Markets & Finance

Warning Signs for Stocks


By Mark Arbeter The second week of the New Year was a little better than the first week, as the stock market tried to put in at least a short-term bottom. However, price and volume action remain weak, and we believe further downside is a strong possibility.

Both the S&P 500 and Nasdaq composite indexes have undercut their respective 50-day simple

moving averages and both indexes hit new lows for the year on Thursday, Jan. 13. While mild pullbacks after strong advances are quite normal, the 50-day moving average usually provides decent support for the market. Furthermore, mild pullbacks within the confines of an intermediate-term advance usually occur on lighter than average volume. That has not been the case since the market rolled over at the beginning of 2005.

The intraday price action this year, in our opinion, is another worry. Early day rallies are met by selling. It appears that institutions are not only dumping stocks but also selling into any strength. Late-day weakness has been the norm this year and we believe this is not a bullish sign. The S&P 500 has dropped six out of ten days this year and each down day has been accompanied by higher than average (50-day moving average) volume.

The Nasdaq has fallen seven out of 10 days in 2005, and volume has been well above average during the down days. The bounces after weakness have lacked strength and conviction, and we believe that some caution is definitely warranted at this point.

In addition, the leaders of the rally at the end of 2004 rolled over very quickly, with leadership moving back to defensive issues as well as oil stocks. We believe markets tend to do their best when leadership comes from growth stocks, and during times of weakness, institutions have a tendency to rotate back towards defensive stocks. The chart damage to many leading issues has been severe, in our opinion, with many stocks breaking their uptrends and undercutting their 50-day moving averages. Since the rally at the end of 2004 was fairly vertical, little near-term chart support exists for these highfliers.

The S&P 500's 50-day exponential moving average is at 1,181 (simple moving average 1,187), and after dropping below this average on Thursday, the index popped marginally back above on Friday. The next important area for the index is at 1,170 as a confluence of support comes in at this level. There is near-term chart support there, and the 80-day exponential moving average and a 38.2% retracement of the advance since October also lie in this area.

Below that level, chart support begins at 1,160, which is the top of the trading range that the index traded in for most of 2004. Chart support is therefore thick underneath 1,160 because the index traded in a range for much of 2004. A 50% retracement of the rally since October would target the 1,154 level. The 150-day exponential moving average comes in at 1,148, and the 200-day exponential moving average is at 1136.

Long-term

trendline support, drawn off the March, 2003, and October, 2004, lows is sitting at 1,140. This trendline has supported prices during the entire bull market and is therefore very important long-term support, in our opinion.

Daily momentum indicators on the S&P 500 are negative and oscillator based indicators are oversold but not at extreme levels. A more critical note is the condition of the weekly indicators we follow. The weekly MACD or moving average convergence/divergence indicator is close to giving a sell signal. This trend-following momentum indicator is the difference between a 12-week exponential moving average and 26-week exponential moving average with a 9-week exponential moving average (signal line) plotted on top.

Currently, the MACD indicator line is heading lower and is not far from crossing the signal line. If this happens, it would be the first sell signal from the weekly MACD since early March, 2004. The indicator remained on a sell signal until September, 2004.

The weekly stochastic indicator we monitor moved to an extreme overbought condition during December, up above 90. The stochastic indicator is an oscillator that fluctuates between zero and 100 and compares where a stock's price closed relative to its price range over a given time period. This indicator has rolled over and will give a sell signal once it falls back below 80. The stochastic indicator has been on a buy signal since August, 2004.

As we commented on earlier, the Nasdaq broke below its 50-day exponential moving average and this is the first break of this average since the end of September, 2004. The index only remained below this average for two days so the break at that time was not significant. The index also took out trendline support drawn off the lows in August, September, and October of last year. Chart support is pretty heavy between 2,070 and 1,875. A 38.2% retracement of the rally since August would target the 2,016 level and a 50% retracement equates to a drop to 1,965. The 200-day exponential moving average lies at 1991. Long-term trendline support, off of the March, 2003, and August, 2004, bottoms comes in at 1,960.

As far as other markets were concerned last week, oil was the big story. Crude oil prices continued their strong rebound, rising about $3 per barrel, and in the process, completed a bullish,

double bottom reversal formation. Crude oil is back above $48 for the first time since the beginning of December. The next piece of chart resistance is up at $50, and above that, the all-time high just over $55 comes into play.

We believe the rally in oil prices caught a lot of investors by surprise as many think (hope) that oil was in the midst of a longer-term decline. Technically, oil remains in a long-term bull market, and until that changes, it is possible from our work that oil has not yet put in a top in prices.

Required Disclosures

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041.

Other Disclosures

This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS.

Disclaimers

This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

Readers should note that opinions derived from technical analysis may differ from those of our fundamental recommendations. Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's


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