Can Stocks Hold the Line?

The S&P 500's ability to hold support around 1430 in this volatile environment would be a victory for the bulls

Fear, relief, and panic sum up the wild swings in emotions we saw last week as price volatility on a daily basis soared. August is often the slowest trading month of the year but not in 2007. We have seen record volume on the Nasdaq while NYSE came very close to setting a record. Let's hope September and October, which have typically been tricky months for the market, turn out differently this time.

The retest of the Aug. 3 closing low of 1433 and the intraday low of 1427 on Monday, Aug. 6, was something I have been talking about, but it occurred way faster than we anticipated. It only took a week to make a round trip back to those levels as the intraday low on Friday, Aug. 10, was 1431.42. We are by no means out of the woods yet, but holding support in this kind of environment is a victory for the bulls.

If the 1430 area does hold, as we expect, then we would like to see a strong rally develop and take out the recent closing high up at 1497. This would complete a very compact double bottom reversal formation, and it would suggest to us that the worst is finally over. Even if the S&P 500 does hold around 1430 and rallies, we would still expect more testing sometime in later August or September.

We hate to use the word "if" so many times but in this volatile market, but in this case it's appropriate. If the 1430 zone does not represent a floor for the S&P 500, the next area of chart support sits in the 1364 to 1410 range. This zone represents the base the "500" put in back in February. There are other pieces of technical support in that range, so it makes it that much more important.

Long-term trendline support, off the highs over the past couple of years, sits at 1428, very close to Monday's intraday low. A 61.8% retracement of the rally off the March lows, targets the 1437 level. The 65-week exponential moving average lies at 1412 and this average has done a good job of acting like a floor for the "500" during the bull market.

Another piece of potential support within the zone of chart support outlined above is the 80-week exponential average, and that lies at 1391.

If this zone of support is taken out, there is long-term trendline support, off the lows of the past couple of years, at 1330. The top of the next zone of chart support sits in the 1325 area.

The quick rally that occurred during the week, if you can still remember, ran out of steam right in an area of thick, technical resistance. The S&P 500 finished Wednesday at 1497.49, and had an intraday high of 1503.89. Chart resistance begins in the 1490 zone, from the double bottom in June, and extends up to the all-time high of 1553. A 50% retracement of the recent decline targeted the 1493 level while a 61.8% retracement is up at 1507.23. In addition, both the 65-day exponential moving average and the 50-day exponential average sit just below 1500.

We suspect the recent price volatility has shaken even some of the most grizzled Wall Street veterans. In the last 13 trade days (ending Thursday), the S&P 500 has fallen 1.98% or more on four different occasions. Since July 12, the index has also rallied at least 1.9% on two days. Since the major bear market lows in October 2002 and March 2003, moves of this magnitude have been pretty rare. These wild price swings often occur near a major low, but there have been times (2000) when they occurred near a price high. The marketplace had gotten used to low price volatility over the last four years and we are paying for that calm right now.

Market sentiment (emotions) has been on a roller coaster of late, and fortunately in our view, has swung back to the bearish side very quickly. This sets the market up for a potentially powerful reversal to the upside. One of the most dramatic moves in market sentiment can be witnessed by the sea change in the Investor's Intelligence poll. In the last two weeks, bearish sentiment has jumped to 31.5% from 18%. The increase of 13.5 percentage points in just two weeks is the biggest move since February 1990, just as the market was starting a pretty good rally. Bullish sentiment has dropped to 43.8% from 53.9% over the last two weeks. The spread between bulls and bears is at its narrowest point since the correction in the summer of 2006.

Option investors have been getting defensive in a hurry as put/call ratios have spiked higher. The 10-day equity-only put/call ratio has moved from 0.54 in the middle of July to a recent high of 0.78. The peak in this ratio was 0.82 during March's bottom and 0.74 last summer. The CBOE total put/call ratio has jumped from 0.89 in the middle of July to 1.25 on August 6. The peak in March, which was an all-time high, was 1.31 while the high last summer was 1.21.

The ISE Sentiment Index, which only measures opening long transactions by investors, has fallen from a recent high of 186 in early July all the way to 51 on Aug. 7. This is the lowest reading, and most pessimistic, since data started back in October 2002.

Internally, the market is showing signs of a major washout, in our view, and at levels that have been close to intermediate-term bottoms. NYSE new lows/issues traded has soared to 23.5% on July 26, and hit 19% on August 6. The July figure was the highest since May 2004. New lows have traced out one positive divergence, a positive in our view, as this is often seen near market lows.

The market often times looks the ugliest near intermediate- and long-term lows. It can also look bad when standing at the precipice. While we think the market is trying to hammer out a low, we would remain cautious until we get price confirmation.

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