Another New High

Some relative strength readings show the S&P 500 may have room for additional gains

From Standard & Poor's Equity Research

The market oscillated back and forth until Friday, when a weaker than expected April nonfarm payroll report pushed the S&P 500 and the Dow Jones Industrials to marginal new highs. Bond yields were virtually flat on the week while crude oil prices fell back near $70 a barrel.

With Friday’s advance, the S&P 500 ran right back up to trendline resistance that has acted as a ceiling since December, 2004. The index has been bumping up against this trendline on a regular basis since the middle of March. An eventual break of this trendline to the upside could, in our view, lead to a steepening in the advance.

Longer-term chart resistance begins at 1350 and runs back up to the old all-time high at 1527.46. Near-term chart support sits between 1280 and 1315. The 50-day simple moving average lies at 1298 and the 80-day moving average is at 1290. Short-term trendline support comes in at 1295 and 1280.

Momentum indicators based on the price action of the S&P 500 remain positive from a daily and weekly perspective. The daily moving average convergence/divergence (MACD) is in positive territory and above its signal line. The weekly MACD is also in positive territory above zero and just popped back above its signal line. The monthly MACD remains on a buy signal that was generated in May 2003.

Daily relative strength (RSI) readings are neutral, sitting in the 50–60 range. In our view, this gives the market room for additional gains from here. Weekly RSI is also not yet in overbought territory, and in positive territory above the 50 line. Monthly RSI has moved to an overbought condition, but are not nearly as high as prior market peaks. For instance, the 14-month RSI is at 70. Back in the mid-to late 90’s, the 14-month RSI got well above 70, and put in numerous negative divergences before the market peaked. In the later part of 1989, the 14-month RSI got above 72 and then put in a couple negative divergences before the market rolled over. This pattern can also be seen back in 1986 and 1987.

One technical indicator that attempts to measure the degree of directional movement is the average directional movement index, or ADX. J Welles Wilder developed this indicator and is better known for developing the relative strength index (RSI). The ADX measures the strength of the underlying trend, with no regard to the direction of the trend. A high ADX reading defines a strong trend, either up or down and a low ADX value indicates a market that is in a consolidative pattern.

Besides ADX, there is another component to this analysis. Directional movement (DM) is defined as the difference between the extreme of the current period that falls outside the range of the previous period. In terms of a weekly chart, price action above last weeks’ high is positive directional movement (+DM) and anything below last weeks’ low is negative directional movement (-DM).

Over the last 10 years, the range for the 14-week ADX has been 9 to 46. Generally, a market is considered to be trending when the ADX is above 20. Since the beginning of the year, the 14-week ADX has oscillated above and below 20, indicating that the trend has been basically flat, with a slight upward slope. The one small positive is that the ADX has been rising since July, putting in a series of higher highs and higher lows. This indicates that the trend is getting stronger. Looking at the directional movement (DM) indicators, we see that the (+DM) crossed above the (-DM) back in early November, and remains on this buy signal.

The DJIA is closing in on its all-time high of 11,722.98 hit on Jan. 14, 2000. The index has run up to the top of a bullish channel that has been in place since October, 2004. From a longer-term chart perspective, the index looks better than the S&P 500 and the Nasdaq, in our view. However, it is worrisome that the DJIA has taken on a leadership position relative to the other major indexes, at least from a shorter-term perspective.

Stepping back a bit, the DJIA has consistently underperformed the S&P 500, Nasdaq, and Russell 2000 since 2002. There have been periods during the last 4 years when the DJIA did outperform these other indexes on a short to intermediate timeframe. During these times of DJIA outperformance, the overall market has pulled back or corrected. Since the end of January, the DJIA has outperformed both the S&P 500 and the Nasdaq. So far, the DJIA has been unable to outperform the Russell 2000. If the DJIA continues to outperform, we believe that eventually the overall market will correct.

The bond market did very little this week, with the 10-year Treasury yield ending at 5.11%, very close to where it started. The market is extremely overbought on a weekly basis. For instance, the 6-week RSI is close to its highest or most overbought condition in the last 10 years. The 14-week RSI is at its most overbought level since November, 1994. In addition to being overbought, the 10-year is approaching strong chart and psychological support in the 5.25% to 5.5%. Because of these factors, we see a counter trend move in rates in the not too distant future. The next 40-week cycle low for bonds comes in during early July.

Crude oil prices reversed sharply this week, and we believe an intermediate-term top was put in. Crude got as high as $74.90 a barrel this week, just shy of the high from back on Apr. 21. On Wednesday, the market reversed sharply to the downside, going as low as $69.30 on Thursday.

We believe this completed an intermediate-term topping process with crude oil tracing out a small double top. The completion of this pattern was confirmed as the intervening low was taken out at $70.75. Other signs of a top include a very overbought condition from a daily basis back in late April, rolling over of the daily MACD, weakening money flow into oil stocks, and a build up of bullish futures positions by large speculators which coincided with a large build up of bearish futures positions by commercial hedgers.

Recent oil corrections have tended to be 61.8% to 75% retracements of the prior advance. This would target the $63 and $60 levels. Intermediate-term trendline support comes in at $63 and $61. The market has tended to bottom about every 90 days over the past couple of years and this would target late-June as the next major low for crude oil prices.

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