Technical analysts used to be the Rodney Dangerfields of Wall Street, for years calling one downturn after another while the market plowed ahead. But last year, they finally got respect. As most of the technicians predicted, stocks tumbled and continued their descent through the first quarter of this year. So what are the indicators telling them now? Is this current rally sustainable, or is it just a bear trap?
For the moment, it seems the technicals are on the side of the bulls. Market internals such as the ratio of advancers to decliners, up-to-down volume, and investor-sentiment readings are positive, in stark contrast to the way matters stood a little more than a year ago. "We have seen an important low point," says Richard W. Arms Jr., whose Arms Index tracks the relationship between advancing and declining issues and the advance/decline volume ratio. "The market is moving higher."
Technical analysis is the study of the information generated by the internal workings of the market. Technicians pay little attention to such fundamentals as interest rates and Fed policy. Instead, they argue that outside factors can be reduced to things like volume, price, sentiment, and momentum. By analyzing such variables and matching emerging trends with past trends, it's possible to predict future price movements, since history tends to repeat itself. Richard H. Driehaus, a money manager who uses technical analysis, asserts that markets "are more behavioral than science."
Richard McCabe, chief market analyst at Merrill Lynch & Co., homes in on the ratio of Nasdaq-to-New York Stock Exchange volume to gauge speculative activity. During the Nasdaq runup, that ratio was around 2 to 1 in Nasdaq's favor. Now it has fallen to 1.3 to 1. "That's a healthy sign," says McCabe.
There are other bullish indicators. Investor sentiment, a contrarian indicator, hit a low in March, a good sign for the market. And the all-important advance-decline (A/D) line has gotten stronger. In fact, before last year's market rout, technicians became bearish because the A/D line had turned negative. That divergence indicated a two-tiered market.
According to Ralph J. Acampora, the hyperkinetic Prudential Securities director of technical research, the improvement in the A/D line means the market's outlook is rosier. For 23 months, beginning in April, 1998, the line went down even as the indexes were rising. "The A/D line reached its low in March, 2000--the Nasdaq's top," says Acampora. "Since then, breadth has been improving." Acampora thinks the rally is sustainable.
NARROW FOCUS? Still, there are bears among the technicians. Salomon Smith Barney Inc. Vice-President Jonathan A. Lin argues: "The big picture is that the A/D line has been trending down." The current rally, asserts Lin, is a cyclical rally within a secular bear market. "The bull market is unwinding," says Lin. To change his view, volume would have to be healthier, buying force would have to improve, and the indexes would have to be closer to their old highs.
Acampora says the bears, such as Lin, focus too narrowly on the divergence; ultimately, the broadening in the A/D line will be reflected in the Dow, which will not only return to its old high but also break through it.
For now, the bulls outnumber the bears. First Union Securities analyst Gregory A. Nye says that the market has been deeply oversold and the pendulum is starting to swing back. "Volume is coming in on the buy side," he says.
If the techies continue to call the market correctly, they may become the new gurus on the Street.
By Robert J. Rosenberg in New York
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