell signal as well. When looking out a bit, the weekly momentum indicators suggest to us that a continuation off the April lows may have further to run. The weekly MACD has given an intermediate-term buy signal recently, the first bullish signal since last September. The weekly stochastics is overbought but still has room to go before moving into extreme overbought territory. Many times, the stochastic indicator will trace out bearish divergences before an intermediate-term peak, and this indicator has yet to trace out its first peak.

The S&P 500 index has traded in a fairly tight range of 1184 and 1209 since May 19, and has run into an area of decent chart resistance up in the 1190 to 1225 zone. We see a very mild pullback for the S&P 500, as support levels are much closer than they are for the Nasdaq. Initial support comes from the 50-day exponential moving average at 1183, with the 80-day exponential average at 1181. The 150-day and 200-day exponential moving averages come in at 1175 and 1170 respectively. Trendline support lies at 1177 and 1164 with fairly good chart support in the 1175 area, in our opinion.

A 38.2% retracement of the advance from the April lows would target the 1181 level for the "500" while a 50% retracement would target 1172. Like the Nasdaq, there is a concentrated area of support, which is usually a positive for the market and gives us more confidence in making downside projections.

The bond market has reversed hard since June 3, and it appears to us that a firm bottom has been traced out for yields. Following the weaker-than-expected payroll report on June 3, the 10-year Treasury yield plunged to an intra-day low of 3.8%. Bonds quickly reversed and after the weakness on June 10, the 10-year yield was back up to 4.05%. There are a number of factors that suggest to us that yields could be headed higher over the intermediate term. First, the 10-year Treasury has had a fairly large move since peaking out at 4.7% on March 23. Second, both daily and weekly technicals were very overbought. Third, the 10-year moved to an area of strong chart resistance down in the 3.8% to 4% area.

Finally, sentiment towards bonds was also very overbought. The MarketVane poll is currently showing 76% bulls, the highest percentage of bullish sentiment since the major bottom in yields back in June 2003. During the middle of 2003, the 10-year fell to a multi-decade low near 3%. We project that yields on the 10-year could approach the 4.5% area over the next couple of months.


S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:

A+ Highest B Lower
A High C Lowest
A- Above Average D In Reorganization
B+ Average NR Not Ranked
B- Below Average

S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.

S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.

S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.

Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.

Required Disclosures

In the U.S.

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations and 12.5% with sell recommendations.

In Europe

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 29.2% of issuers with buy recommendations, 50.5% with hold recommendations and 20.3% with sell recommendations.

In Asia

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 34.3% of issuers with buy recommendations, 48.0% with hold recommendations and 17.7% with sell recommendations.


As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations and 13.8% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.

For All Regions:

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, NY, NY.

Other Disclosures This report has been prepared and issued by Standard & Poor's and/or one of its affiliates. In the United States, research reports are prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). In the United States, research reports are issued by Standard & Poor's ("S&P"), in the United Kingdom by Standard & Poor's LLC ("S&P LLC"), which is authorized and regulated by the Financial Services Authority; in Hong Kong by Standard & Poor's LLC which is regulated by the Hong Kong Securities Futures Commission, in Singapore by Standard & Poor's LLC, which is regulated by the Monetary Authority of Singapore; in Japan by Standard & Poor's LLC, which is regulated by the Kanto Financial Bureau; and in Sweden by Standard & Poor's AB ("S&P AB").

The research and analytical services performed by SPIAS, S&P LLC and S&P AB are each conducted separately from any other analytical activity of Standard & Poor's.

Disclaimers This material is based upon information that Standard & Poor's considers to be reliable, but neither S&P nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. With respect to reports issued by S&P LLC-Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails. Neither S&P LLC nor S&P guarantees the accuracy of the translation. Assumptions, opinions and estimates constitute Standard & Poor's judgment as of the date of this material and are subject to change without notice. Neither S&P nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested. Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate. Where an investment or security is denominated in a different currency to the investor's currency of reference, changes in rates of exchange may have an adverse effect on the value, price or income of or from that investment to the investor. The information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

For residents of the U.K.: This report is only directed at and should only be relied on by persons outside of the United Kingdom or persons who are inside the United Kingdom and who have professional experience in matters relating to investments or who are high net worth persons, as defined in Article 19(5) or Article 49(2) (a) to (d) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001, respectively.

Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations.

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

    Before it's here, it's on the Bloomberg Terminal.