The Bulls Take Control

S&P believes the short-term market outlook is now constructive. But it still has concerns over the longer term

By Mark Arbeter

The bulls had the upper hand last week as the major indexes took some big steps towards repairing a lot of the recent technical damage, in our view. While we believe the short-term market outlook is now constructive, we still have our concerns over the intermediate to long term.

With the close on Wednesday, Nov. 2, the S&P 500 had put in its best 4-day price performance since May, rising a little more than 3% during that period. In addition, the index also had its best 10-day advance (as of the close on Thursday) since May, climbing almost 3.6%. At the recent bottom on Oct. 13, the 10-day price rate-of-change (ROC) for the S&P 500 was negative 4.1%, which happened to be the weakest 10-day price performance since May, 2004.

This extreme choppy action is great for traders but frustrating for investors. It is often seen during trading ranges, which is what the market is in, and typically reflects a lack of conviction on the part of the bulls and the bears. It may also have a lot to do with the rise in the hedge fund industry as well as exchange traded funds. Short-term bets on sectors or individual industries seem to be the norm these days, while individual stock selection has taken a back seat, in our view. We believe this has created a rocky environment for investors.

The S&P 500 ran right up to key trendline resistance, drawn off the recent peaks, on Thursday, Nov. 3, before pausing. This trendline comes in at 1220, and if taken out, would imply another run-up to the cyclical bull market peak at 1245, in our view. Above 1245, there is potential resistance from a 61.8% retracement of the bear market at 1253. In addition, longer-term trendline resistance off the highs in March and August comes in at 1260.

More immediate trendline resistance, off the March, 2003 and April, 2004 lows, sits at 1235. This trendline is one of the primary, bull market lines that have supported the market since 2003. The S&P 500 already took out the bull market line drawn off the March 2003 and October 2004 lows. After this important, long-term trendline was busted to the downside, the S&P 500 ran back up to the underside of it, and moved higher with the trendline for about two months. The key, in our view, was that the index never broke back above this trendline, confirming a loss of longer-term momentum. The more primary trendlines off the bear market lows that are taken out, the higher the probability that the market will eventually roll over, in our opinion.

After getting very oversold in the middle of October, daily momentum indicators are back to neutral to slightly overbought territory. The 6-day relative strength index (RSI) has risen back up to 70 after getting extremely oversold in October, when it hit 16. The 14-day RSI is back above 50, a positive sign in our opinion, and is not yet overbought. The 14-day RSI had also gotten oversold in October, when it moved down below 30.

Because these two measures of momentum are not overbought, it suggests that the index has further to run, in our view. The weekly RSI is neither overbought nor oversold. However, like many weekly momentum indicators, the 6-week and 14-week RSI's have put in multiple negative divergences since the momentum peak in January, 2004.

The Nasdaq has been on fire lately, and is quickly approaching its cyclical bull market peak of 2218.15. The 5-day price ROC on the Nasdaq hit 4.67% on Thursday, Nov. 3, and represented the index's best 5-day performance since October, 2004. That period in 2004 represented the early part of a very good move for the Nasdaq. More importantly, in our opinion, the Nasdaq broke strongly above trendline resistance off the recent highs, reversing the current downtrend as well as breaking the pattern of lower highs and lower lows.

Volume has been very strong during the 5-day advance, coming in near or above 2 billion shares each day. This is well above the 50-day average of volume, which is currently 1.7 billion shares. Besides chart resistance up near the high of 2218, there is also trendline resistance off the peaks in 2004 and 2005 that comes in at 2220.

While stocks had a very good week, bonds continued their ninth week of deteriorating prices and higher yields. The yield on the 10-year Treasury note ran up to 4.68% on an intraday basis Friday, the highest intraday yield since March, 2005. On a closing basis, the 10-year yield is at its highest level since June, 2004. Using daily technical indicators, the 10-year Treasury is in very overbought territory, so in our view, yields could pull back at anytime. However, on a weekly basis, technical indicators are not yet overbought, suggesting that yields could still move higher over the intermediate term, in our view. The next area of chart support is in the 4.7% to 4.9% zone.

Looking at a longer-term chart of the 10-year, yields have moved sideways in an erratic fashion since the middle of 2002, between 3% and 4.9%. Looking out very long term, yields have been in a downtrend since 1981, and in our view, would have to break above 5% to reverse the very long-term direction in yields. We believe this will happen but it takes a long time for a market to change course when it has been moving in the same direction for so long.

Crude oil prices bounced around quite a bit last week, but ended up moving very little since the close on Friday, Oct. 28. Oil prices are approaching a mountain of support down near the $58 level, so we believe a rally could occur very shortly. The trendline drawn off the recent lows comes in around $57.80. The 200-day exponential moving average, or long-term support, lies at $57.60. A 50% retracement of the rally from May until August is at $58.40. Chart support, from the high back in April, lies at $58, while a layer of price congestion from June and July sits in the $56 to $61 area. Often, when this many pieces of support all lie in one focused area, it represents at least a minor if not major low for a market.

In addition, commercial hedgers, who are typically considered the smart money, are currently very bullish on oil prices, while large speculators, typically considered the not so smart money, are very bearish on oil prices. The last time we saw this type of position in the futures market was back in May, right at the last major low for oil.

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

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