A Successful Test for Stocks

Major indexes' ability to bounce off recent lows could be setting the market up for another run higher

By Mark Arbeter

The stock market did some more testing of the recent lows last week, and in our view at S&P Equity Research, was hurt by some profit taking and renewed mid-week strength in energy prices, especially natural gas. So far, the testing process has been successful for the major indexes, and it could be setting the market up for another run higher as we move towards the end of 2005.

The S&P 500 fell to 1250.91 on an intraday basis on Thursday, very close to the recent closing low of 1249.48 on Nov. 30. If this short-term chart support level gives way, there is intermediate-term chart support in the 1240 to 1245 zone. The index broke below its 10-day exponential moving average but the 20-day exponential moving average provided support as this average comes in at 1250. Trendline support, drawn off the peaks in August and September, lies at 1235 with the 50-day exponential average at 1233. During the latest testing phase, trading volume has not been real heavy, another positive in our view.

Some of the daily momentum oscillators have worked off their overbought condition while others are still in the process. The 6-day relative strength index or RSI has dropped from an extreme overbought condition of 90 down to a neutral reading of 47. The 14-day RSI has declined from an overbought level of 75 down to a neutral reading of 58. Both the daily stochastic oscillator and the daily moving average convergence/divergence have rolled over to the downside from overbought territory, suggesting in our opinion that further sideways to slightly lower action is needed before the next leg of the advance can begin.

Weekly momentum indicators are giving off mixed signals at this point. The weekly stochastics indicator is very overbought, but has yet to roll over to the downside. Weekly RSI levels are approaching overbought levels but are not there yet. The weekly MACD is currently in a bullish configuration but has not yet broken above the levels seen in August. Therefore, the weekly MACD is still working on a long-term, negative divergence as prices have made a series of new highs while the MACD has put in a succession of lower highs.

The 50-week price rate-of-change (ROC) based on the S&P 500, after peaking in February, 2004, has been flat over the last year and a half. The 100-week ROC peaked in February 2005 and has been falling ever since. The 150-week ROC is still in an uptrend but looks toppy. Oftentimes, these longer-term ROC lines peak and begin to fall prior to a bull market top.

The Nasdaq index also tested its recent low in the 2230 area. In addition, the index tested its breakout point, which is defined by a trendline drawn off the January and August highs. Oftentimes, following a breakout, an index or individual stock will retrace back to the breakout point before resuming its advance. Chart support for the Nasdaq sits at 2218 and the 50-day exponential moving average lies at 2189. Chart resistance is up at the recent high of 2273.

An important component of the Nasdaq, semiconductor stocks, also did some testing this week. The Philadelphia Semiconductor index (SOX.X ) pulled right back to its breakout zone on an intraday basis Thursday, and rallied from there. In our view, this raises the probability of additional gains for the semis and the Nasdaq.

Market sentiment on some investment polls is getting downright frothy, in our view. While high levels of bullish sentiment do not necessarily mean a top is in, they do bear watching. Sentiment, in our experience, has to start swinging the other way before a correction can gain steam. The short-term Consensus poll hit 74% bulls last week, the highest reading since December, 2004, which just happened to represent a short-term peak for stocks. Combining both the Consensus and MarketVane polls gives us a reading of 143% bulls. This is highest since November 2004 when this combination hit 144%. The only other times that this reading rose to this area was January 2004 and March and April 1998. Both those times represented peaks in the market.

The 10-year Treasury bond yield pulled right back to its 50-day exponential moving average on Thursday, Dec. 8, at 4.46%, before reversing back to the upside on Friday. The 10-year finished the week at 4.54%. In our view, Treasuries have been consolidating since early November and have worked off their overbought condition. Chart support remains in the 4.6% to 4.7% area and a break of this zone would then target the 4.9% to 5.0% range. Short-term Treasury bills remain in a strong uptrend with little deterioration in weekly momentum. This suggests to us that the short end of the curve has further to run and that the Federal Reserve is not done raising the federal funds rate.

Crude oil prices were volatile last week, running up to close at $60.66 per barrel on Thursday, Dec. 8, before getting hit Friday and finishing the week at $59.39. Crude oil ran into important trendline resistance, drawn off the peaks since the end of August, right above the $60 level. The inability of crude to finally break out and reverse its intermediate-term downtrend suggests that some basing is required. Chart support sits in the $58 to $59 area.

Daily momentum is positive while weekly momentum has flattened out but has not yet turned positive. We believe crude oil will eventually break to the upside as commercial hedgers (considered smart money) are long this market and large speculators (considered dumb money) are short this market. Oftentimes, when we have seen this combination, the oil market has broken higher.

Gold futures surged last week, with the February contract closing at $530.20 per ounce, the highest since 1981. Gold has broken above the channel that it has traded in since 2001 and is very overbought on both a daily and weekly basis. The next Fibonacci target for gold is $550, which represents a 50% retracement of the bear market from 1981 until 1999. While we believe that gold has further to run -- but a correction is probably not far away.


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In the U.S.

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations and 11.0% with sell recommendations.

In Europe

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.8% of issuers with buy recommendations, 44.8% with hold recommendations and 20.4% with sell recommendations.

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

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