Stocks: The Ugly Resolution

It appears the stalemate between the bears and the bulls is over, and the bears still rule

This comment was issued by Standard & Poor's Equity Research Services on Feb. 20

Our wish last week was that the stock market do something, and our modest request came true very quickly as the major indexes finally broke down out of fairly narrow trading ranges. It appears the stalemate between the bears and the bulls is over, and the bears still rule as the downtrend in the market is alive and well. The safe haven areas continue to work like a charm with the U.S. dollar continuing higher, long-term treasury yields moving lower and gold prices soaring above $1000 per ounce.

Taking a look at the three major indexes from a chart standpoint, the DJIA is clearly the weakest with the Nasdaq holding up the best, and the "500" somewhere in between. The DJIA was the first of the three indexes to break below its November bear market bottom at 7,552, and is now approaching the 2002 bear market low at 7,286. Bearishly, there was not much of a fight by the bulls at the November lows, just some intraday short covering.

The problem for the DJIA, as well as the other indexes, is that once the 2002 bear market lows are taken out to the downside, there isn't a lot of clearly identifiable chart support that we can talk about as a possible bottom. This makes the technician's job mighty hard at forecasting the next price nadir. In our view, chart support and resistance are by far the most important levels on the chart for identifying potential tops and bottoms. Going all the back to 1996, there is a layer of potential chart support from a sideways consolidation that sits between 5350 and 5780 for the DJIA. Very long-term trendline support, starting off the lows in 1932 and extending through the lows in 1982, using a semi-log chart, and projecting out about a year, does not come in until the 4000 to 4500 zone.

Another way to get a potential downside target for the DJIA because of the lack of definable chart support is to base our projections on the width of the latest consolidation. Using the low from November 20, the consolidation measured 1483 DJIA points. Subtracting this width from the breakdown point of 7552 gives us a potential measured move down to 6069. Looking at Fibonacci extensions based on the width of the latest consolidation gives us an initial target of about 6600 and a potential secondary target of 5100. There are a lot of potential targets to chew on, but we don't know where the next bottom will eventually be. We just have to wait until the market decides where it is.

While the S&P 500 has not busted through its November 20 lows at 752, the picture is not that encouraging either. The last bastion of near-term chart support for the "500" lies between the intraday low of 741 from November 21, and the November closing low of 752. We think that these lows will be taken out, although we do expect more of a fight by the bulls when the index gets near or into this range as this is a logical spot for shorts to cover their positions. Even though put/call (p/c) ratios are finally starting to rise again, as fear strikes the options market, we just don't think that the p/c's have spiked enough to even illicit a decent counter trend rally. The closing low from the 2002 bear market was 777 so once the November lows give way; we have to go way back on the chart to find the next potential piece of chart support. This comes from the 1996 price consolidation that ranges between about 600 and 680.

The width of the latest price consolidation on the S&P 500, assuming that 752 gives way, is 182 points. This gives us a potential measure move (752-182) down to 570. An initial Fibonacci extension, based on the width of the consolidation, targets the 640 level. Major long-term trendline (semi-log scale) support off the low in 1932, which touches the significant lows in 1942, 1974, and 1982, comes in between 550 and 580 when extending the line out into next year.

While we almost always look at semi-log charts, where the distance on the y-axis is proportional based on percentage moves, there are some technicians that use standard, arithmetic charts. Interestingly, there is a pretty nice trendline starting in 1982, and going through the lows in 1984, 1987, and 1990, that comes in around the 720 level. Possibly more panic and most likely, strong, powerful demand will define the next price low, so we will just have to wait and see what level finally attracts a sufficient number of buyers.

Gold prices have reached our initial target just above $1000 per ounce so we would take some profits as we think there could be some profit taking near the prior highs we set in 2008. With the metal hitting major chart resistance as well as cycling into overbought territory, we see two potential scenarios playing out. The most likely from a technical standpoint and most preferred from an investment perspective, in our view, is a near-term pullback back to the $900 to $950 area. There are many pieces of support in that zone starting with a 23.6% retracement of the move since November, and that targets the $935 level. Trendline support, off the highs since 2008, and once a resistance line, also sits near the $935 area. Chart support lies between $892 and $921 while key trendline support, off the lows since November, comes in around $900. A 38.2% retracement of the rally since November sits just below $900.

The other scenario that has less probability, in our view, is that gold hangs around the $1000 area for a couple of weeks before resuming its advance. This would not allow investors wishing to either increase their positions on weakness or initialize positions on weakness much of an opportunity. If gold pulls back or pauses, we think any strong break above $1000 will open the door to another powerful move up to the $1200 to $1500 range. This projected range is based on the width of the latest correction, Fibonacci extension targets, and longer-term trendline resistance. Needless to say, the quicker the stock market declines, the faster gold will continue to head north, in our view.

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