Stocks: Signs of a Bottom?

S&P says market sentiment has swung far enough to the bearish side to suggest that a bottom could be close for the major indexes

by Mark Arbeter From Standard & Poor's Equity Research

The major question on many a mind is whether the retest of the late-January lows will be successful, or whether the stock market must endure another leg to the downside. Unfortunately, we don’t have the precise answer. What we do know is that there has been a dramatic improvement in the market internals from late January to early March during the testing so far. In addition, market sentiment has swung far enough to the bearish side to suggest that a bottom is here or very close in time. However, these two positive technical factors do not prohibit the stock market from making another stab lower. They just raise the possibility, in our view, that the majority of the downside is behind us.

As we said last week, the primary trend of the stock market is still lower, and the majority of the ten S&P sectors is in major corrections or bear markets. No surprise to anyone in the business: Market bottoms after major corrections or bear markets are ugly affairs. There is plenty of price volatility, numerous stocks hitting 52-week lows, an abundance of ugly charts, and of course a surplus of terrible fundamental news. Kind of feels like current conditions.

The other question that we cannot answer: Has the market sufficiently priced in all the bad news? Once again, market internals and sentiment lead us to say yes from a probability standpoint, but it certainly isn’t a sure thing. We may need another capitulation to the downside to finally put an end to the carnage.

Despite the fact that things feel horrible, we are seeing some fairly strong bullish divergences in market internals, a prerequisite, in our view, of a major market low. On Jan. 22, when the S&P 500 closed at 1310, NYSE new lows as a percent of total issues soared to 33.2%, an extreme reading, and the highest since August 31, 1998. That happened to be the initial low of the double bottom in 1998. On Mar. 6, when the S&P 500 closed at 1304, the percentage of new lows on the NYSE was only 8.9%, setting up a fairly dramatic bullish divergence. This suggests to us that the chart condition of many stocks on the NYSE is in far better shape than at the panic lows in January. Over on the Nasdaq, we had 27.8% of Nasdaq issues hitting new lows, the highest in over a decade, while on March 6, with the index below the January closing levels, there was only 9.5% of Nasdaq issues hitting new lows.

Looking at other internal measures, we are basically seeing the same bullish divergences. Nasdaq declining volume on Jan. 22 was 2.5 billion shares, much higher than the down volume of 1.9 billion shares on Mar. 6. On the NYSE, the recent peak of down volume occurred on Jan. 17 at 1.9 billion shares vs. 1.5 billion on Mar. 6. However, all the internal data is not showing bullish divergences as the number of declining issues on both the NYSE and the Nasdaq from Mar. 6 have exceeded the number of decliners from back in late January.

Daily momentum based on the price action of the S&P 500 has rolled over to the downside but may be setting up for some positive divergences. In late January, both the 14-day RSI and daily MACD got very oversold, and with the recent move higher, worked those oversold conditions off. If prices were to reverse in the next couple of days, both the RSI and MACD would be at higher levels than they were in January, and, therefore, they would have traced out bullish divergences. On a weekly basis, momentum is in a clear downtrend, but it is possible that the 14-week RSI could be tracing out a bullish divergence. That is not the case with the weekly MACD, as it hit another new low on Mar. 6.

On the sentiment side, we continue to see fairly dramatic bearish readings that have many times marked the bottom, or were very close to marking the bottom, of major corrections and bear markets. The CBOE equity-only put/call p/c ratio rose to 1.12 on Mar. 6, an extreme level of fear, and the highest reading since August 6, 2004. This was right near a major low for the stock market. The 5-day equity-only p/c ratio has risen to 0.91, very close to the recent high in January. The 10-day has also jumped to the levels seen in January, and that was the highest since 2004.

The ISE sentiment Index has consistently posted very low readings since the beginning of January, showing a high degree of fear by individual investors in the marketplace. These low readings have pushed the 21-day exponential average down to 90 and the 50-day exponential average down to 98, both of which are all-time lows for the index.

The Consensus poll fell to only 23% bulls, the lowest since February 2003, and very close to the final low of the bear market. The AAII poll is showing only 22% bulls, one of the lowest readings in over a decade. Unfortunately, we are not seeing the same type of bearish sentiment on the Investor’s Intelligence poll of the MarketVane poll. We would prefer to see all sentiment indicators showing lots of fear, but things don’t always line up that way.

We continue to believe the Federal Reserve is behind the curve as the yield on the 2-year Treasury note is 140 basis points below the federal funds rate. Unfortunately, since the second half of 2007, the Fed has lagged market rates, and we think this has a lot to do with the weakening economy and the lagging stock market. It is possible that until the Fed catches up with market rates, that the stock market and the economy will continue to disappoint. If and when the stock market bottoms and starts to head higher, we think that will be a good time to sell longer dated Treasuries, as fixed income has benefited from the outflow from stocks.

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