A Swelling Tide of Selling
By Mark Arbeter
The major indexes ended last week little changed despite a fair amount of mid-week volatility. We're left with the S&P 500 and the Nasdaq down near important short-term support as the market has gotten hit by some fairly aggressive selling of late. The pullback, in our view, has further to go, so we would remain cautious over the near term.
The weakness in the market started on June 23, with NYSE volume picking up sharply to 1.6 billion shares. On the following day, the market was hit with another day of heavy selling, with 1.8 billion shares changing hands. The stock market then rallied nicely on June 28, but NYSE volume was below average at 1.37 billion shares.
Following the Fed's decision to raise rates again, the market saw another distribution day on June 30, with 1.6 billion shares on the NYSE. With average volume on the NYSE at 1.46 billion shares, it is clear from our view that institutions have stepped up their selling and we believe that bodes for more weakness over the near term.
The latest selling, both last week and this week, dropped the S&P 500 to an initial area of support in the 1190 area. The 50-day exponential moving average comes in at this level as well as chart support from the highs back in April. Under 1190, there are multiple layers of support not far from 1190. The 80-day exponential moving average is at 1188, with trendline support, drawn off the lows in April and May, also at 1188.
Additionally, there is a high volume day of accumulation that lies between 1174 and 1188. Long-term moving average support comes in between 1172 and 1179. We still believe that the current pullback will be contained within the 1170 to 1180 zone.
After failing once again at the 2100 level, the Nasdaq's correction has been contained so far by support in the 2050 area. The 50-day exponential moving average lies in this zone, as well as chart support from the consolidation earlier this year. So far, the Nasdaq has retraced about 23.6% of its advance from April to June. The next Fibonacci retracement target is down at 2020, which would represent a 38.2% giveback. The 200-day exponential moving average and chart support also come in at 2020.
The action of both the S&P 500 and the Nasdaq is similar in at least one respect, as both indexes bounced off their 50-day moving averages during the initial stages of their respective retracements. This is fairly common action with an index or individual stock, as many times, the initial upside or downside reaction will run out of steam at the 50-day moving average. If there is a strong break through the 50-day, then many times that will lead to additional strength or weakness.
The major indexes have worked off overbought conditions that developed in May and early June. The daily stochastics oscillator based on the price action of the Nasdaq has moved into an oversold condition while stochastics on the S&P 500 are approaching oversold territory. This movement from overbought to oversold on the daily stochastics has been more a function of time then price action. Overbought conditions can be worked off if the market travels sideways, as the Nasdaq did for much of June. We would look for a positive divergence with respect to the daily stochastics, as this formation tends to play out at many short- to intermediate-term bottoms. The 6-day relative strength indicator (RSI), based on the Nasdaq, has also moved to oversold territory while the 14-day RSI is in neutral territory. Weekly momentum indicators for both the S&P 500 and the Nasdaq are mostly in neutral territory.
During the recent increase in selling, our accumulation/distribution models on the NYSE and the Nasdaq have fallen from bullish to neutral. The 6-day summation of advancing volume/declining volume on the Nasdaq recently fell to its weakest level since April. The advance/decline lines of both the NYSE and Nasdaq up-down volume are back in neutral territory and are currently testing important moving average support. We believe another couple of days of heavy selling will turn our accumulation/distribution models negative and this could potentially signal more downside then we are currently expecting.
Crude oil futures, after running into both trendline and psychological resistance near the $60 level, slid back to strong support in the $57 area last week, before rallying about 4% on Friday to finish the week at $58.75. Friday's close was the second highest ever, and is just under the record $59.84 close on June 24. Weekly momentum is still heading higher, and not yet overbought. However, there is the possibility that crude oil is putting in some negative divergences. To alleviate this condition, we believe oil will have to break strongly above the $60 level. If that happens, we see crude running up to the mid-$60s area.
The bond market took a hit last week, with the 10-year Treasury yield rising from 3.91% to 4.05%. In the process, the Treasury market appears to be tracing out a double bottom in yields and a double top in prices. To complete this formation, the 10-year Treasury would have to close above the recent high yield of 4.13%. If that were to happen, we could see 10-year yields approaching the 4.4% to 4.5% area. Both daily and weekly momentum, after getting very overbought, have turned higher and issued sell signals. In addition, sentiment towards bonds remains very bullish.
With the Fed raising rates, and long-term rates moving very little, the yield curve has narrowed quite a bit. The recent peak in the yield curve occurred in May, 2004, when the 10-year Treasury was 382 basis points above the 3-month T-bill. As of June 30, the yield curve had narrowed to 88 basis points. This is the most constricted the yield curve has been since April, 2001.
The U.S. Dollar Index rallied to the 90 level on Friday, July 1, its highest close since June, 2004. The index has moved into a strong area of chart resistance between 87 and 92, so a near-term pullback could occur at anytime, in our view. Also, daily momentum indicators have moved to very overbought conditions.
However, weekly momentum indicators are trending strongly higher and are not yet overbought. Also, monthly momentum indicators have given buy signals, from oversold territory, for the first time since 1995. That period represented the last major low for the U.S. Dollar Index. It still appears to us that the dollar has put in a long-term bottom, and that higher levels will be seen over the next 6 to 12 months.
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Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's