Markets & Finance

Stocks Fail a Crucial Test


By Mark Arbeter The stock market declined to new lows for the year despite the continued correction in oil prices and a rally in the bond market. The Nasdaq composite index has now fallen over 10%, and by definition, has entered a correction. The exit from cyclical stocks has been nothing but dramatic as some money rotates to defensive areas of the market. With investors on the skittish side, and opinions about the market varying widely, we continue to take a cautious stance towards stocks.

The S&P 500 has pulled back 6.7% from its Mar. 7 closing high of 1,225.31 and is now down 5.7% in 2005. The index undercut its January closing low of 1,163.75 on Thursday, Apr. 14, and is at its lowest level since November 2, 2004. The Nasdaq has entered a full-fledged correction and has fallen 12.4% from its December 30, 2004 closing high of 2,178.34. The index is now trading at the lowest level since October 14, 2004. The S&P SmallCap 600 index has not escaped the damage, off 9.8% from its Mar. 4 closing high of 336.51. The Dow Jones Transportation index has really gotten hit, having given up 12.8% from its Mar. 7 peak.

We suspect some of the remarkable performance of many subindustries recently, and the dramatic shifts in market sentiment towards different sectors of the market, is due to the increased participation by hedge funds, and their aggressive approach to the market. For instance, many cyclical subindustries have been in a leadership position over the last couple of years. During the last month or so, many of these subindustries have gotten absolutely clobbered without really putting in typical topping formations. It has been from straight up to straight down.

The rotation out of technology and other cyclical stocks has really hurt the performance of many subindustries of late and aided the defensive segments of the market. Some of the worst performing subindustries over the 10 days ended Thursday, Apr. 14, include many auto indexes, steel (-12.2%), diversified metals and mining (-11.8%), Internet retail (-11.5%), railroads (-9.8%), and diversified chemicals (-8.1%).

Over the same 10 days, the best performing subindustries have been housewares and specialties (+4.9%), pharmaceuticals (+4.3%), and airlines (+4.2%). Over the last 30 days, some of the auto subindustries are down 23%, Internet retail has fallen 21.5%, steel is off 20%, and electronic equipment manufacturers are down 15.6%. The best performing subindustries over the last 30 days have been healthcare facilities, with a gain of 11.4%, and healthcare services, up 4.9%.

The S&P 500 has broken important chart

support at the 1,164 level and next support is down in the 1,140 to 1,145 zone. Chart support, from the peaks in October and June, 2004, lies in this area. A 50% retracement of the advance from August until December lies at 1,144. What is getting particularly worrisome from a technical standpoint is the longer term supports that the major indexes are breaking. While the S&P 500 has solid chart support between 1,060 and 1,160, the index broke a long-term

trendline off the lows in March, 2003, and October, 2004, on Friday. This trendline has supported prices for the entire bull market off the 2003 lows.

In addition, the S&P 500 busted right through its 150-day and 200-day exponential

moving averages as well as the 200-day simple moving average. While it is initially tough to declare the end of the cyclical bull market, it is in our opinion getting close to the day of reckoning.

As we have been saying, weekly momentum indicators have been bearish for quite some time. Monthly momentum indicators, which give very few signals because of their long-term nature, are beginning to look worrisome from our perspective. The monthly stochastics indicator is starting to roll over after getting extremely overbought. The last major sell signal from this indicator was back in April, 2000. The monthly moving average convergence/divergence or MACD is also rolling over but has yet to cross the signal line. The last sell signal from the MACD was March, 2000. Buy and sell signals from these monthly indicators are rare, but must be taken very seriously from a long-term perspective.

The Nasdaq has had a much clearer break to the downside and from our work; the cyclical bull market that started in October, 2002 is over. It is anyone's guess as to whether we have entered a sustained down move or not, but the action speaks for itself. The index is now trading below its 200-day exponential and simple moving averages, as well as long-term support from a trendline drawn off the lows since March, 2003. Weekly and monthly momentum indicators are both bearish. The Nasdaq advance/decline line has been in a downtrend since January 2004. The next major level of support for the Nasdaq is down in the 1,750 to 1,865 zone. The low last year occurred in August at 1,752.49.

Longer-term, the Nasdaq remains in a very wide trading range, following the bear market, between 1,100 and 2,200. After a dramatic advance and subsequent drop in a stock or index, the most common formation is a long-term base. We believe that is exactly what the Nasdaq and many of its components are working through right now.

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 March 31, 2005, SPIAS and their U.S. research analysts have recommended 30.9% of issuers with buy recommendations, 56.6% with hold recommendations and 12.5% 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 of 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 might differ from those of our fundamental recommendations. Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's


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