Markets & Finance

Is the Rally Losing Steam?


By Mark Arbeter The stock market's short consolidation has ended, as the major indexes broke to new recovery highs last week. Both the S&P 500 and the Nasdaq indexes moved to four-year highs while the Dow Jones industrial average moved to its highest level since March. There was some profit taking on Friday, July 29, as crude oil prices spiked back above $60 and Treasury yields rose to their highest level in over three months.

The S&P 500 rose to 1243.72 on Thursday, July 28, the highest close for the index since June 12, 2001. The "500" has moved into an area of chart

resistance, from back in 2001, that runs between 1240 and 1315. In addition, there is a huge zone of chart resistance, in our view, from 1998, 1999, 2000 and 2001, that begins at 1240 and runs clear up to the all-time highs. In our opinion, this will be a tough area for the S&P 500, and will take considerable time to work through.

As well as chart resistance, there are two

trendlines that come in around the 1260 level. The first piece of trendline resistance is drawn off the highs of 2004 and the recent highs posted in 2005. The second trendline is drawn off the lows in 2003 and 2004. The next key Fibonacci retracement, 61.8% of the bear market, would target the 1253 level.

On the downside, key chart

support lies at 1225, which was the recent breakout area. The 20-day exponential moving average is at 1224, while the 50-day exponential moving average lies at 1209. Trendline support, off the lows in May and July, comes in at 1220. Because of the strong levels of support just below, we believe any pullback will be mild over the near term.

The Nasdaq closed at 2198.44 on Thursday, July 28, the best close since June 8, 2001. The index continues to struggle with chart resistance up in the 2190 to 2200 area, and has been unable to break cleanly above the highs posted back in the beginning of the year. Immediately above current prices at 2210 is trendline resistance drawn off the two peaks in 2004. A break above 2210, which we see in the near term, would then bring the 2250 to 2330 area into focus. This is chart resistance from back in 2001. Minor chart support lies in the 2150 area with more substantial chart support in the 2100 zone. The 20-day exponential moving average lies at 2148 while the 50-day exponential moving average comes in at 2102.

While momentum has been strong since early May on both a daily and weekly basis, we are starting to see some negative divergences on some of the daily charts. The daily stochastics oscillator on both the S&P 500 and the Nasdaq are very overbought, and the stochastics based on the Nasdaq are starting to put in lower lows despite higher highs in prices. In addition, the 6-day relative strength index (RSI), after getting very overbought, has also put in a series of lower lows.

Weekly momentum is also fairly overbought, but these technical indicators have yet to trace out any negative divergences typically seen at intermediate-term highs. In our opinion, momentum is suggesting that a near-term pullback is possible but that there is still time and room for the indexes to extend themselves into the next month or so.

For the most part, market sentiment remains fairly to extremely bullish, which eventually could lead to some trouble for the stock market, in our view. Investor's Intelligence poll of newsletter writers is showing 55.9% bulls, the highest since February. Bearish sentiment is fairly low at 22.9%. In the options market, the equity put/call ratio has moved to fairly low levels, as investors have increased their level of bullishness and increased their call buying. The 5-day, 10-day, and 30-day equity-only put/call ratios have moved to their lowest levels since January 2004, just prior to the pullback we had during that year. However, CBOE put/call ratios are in neutral position, so we are not getting the usual confirmation from the options market.

The Treasury market got hammered on Friday, July 29, pushing yields on the benchmark 10-year note to 4.29%, the highest level since Apr. 21. The 10-year Treasury yield is sitting above its 200-day exponential moving average, and we continue to believe yields have further to go on the upside. Trendline support, drawn off the yield peaks in 2004 and 2005, comes in at 4.6%. Chart support also lies up in this area. Taking the width of the latest double bottom reversal formation and adding it to the breakout point also gives us a target up in the 4.6% zone.

As we have said recently, despite the reversal in yields to the upside, bond sentiment as measured by MarketVane and Consensus remains pretty bullish. In our view, that could be a problem for bonds over the next couple of months.

Crude oil prices spiked back above the $60 level on Friday and are sitting less than $1 below the all-time high set in the beginning of July. The mini-pullback in crude during the month of July alleviated an overbought condition in the oil market and, in our view, sets the stage for new highs. During July, crude oil fell right back to short-term chart support in the $57 area and held very nicely. The 50-day exponential moving average also lies in this area. Long-term chart resistance lies up near $65 and we believe this is achievable over the next month or so. We then would expect a fairly decent-sized correction.

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