Last week, the market made an important turn higher that prevented what could have been some real damage. The Nasdaq broke below its prior trading range low or support of 1918.50 and fell as far as 1882.14 on Tuesday before turning higher on Wednesday. For a real downside break to occur, the Nasdaq would have had to drop below support by 2% to 3% for two consecutive days. So far, that has not happened. The only thing that did occur was that the trading range was extended lower, something that is quite common during a trading range environment.
The S&P 500 was able to hold above the bottom of its trading range that comes in at 1114.50, falling to 1118 on Tuesday. For the S&P 500 to be in danger of rolling over, it would have to close below 1114.50 by 1% for two straight days. We give the Nasdaq a little more room because it is more volatile than the "500". The top of the trading range or resistance for the S&P 500 lies up at 1177, while the top of the range for the Nasdaq is up near 2100. For the indexes to get out of danger of moving into a decent-sized correction, we would like to see them move back above their respective 20-day moving averages of 2088 for the Nasdaq and 1147 on the "500". That would then suggest that the indexes were headed back to the top of their recent ranges.
If the indexes were to turn lower and meet the parameters set out above for a downside breakout, they would likely retrace about 50% of the entire move since the Sept. 21 bottom. This would equate to a downside target for the Nasdaq of 1743 and 1060 for the S&P 500. These are doubly important support areas because there is chart support around these two targets. Good chart support on the Nasdaq comes in between 1628 and 1776 and for the "500", in the area of 1054 to 1111. These chart support areas were formed during the sideways consolidation in October.
While we still believe the major indexes will hold in their recent trading ranges, the potential for a downside break is real and must be monitored closely. There has been some heavy distribution by institutions of late, evidenced by the weakness seen in volume patterns on both the Nasdaq and the NYSE. Advancing volume versus declining volume on both indexes has moved into bearish configurations. The reason we are not raising the red flag is that this deterioration has been seen following the initial spike after a major bear market low. There must be an improved pattern of accumulation by institutions to suggest that the lows have been seen for this down move and for the possibility of a run back to the top of the trading range.
Along with the deterioration in volume measures, the stocks that were leading the market higher, or those that either broke out to new all-time highs or that moved to 52-week highs, have rolled over and fallen back into their respective bases. If these new leaders can hold within their bases, and then mount another move back to new highs, it would alleviate the potential for any damage on the downside.
Another problem with the technicals is that sentiment has moved too far to the bullish side. The numbers posted by the Investors Intelligence poll of newsletter writers is showing 52.6% bulls and only 23.7% bears. Just a few weeks ago, the difference between bulls and bears reached its highest level since last February.
In the options market, complacency is running way too high and this can be seen by the anemic levels in the volatility indexes. These indexes measure premium levels in the option market. The VIX, or premiums on the OEX, has been drifting below 25 for the last couple of weeks, while the VXN, premiums on the Nasdaq 100, has been mostly below 50 recently. Historically, these are very low levels and have prompted corrections in the past. However, the overall shift in sentiment to the bullish camp, like the deterioration in volume mentioned above, is also common after a market spike and usually suggests that the market must go through a longer period of consolidation and not a major correction.
While many market participants are likely to be disappointed and frustrated by a period of sideways action, it is far better than what we have witnessed over the past two years. Arbeter is chief technical analyst for Standard & Poor's