An Uphill Climb for Stocks

Major indexes face tricky resistance levels on the upside as sentiment indicators are turn more bullish

The stock market continues to battle with overhead resistance, a stream of deteriorating economic news, and the ongoing shakeout from the credit crises. If that is not enough, the U.S. dollar index has fallen to a multi-decade low, and crude oil traded above the $80 per barrel mark last week. Despite all this, the overall stock market actually finished higher last week.

During the first part of September, it appeared that the major indexes were completing inverse, head-and-shoulders (H&S) patterns. To trace out an intermediate-term bottom, the market must put in a bullish reversal pattern. This formation simply reverses the prior trend, which was down. Many times, these reversal formations are simple double bottoms. Because of the Federal Reserve's action this time, it is very possible that the bottom will take the shape of a H&S pattern. However, with the price decline last week, the indexes dropped back through the neckline of the pattern. It now appears that the H&S pattern is still intact; however, it looks like it is taking a more complex form.

Sometimes, H&S tops and bottoms have multiple shoulders on both sides of the head. In other instances, we have seen patterns develop with two heads. The pattern as it stands looks to be putting in multiple shoulders on either side of the head. The shoulders closest to the head both bottomed out near the 1433 level. The second right shoulder that was formed with the decline late last week and early this week bottomed out at 1452, while the furthest shoulder to the left of the head bottomed out at 1455. This shoulder at 1455 is not well formed so we are taking a leap of faith here. Unfortunately, real-time analysis does not always lend itself to the perfect patterns that we see in text books.

If we are correct in our assessment of the unfolding complex H&S formation on the S&P 500, the new neckline, drawn off the intraday highs of Aug. 8 and Sept. 4, comes in at 1494. Another neckline can be drawn off the closing highs, but we prefer to use the higher piece of resistance. As we have said, even if the pattern does pan out, we really won't feel comfortable until the S&P 500 takes out the closing and intraday highs from August 8 of 1497.49 and 1503.89, respectively. The buying during Aug. 6, 7, and 8, was very heavy, and this is why we think the "500" has struggled to get through this tough resistance.

In addition to a zone of heavy buying that runs up to 1504, the S&P 500 also has to deal with a fairly thick area of overhead resistance from this summer, which sits between 1490 and 1540. This week's advance is the fourth attempt into the bottom of this zone and third try since the latter part of August. The "500" is also dealing with the 61.8% retracement of the correction, which comes in at 1496.

Since the closing bottom on Aug. 15 and the intraday bottom on Aug. 16, the index has traced out a series of higher highs and higher lows. In addition, the "500" has retaken its 50-day and 65-day exponential moving averages for the second time, a positive sign, in our view. Trendline support, off the recent lows, sits down at 1470 when projecting out to the middle of this week. Immediate chart support, from the recent closing low, is at 1452, with further more durable chart support at 1432.

With the somewhat improved tone that we are seeing in the market, despite all the bad news, we are seeing some movement back towards the bullish camp in the sentiment indicators we monitor. The Consensus poll has seen an increase in bullish sentiment to 62% from 41% in the last three weeks. MarketVane sentiment is up to 59% bulls from 52% three weeks ago.

Investor's Intelligence showed a big turnaround this week as bullish sentiment rose to 48.3% from 42.9% and bearish sentiment fell to 31% from 37.4%. The one-week change in bullish sentiment of 5.4 percentage points was the largest since December, 2005, while the drop of 6.4 percentage points in bearish sentiment was the steepest decline since the bear market low in the middle of October, 2002.

Put/call ratios are heading lower, another sign of a pickup in bullish sentiment, and a lessening of bearish sentiment. We believe this turn in sentiment to the bullish side of the fence is positive, as a lot of the bearish activity gets unwound and market participants move back to the long side from the short side.

The U.S. dollar index has slightly undercut major long-term support, and, in the process, gold prices have broken out while oil prices have moved to an all-time high. The dollar index broke below 80, which was the low from back in December, 2004, and was also a key low from way back in 1995. The index is now challenging the all-time low of 78.33 from back on August 31, 1992. The dollar index peaked in July, 2001, and really started to fall apart in early 2002. After a nice counter-trend rally in 2005, the index has been in a very consistent downtrend. While we believe the chart pattern looks terrible, the index is oversold on a daily, weekly, and monthly basis, and if the beleaguered currency can find a bottom and rally soon, there is the possibility of some positive divergences on a daily and weekly basis. However, the index would have to at least break above the 82 level to break the nasty downtrend. Dollar sentiment is bearish, but this condition has been in place for most of 2007.

The obvious beneficiary of a weak dollar is commodities. Gold has broken out of a fairly large ascending triangle and is close to the recovery high of $725 from May, 2006. A break of the 2006 high sets up the precious metal for a move to $825 based on a Fibonacci extension, right near the all-time high of $850 from back in 1980. If prices can break above the $825 to $850 area, the next Fibo target is up near $1000.

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