Stocks: Primary Trend Still Bearish

S&P says major indexes may test the lows from January and February

In the near term, we think prices are heading lower after moving to areas of stiff resistance. Market sentiment is showing plenty of fear, and may be indicating a potential bottom over the next month.

The major indexes rallied early last week and tried to break above the most recent highs, but failed and rolled back over to the downside. This sets up the possibility that another triangle is forming as well as a small double top, and that more price testing of the lows from January and February will be seen. The major trend is still firmly bearish, and we still believe there is a possibility that another downleg could take place. Whether we continue to base or move into another downdraft, we would continue to recommend a cautious and patient stance towards equities and wait for confirming technical evidence that would suggest the worst is over.

While many individual stocks have bounced nicely since the panic lows in late January, few stocks have traced out bullish bases and even fewer have broken out to the upside. Most of the stocks that are basing and breaking out come from the oil and materials sectors. We have a hard time believing that commodity stocks can lead the overall market higher. The problem is that so many of the 10 S&P sectors are still in major downtrends, and we think this will have to reverse before we can start to see strong intermediate term moves to the upside.

Taking a look at the 10 sectors, only energy and materials are near their recent highs and look attractive technically, in our view. Consumer staples are the third sector that we believe is still in an uptrend. The other 7 sectors are either in bear markets or very definable downtrends. The consumer discretionary, financial, healthcare, industrials, technology, telecom, and utilities are all below their 40 week exponential averages. In addition, most of these sectors have seen bearish moving average crossovers, where the 17-week exponential has crossed below the 43-week exponential, giving long-term technical sell signals. With this much prevailing weakness, we do not think that the overall market will have much staying power on the upside.

The S&P 500's recent strength failed to propel it to the February 1 closing high of 1395.42, disappointing action, in our view. We have now set up the possibility that the "500" is tracing out a small double top, and a close below the recent low at 1326 will confirm this bearish pattern. This would then set up the chance for a measured move of about 70 points to 1256, based on the width of the pattern. For the very near term, the index has dropped back into a zone of congestion that sits between 1326 and 1367. Trendline support, off the most recent lows, sits at 1332. Most critically, chart support from the January closing low is at 1310.50, while support from the intraday low in January runs down to 1270.

There is a mountain of resistance overhead and it may take months of basing action before the market is ready and capable to start chipping away at this brick wall, in our view. Early this week, the "500" ran into the falling 50-day average at 1387 and rolled over to the downside. This was the first rally by the index up to the 50-day, and many times, the initial attempt to crack this average fails. Trendline resistance, off the highs in December, sits at 1393, while the 65-day exponential average lies at 1398. Just above these pieces of resistance is where the heavy lifting will have to take place and that is right at 1407. This is where the two pivot lows occurred in August and November, and there was a lot of buying from that level on up.

We continue to like what we are seeing in the sentiment arena as fear levels continue to rise, a prerequisite for a major market low, in our view. The Consensus poll fell to only 23% bulls a week ago, the lowest and most fearful this poll has become since February 2003, right near the final low of the 2000-2003 bear market. The 3-week average of bullish sentiment on this poll has dropped to 26%, also the lowest since February 2003. We have seen four straight readings of below 30% bulls, indicating a great deal of pessimism towards stocks, a bullish sign from a contrarian view, in our opinion. The Investor's Intelligence poll has shown a buildup in anxiety towards equities, but we would like to see more. At its most fearful, bulls and bears were almost equal. One never knows how far newsletter writers have to go to signal that a major low is here, but back in 2002, bears exceeded bulls by almost 15 percentage points. We are nowhere near that degree of pessimism.

Something we find not so surprising in this economic environment, is that Treasury bond prices are moving in the opposite direction of stocks, and we think there are a couple of important reasons for this. First, bonds benefit when there are worries over the economy, and at the same time, stocks suffer from these worries. Money comes out of equities and into the safe haven of treasury bonds. In addition, there is evidence that some of the petro-dollars from the Middle East are being reinvested back into U.S. Treasuries. 10-year Treasury yields have fallen back to 3.54% and are approaching the recent closing low of 3.43% from January. This low in yields was hit while the stock market was in panic mode.

We think yields will test the recent lows below 3.5%, and we also think that this is part of a bottoming out process for yields. If yields hold near the January lows, it will be a good indication that stocks are also holding there recent lows. However, if yields start to break below the recent lows, it will suggest that worries over the economy are intensifying and that stocks may also have another leg down. Yields have been in a pretty consistent downtrend since peaking in June 2007 at 5.25%. If yields break below the recent lows, it may set up for a test of the June 2003 multi-decade lows down near the 3% zone.

From a longer-term perspective, we think yields are tracing out a massive base. The 10-year has traded between 3% and 5.5% since late 2000, and we eventually believe that this range will be broken to the upside. Remember, yields were in a downtrend from 1981 until 2003. We think reversing such a long trend will take a lot of time.

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