Staying Cautious

Volume measures have shown weakness, sector leaders are rolling over, and the market is moving into a weak time of year

By Mark Arbeter

The major indexes, which have traced out a series of lower lows and lower highs since the beginning of August, bounced off strong near-term support late in the trading week. However, we think that any rally near term will be counter trend in nature, and we see additional losses for stocks. We therefore maintain our cautious stance towards equities.

The S&P 500 fell to three pieces of support during the week and bounced, albeit weakly. The first support level at 1219 was provided by the 50-day exponential moving average. This is the first time since late June/early July that the 50-day exponential moving average has been tested. The second support level was chart support from the closing high in mid-June, at 1217. Lastly, a trendline drawn off the peaks in March and June, and was once resistance, provided support at 1216. Many times, when an index first tests an area with multiple support or resistance levels, the index will either bounce or rollover, unable to drive through this key area.

With the S&P 500 hitting multiple layers of support, and oversold on a short-term basis based on the daily stochastic oscillator and the 6-day relative strength index (RSI), it is possible that the index will see a snapback rally over the very near term. We believe the S&P 500 could move up to trendline resistance in the 1230 area before succumbing to more downside pressure. There is also near-term chart resistance in the 1223 to 1238 zone and the 10-day and 20-day exponential moving averages are sitting up near 1227. Near-term chart support comes in at 1183 to 1204, and this is provided by the small consolidation that took place during late June/early July. In addition, longer-term averages such as the 150-day and 200-day exponential moving averages lie in the 1187 to 1197 region.

The Nasdaq, which has been the weakest of the major indexes since peaking on Aug. 2, rebounded Thursday after falling right to its 50-day exponential moving average at 2132. Like the S&P 500, this is the first time since late June/early July that the Nasdaq has tested its 50-day average. During the latest decline, the Nasdaq has taken out both its 10-day and 20-day exponential moving averages, as well as trendline support drawn off the April and July lows. If, like the S&P 500, the Nasdaq can rally back to trendline resistance drawn off the recent peaks, the index could move up into the 2150 area.

On the downside, we think key intermediate-term chart support sits in the 2100 zone. That level had provided quite a bit of resistance during much of the year, and therefore is now considered important support. The 80-day exponential moving average lies at 2108. Below 2100, there is a good layer of chart support in between 2000 and 2100, with longer-term moving averages in the 2060 to 2075 area.

As we commented on last week, the market is moving into the weakest period of the year on a historical basis. There is a very consistent pattern of weakness during the late summer/early fall months, and this is one of the many reasons for our near term concern. Many mid-summer market peaks are followed by sell offs in August, September, and into the month of October. Just looking back to 1990, there have been either a minor or major low in 2004, 2002, 2001, 1999, 1998, 1997, 1994, 1992, and 1990. This weakness has set the market up for many year-end rallies; so in our view, it is worth keeping some powder dry for later this year.

Another reason for our guarded approach to stocks has been the weakening trend in many volume-based indicators we track. Over the last couple of weeks, we have seen a pickup in volume during down days and a contraction in volume during advancing days. In our view, this is clear evidence of institutional distribution. All of our accumulation/distribution models on both the NYSE and the Nasdaq are in bearish configurations for the first time since March.

Along with this increase in downside volume, the intraday action of the market has taken on a different look recently. We are seeing weakness late in the day, with many rallies fading by the close. This is just the opposite of what is seen during strong advances and in our opinion, raises the probability of more downside action.

Stocks and sub-industries that have led the market over the last 6 to 12 months have gotten hit quite hard of late. For instance, the S&P Construction & Engineering index has plunged 11.8% over the last 10 days, the worst performance of any sub-industry. Over the last 6 months, Construction & Engineering has held a leadership position. Other leaders over the last 6 to 12 months that have gotten hit include homebuilding, REITs, many oil sub-industries, as well as wireless telecom services. In our view, it is a negative sign for the stock market when the leaders of the last 6 to 12 months rollover.

Despite the recent slide in the stock market, bullish market sentiment goes unabated. Investor's Intelligence poll of newsletter writers is still exhibiting 2-1/2 times more bullish sentiment than bearish sentiment. The combination of the Consensus and MarketVane polls recently hit the highest level of bullish market sentiment since November 2004. The equity-only put/call ratios are still fairly low, indicating a lot of complacency in the market.

The only sentiment indicator we follow that is showing any degree of bearish sentiment is the CBOE put/call ratios. While we do not have an explanation as to why all the sentiment indicators are not lined up together, as they so frequently are during extremes, with volatility indexes so low, it is very inexpensive to protect yourself from any potential downside.

Crude oil pulled back during the week, despite Friday's $2.08 jump to $65.35. During the day on Thursday, crude hit an intraday low of $62.25, and bounced off trendline support drawn off the May and July lows. Minor chart support sits at $61 with more major chart support down at the $57 level.

With the latest pullback, crude oil has worked off an overbought daily condition, but still remains overbought on a weekly basis. We still expect to see additional downside for oil over the intermediate-term due to the huge move in prices since May. Also, oil tends to have a weak seasonal period late in the year. Over the last 7 years, crude oil has a tendency to bottom out during the months of October to December.

Arbeter is chief technical strategist for Standard & Poor's

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