The Market Is Still Stuck in a Rut
By Michael Kahn
Technical analysts try to gauge where stocks or markets are going by looking at where they've been.
So, what does recent price action tell us about the direction of the market in the weeks ahead?
From its bottom in March to its top in May, the Dow Jones Industrial Average gained just over 2,200 points (see chart 1). But between its highs in May and its lows in July, it shed about half of that gain in what is known as a 50% retracement. Notably, markets often find support in that range.
Chart 1
Source: Bridge
Last week, however, the market fell too far too fast, and supply and demand were out of balance. As can be seen on chart 1, the Dow touched the bottom of the channel drawn from the May top. Prices fell low enough to stimulate demand, and sure enough, the market snapped back sharply from its oversold condition.
Over the longer term, the picture remains pretty much as we've painted it in Getting Technical over the past few months. While the Dow remains locked in a two-year trading range, the broader Standard & Poor's 500 continues to be stuck in a declining trend that began in September of last year. It fell by roughly two-thirds from its May peak, also a level where support is commonly found (see chart 2). The trading range we saw earlier this month formed at the equivalent 50% retracement level that supported the Dow.
Chart 2
Source: Bridge
To put it bluntly, this market has no direction. Companies like Yahoo! and Motorola report good news, sparking a July 12th rally that takes tech stocks with them. But since then, they either haven't budged or fallen back to where they were.
Clearly, the market is not ready to embark on the rally that everyone seems to so desperately need. How do we know that? The sentiment indicators such as the CBOE VIX index have barely backed off their extremely bullish readings, which means that investors have already placed their bullish bets. The market usually does not accommodate the masses.
So, rather than focus on each earnings report or CEO conference call, we should be listening to the market itself. What is it telling us? Right now, the market has drawn "lines in the sand" above which prices must cross. On the charts, these are trend lines from the post-rally May highs.
The S&P 500, in fact, is sitting right on its line. The Dow has a bit more room to rally before it hits its trend line. The Nasdaq Composite index is somewhere in between. Will news that Nokia beat its oft-reduced numbers be the spark that drives the market through these lines? Possibly, but count us among the skeptical.
Should the market finally make that upside move, the S&P's path to the May high of 1315 would be far from easy. Too many times since April, investors who turned too bullish too early were left with losing positions and are still waiting to break even. When they get that chance, they are likely to become active and flood the market with supply.
Still, as always, the market has some pockets of strength. Over the past week the Morgan Stanley Cyclical Index (CYC) broke out to the upside from a corrective decline. Such cyclical names as FedEx (see chart 3), Wal-Mart and USX US Steel have made their own breakouts. Transportation stocks, like railroads CSX Corp. (see chart 4) and Canadian National, are also doing well.
Chart 3
Source: Bridge
Chart 4
Source: Bridge
Financial stocks may have rallied off last week's reversal low but there is a split going on between internationally oriented names and domestically oriented names. A strong dollar and problems in Latin America have pressured the multinationals but the others are doing quite well. Compare, for example, the performance of regional bank Fifth Third Bancorp with that of global banking and financial firm J.P. Morgan Chase (see chart 5).
Chart 5
Source: Bridge
Right now, as we said, the market doesn't look as if it's ready to rally yet. But when it finally does head higher for good, stocks that held up best beforehand tend to be the fastest out of the gate. For now, two sectors of the economy, the cyclicals and the financials, fit that bill, and these are the ones to watch down the road.
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Michael Kahn is Chief Technical Analyst for BridgeNews (www.bridge.com) and the author of two books on technical analysis, most recently Technical Analysis: Plain and Simple. He also is Marketing Director of the Market Technicians Association, and can be seen regularly on such financial news broadcasts as PBS's Nightly Business Report and Yahoo! Finance Vision (vision.yahoo.com). |
