By Mark Arbeter Since the stock market peaked in May, the S&P 500 and the Nasdaq have traced out a series of lower price lows and lower highs. The rallies of late have been very short, lasting only a day or two, and then the market resumes its downward trend. The potential danger at this point is that if the market goes on to set yet another closing low for this move, critical support levels will have given way and therefore the probability that the lows of March and April will be tested.

While this action would be preferable in our technical work because it would set the market up for a wide double bottom typically seen after a major bear market, it would be very painful for many investors. Then again, fear and pain should be pervasive at a major low.

Average daily volume on both the NYSE and the Nasdaq has declined since the spring months and as we move into the heart of vacation season, volume should tail off even more. We mention volume because at this point, the market needs more participation to turn things around, and it won't get a pickup in volume until the Fall months. Therefore, at best, the market is likely to drift sideways during the rest of the summer.

Unfortunately, that brings us to the September/October timeframe which has historically been very tough on equities. There have been more major bear market lows in October ('98, '97, '92, '90, '89, '87, and '74) since 1970 than in any other month.

If the market is not going to make a return trip to test the March/April lows, critical support levels just below the market must hold. They are 1180 to 1192 for the S&P 500 and 1923 on the Nasdaq. These support levels were originally created by the heavy volume day on April 18th. If these levels are broken on a closing basis by a couple percent and by a couple of days, the chances for trouble become very real. Once an index falls below the range traded on a heavy volume day, that days' range becomes formidable resistance.

The two great recent examples of this are Jan. 3, 2001, and Apr. 4, 2000. On both occasions, after the market fell below the ranges from these days, the market was unable to rally above the wide ranges set on those days as supply eventually overcame demand. In 2000, the market tried for months to break through this resistance, only to fail and rollover.

Market sentiment remains a mixed bag. Shorter term measures of sentiment are moving to bearish extremes while longer term measures of sentiment are still showing a high level of bullishness. The Consensus Poll is now showing only 24% bulls, way down from 66% in May. The American Association of Individual Investors (AAII) poll shows bullishness falling to 25% and bearishness rising to 36%. In May, bullish sentiment was 62% and bearish sentiment was only 17%. CBOE put/call ratios have been rising for two months but are still not to the levels seen in March and April.

The Investors Intelligence (longer term) poll of newsletter writers is still slanted way too far to the bullish side, with 52.5% bulls and only 23.2% bears. This is the highest level of bulls since March and the lowest level of bears since April '98. The numbers from this poll are very worrisome because at important lows, the numbers usually move to at least a 40%/40% split, and sometimes go to a larger percentage of bears than bulls. We may be in a situation where the market will not finally bottom until this poll does an about face.

We remain cautious on the market for the near to intermediate term. We would prefer to see further weakness and a test of the March/April lows, which we believe would set the market up for a new, durable advance. Arbeter is Chief Technical Analyst for Standard & Poor's