Markets & Finance

Stocks: Hitting the Ceiling?


From Standard & Poor's Equity Research

Each of the major stock market indexes pulled back to important levels of support during the week just past and held, leading to a nice bounce back on Friday. It is interesting to note that the Dow Jones industrial average, S&P 500, and the Nasdaq composite index are all testing different areas of support within their respective chart formations, but we believe they all look like they are topping out on an intermediate-term basis. Bond yields continued higher last week, while oil prices fell back towards the $60 level.

The best looking major index from a chart pattern standpoint, in our view, is the Dow Jones industrials. The DJIA broke out to a new recovery high in the middle of February and has since pulled back to its breakout point or top of its recent base in the 10,970 to 11,000 area. During the pullback, the index also found support from its 50-day exponential moving average. The DJIA has outperformed both the S&P 500 and the Nasdaq since the end of January.

However, the one factor we do not like about the DJIA's chart is that it has been tracing out a potential expanding top or megaphone top since the end of November. This formation is often a topping pattern and is formed by two widening trendlines as prices put in a series of higher highs and lower lows.

The Nasdaq composite looks the worst from a technical perspective, in our opinion, and has fallen the most of the major indexes since peaking on Jan. 11 at 2331.36. The index had fallen all the way to the bottom of its recent range in the 2240 to 2250 zone, before rebounding on Friday. The Nasdaq has broken below both its 50-day exponential and 50-day simple moving averages. The index has also taken out the neckline of the head-and-shoulders pattern that has been forming since late November.

The Nasdaq found support on Wednesday and Thursday in the 2250 area, right where the 80-day exponential moving average sits. The 80-day average provided excellent support for the Nasdaq in early January and mid-February. Additional chart support for the index comes from the late -December closing low at 2205. The 200-day exponential moving average comes in at 2187 while trendline support off the lows in 2005 lies at 2160.

The S&P 500's chart formation of late is somewhere in the middle of the Dow and the Nasdaq. The index has pulled back into the middle of its recent trading range following the failed breakout attempt at the end of February. The index found support from its 50-day exponential moving average in the 1274 area. The low close for the week occurred on Thursday at 1272. In addition, trendline support, off the lows in October 2005 and February 2006 came in at 1275. The 80-day exponential moving average, which provided support in October, sits at 1266.

There is the possibility that the S&P 500 is tracing out a double top reversal formation. To complete this formation, the interim closing low at 1255 would have to give way. The completion of the double top would give us a potential target for the S&P 500 of 1215. Taking the width of the double top, which is 40 points, and subtracting it from the breakdown point of 1255 arrives at this target.

Additional chart support lies at 1246 and, in our view, this level is important because it acted as successful support in December, 2005, and it provided resistance in August and September, 2005. The 1246 level also represents a 38.2% retracement of the rally from October until January. On the upside, chart resistance lies at 1295.

Momentum, on both a daily and weekly basis, continues to deteriorate. The daily moving average convergence/divergence indicator (MACD) based on the price action of the Nasdaq and the S&P 500 have traced out a series of lower highs and lower lows since Nov. 25. The weekly MACD on both the Nasdaq and the S&P 500 has rolled over and turned bearish. Daily price rate-of-change (ROC) data has been deteriorating since November on both indexes while weekly ROC has been declining since June 2003.

Internally, the market continues to look like it is on shaky ground, in our view. The 30-day advance/decline ratio on the NYSE has deteriorated on a short-term and long-term basis. This ratio, which measures market breadth, has put in a series of lower highs and lower lows since early December, and is at its lowest level in four months. Longer term, this ratio has traced out a string of lower highs since June, 2003. We believe this is a good example of a tiring bull market.

Another measure of market internals, the 10-day advancing issues/total issues ratio on the Nasdaq is showing a similar deterioration. Since November, this ratio has put in a succession of lower highs and lower lows. Longer term, this ratio peaked out for the current bull market in June 2003, and for the most part, has traced out lower peaks ever since.

The 10-year Treasury yield finished last week at 4.76%, the highest closing level since June 14, 2004. The 10-year, following its recent breakout, is now pushing up near the top of the range that has existed since the middle of 2002. The highest yield close during this time period was 4.87% on June 14, 2004 and the highest intraday yield during this period was 4.9% on May 14, 2004. A breakout above these yield levels would be significant, in our view, as it would represent a move out of a massive basing formation.

Short rates continue to move higher, as they have since early 2004. Just recently, longer-term interest rates have been rising faster than shorter-term rates, and therefore, widening the spread between short and long rates. The 2/10-year spread, which was slightly inverted, is now slightly positive.

Crude oil prices had a tough week, dropping from $63.67 to $59.96, or almost 6%. Crude prices have retraced about 61.8% of their recent rally and sit within an area of chart support between $55 and $62. Short and intermediate-term trendline support sits at $58, with long-term trendline support at $53. The 43-week exponential moving average remains above the 17-week exponential average so this longer-term crossover system is still bullish. To resume the recent short-term advance off the mid-February low, we believe prices would have to break the most recent high of $63.67.

Glossary

S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:


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