A Key Test for Stocks

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From Standard & Poor's Equity Research

Both these crossover systems have been on buy signals since May and June 2003, respectively, and although there have been some near misses; we have not yet seen a bearish cross in either of these.

We believe Thursday's action represented at least part of a selling capitulation or panic that might not have fully played itself out. Basically, we're waiting for another shoe(s) to drop before we can be more comfortable that the worst is over. Volume on both the NYSE and the Nasdaq were all-time highs on Thursday, as we believe market participants have gotten less rational and more emotional. These periods can be quite nerve wracking but many times represent a market that is closer to a bottom than one that has a lot further downside.

Market internals were horrible Thursday, and this many times is seen after a fairly decent-sized pullback and not usually this close to all-time highs. NYSE new lows/issues traded exploded to 23.5%, the highest reading since May 10, 2004, when they hit 24.2%. It is very rare to see this many lows, and it is even rarer to see this many lows with the market so close to an all-time high. Since 1990, there have been only 15 times when new lows/issues traded exceeded 20% and 4 of them occurred on a consecutive basis during the 1998 bear market and 5 of them occurred during the 1990 bear market. In general, they tend to occur towards the bottom of an extreme washout or where there is evidence of panic selling, when everything is thrown out.

Combining NYSE lows and Nasdaq lows was also striking on Thursday with a total of 1,197. This was the highest reading since July 24, 2002, or a day after the first low of the bear market. During the current bull market, readings over 400 issues have represented oversold territory. What we like to see from these charts before calling a bottom is a positive divergence or lower peak in the number of issues posting 52-week lows. This can take weeks or months, depending on the duration of the pullback or correction.

We think the intermediate-term trend of the stock market is bearish, and despite some of the evidence of panic selling and washed out internals, the market is not at a bottom until the price action tells us so. We like to see a big intraday reversal to the upside, although this is not necessary, followed by a pretty strong rally that fails, and then tests the initial low. We then like to see a strong upside move, preferably on strong volume that takes out the initial rally high.

What we described is a double bottom that many times acts as a bullish reversal formation. This is certainly not the only type of low, but seems to be most prevalent. Until we get some type of reversal formation, it is best to step aside and wait for Mr. Market to tell you when the bottom is here.

Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's .