Arbeter: Searching for a Bottom

After breaking down last week, the S&P 500 index might find a floor near summer lows. But there's still no support for the dollar

by Mark Arbeter From Standard & Poor's Equity Research

It was another ugly week for the stock market, with the major indices breaking key support levels. All of the sudden, the market has woken up to the fact that the U.S. dollar is in a freefall, and the speed of the decline is starting to become worrisome. The medicine for a weak dollar is higher rates or higher GDP, neither of which look likely in the near- to intermediate-term. On the plus side, some sentiment indicators have reversed rather sharply to the bearish side, so we think all is not lost.

The S&P 500 and DJIA sliced through a group of technical supports on Wednesday, and have now traced out a series of lower highs and lower lows, confirming that from a price perspective, a correction had started. First and foremost, the "500" took out chart support at the 1490 level. The index had bounced off that level four times since Oct. 22, so it was a meaningful failure in our view. In addition to breaking chart support, the "500" also broke sharply through its 80-day simple average for the first time since late July. The index also failed to hold the 38.2% retracement level of the August to October rally, and broke below a price envelope shifted 2% above and below a 21-day simple average.

The S&P 500 has fallen to the next group of technical supports in the 1450 zone. This level represents a 61.8% retracement of the recent rally, based on the intraday low from Aug. 16 and intraday high on Oct. 11. It looked like the combination of the 200-day simple and 200-day exponential averages provided some support on a closing basis on Wednesday and Thursday. The simple average sits at 1483, while the exponential is at 1478. However, with Friday's weakness, the 200-day averages now represent potential resistance. The "500" may have also found support in the 1450 level on Thursday and Friday from a long-term trendline drawn off the highs in 2004, 2005, and 2006. This line, which was originally a piece of resistance, is now support, and provided nice support in March and August this year.

It is always difficult to predict where the market will find a bottom, and this may be particularly tricky until after the fact. The reason is this: while we believe the summer lows will provide a floor for the "500," the reversal formation from this summer was fairly spread out. Stepping back, the range from the reversal pattern was 1370.60 to 1503.89. The key potential support levels within the formation, in our view, are the low close of 1406.70 and the intraday low of 1370.60. In addition, the S&P 500 also bounced off the 1432/33 level twice during the pattern, so this also is a potential piece of chart support.

In addition to chart support from the summer lows, the 325-day exponential average lies at 1440. This moving average has been great support during the bull market, and has provided a floor for the index on six different occasions since August 2003. We must say that the market sometimes dropped through this average during some of the pullbacks, but did not stay below this average for long. Nothing works perfectly, but this average has been very good. Trendline support, off the lows in July 2006 and August 2007 comes in at 1415, looking out a couple of weeks.

In some indicators we monitor, market sentiment is quickly reversing from optimism to fear, a good sign in our view. However, we think for a durable, intermediate bottom to be formed, we will need to see further moves on the sentiment front. Although sentiment indicators generally move together, they do not move with the same speed. For instance, the ISEE sentiment Index jumped to 191 on Oct. 29, showing that 191 calls were being bought at the open vs. 100 puts being bought. This, in our view, was a good sign that speculation by individuals was heating up. With the recent decline in the market, this index quickly dropped to 108 on Nov. 7.

The total CBOE put/call ratio has jumped from 0.76 on Oct. 31 to 1.24 on Nov. 8. The equity-only put/call ratio has risen from 0.45 to 0.83 during the same timeframe. The quickest moving sentiment poll, in our view, comes from the American Association of Individual Investors.