Stocks' Balancing Act

Indexes have gained despite rising interest rates and soaring commodities. This combination of price action is not likely to last

From Standard & Poor's Equity Research

For major equity indexes, it was more of the same for the first four trading days of the second quarter, as stocks continued their slow climb despite rising interest rates, soaring metals prices, and higher oil prices. This combination of price action is not likely to last longer term, in our view, so there could be some changes as we move through the year.

The S&P 500 posted a new recovery high on Wednesday, Apr. 5, closing at 1311.56. This was the highest close for the index since May 21, 2001. That period in May 2001 represented one of many major tops for the S&P 500 during the bear market. So, there is some long-term chart resistance at current levels. In addition, trendline resistance, drawn off the March 2005 and January 2006 highs, came in at 1313 on Wednesday. The intraday high on Wednesday was 1312.18.

The chart formation looks bullish from our vantage point, at least for the short term. The S&P 500 traced out a high level consolidation that was very tight. In other words, the consolidation occurred near the recent highs, and was very narrow and well defined. This is often a bullish pattern. So in our view, the rally could extend itself. Trendline resistance sits up at 1322 and 1345. Fibonacci resistance, based on the width of the latest pullback, targets the 1320 level. The S&P 500 has also broken out of a bullish ascending triangle formation, in our view. The width of this pattern is 46 points, which when added to the breakout point of 1295, gives us a potential target of 1341.

On the downside, initial chart support comes in at 1295. Trendline support, off the lows in October, 2005, and March, 2006, lies at 1298. The 50-day exponential moving average is at 1288 and the 80-day exponential moving average lies at 1279. These intermediate-term averages frequently provide support during pullbacks within a primary uptrend. Additional chart supports, from the lows in 2006, come in at 1272, 1255, and 1248.

The Nasdaq composite index extended its recent breakout, closing at 2359.75 on Wednesday, Apr. 5, the highest finish since February 16, 2001. The next piece of resistance for the Nasdaq comes in at 2400, from a trendline drawn off the peaks in August, 2005, and January, 2006. Taking the width of the latest consolidation for the Nasdaq, and adding this to the breakout point, gives us an additional target of 2423. Chart support sits between 2233 and 2331 from the sideways price action during January to March. The 50-day simple average sits at 2292 and the 80-day exponential average is at 2276. Trendline support lies at 2295.

Very short-term momentum indicators have moved into overbought territory. The 6-day relative strength index (RSI) is up near 80 and that is fairly overbought. The 14-day RSI and weekly RSI readings are not yet overbought. Both daily and weekly moving average convergence/divergence or MACDs are in bullish configurations.

There have been many internal nonconfirmations that we have seen over the last year or two with respect to both the Nasdaq and the S&P 500. One we have not mentioned in awhile is the Money Flow Index (MFI). The MFI attempts to measure the strength of money flowing in and out of a security or index. In simple terms, the MFI measures accumulation and distribution. Taking a look at the 14-day MFI based on the Nasdaq, we see a series of lower highs since November 2004 while the Nasdaq has moved to slowly higher. This suggests that less volume is flowing into the Nasdaq as it has moved higher, and eventually, we believe this divergence will be resolved to the downside.

Yields on the 10-year Treasury bond hit 4.907% on Thursday, Apr. 6, slightly exceeding the high of 4.904% from back in May, 2004. This was the highest intraday rate for the 10-year since June 13, 2002. Treasuries have moved very close to the top of the rising channel that has been in place since June 2005. The top of this channel, which comes in at 4.93%, may provide some support for the 10-year. The 10-year is fairly overbought on both a daily and weekly basis. In addition, the yield has gotten very close to key psychological support and long-term trendline support at 5%.

Taking all these factors together, we do see the chance for a counter trend rally in bonds over the next couple of months. The next 40-week cycle low for bonds comes in around the end of June so a counter trend move lower for yields could start over the near term. Yields could back up to trendline resistance in the 4.6% to 4.7% area without breaking the intermediate-term uptrend.

Crude oil prices finished at $67.94 per barrel on Apr. 6, the highest close since Jan. 30. Crude oil rose just above the $68 level on Thursday, running into trendline resistance drawn off the major highs in August, 2005, and February, 2006. Just above this trendline is major chart resistance between $69 and $70. Daily and weekly momentum oscillators are not yet overbought. This, in our view, gives the rally some more room to run.

Both the daily and the weekly MACD are in bullish configurations. A break above $70 for crude would be very bullish from a technical perspective, in our view. If this were to occur, our next upside projection would $80. This is based on trendline resistance as well as a Fibonacci target.

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