What a Week: Fundies and Techies Play Chicken

Technical indicators may explain why relatively good news didn't send stocks even higher.
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SAN FRANCISCO -- Some nagging technical indicators met a large dose of healthy fundamental news this week. The result was a victory for the latter, although proponents of the former see trouble ahead, at least short term.

For the week, the

Dow Jones Industrial Average

and

S&P 500

gained 3% apiece, while the

Nasdaq Composite

climbed 4.7%.

Last week, stocks didn't drop precipitously despite some horrid economic news. Conversely, this week may have felt disappointing to some investors because major averages didn't skyrocket amid a slew of positives.

Those included: rate cuts by central banks in the U.S., England and the eurozone; a drop in jobless claims; not-as-bad-as-expected retail sales; an optimistic forecast from the Semiconductor Industry Association; a rise in third-quarter productivity; and, better-than-expected earnings from

Cisco

(CSCO) - Get Report

.

The trend was evident on Friday as major averages struggled despite an unexpected rise in the University of Michigan's consumer sentiment index and reports the Northern Alliance had captured the Taliban stronghold of Mazar-i-Sharif.

Of course, the news wasn't all good as

Enron

(ENE)

was forced to restate five years of earnings in order to pave the way for a possible buyout by

Dynegy

(DYN)

.

Elsewhere, oil prices turned higher after OPEC announced production cuts, which Russia pledged to support. Finally, minutes of the

Fed's

Oct. 2 meeting showed the central bank's forecast for a gradual recovery next year was "subject to an unusually wide range of uncertainty, notably in the direction of a potentially much weaker outcome in the nearer term."

Technical Tickles

But overall, the news flow was positive this week and stocks could have been expected to perform even better. Aside from the pat answers of "profit-taking" or "selling on the news," technical analysis offers an explanation for why the averages didn't post bigger gains.

For example, on Thursday the Dow failed to sustain an intraday move above its Sept. 10 closing level of 9605, although it managed to end the week 3 points above that level. The Nasdaq 100 reversed after hitting key support at 1580 on Thursday, which is where a downtrend exists from the NDX's high in March 2001. Also, the Philadelphia Stock Exchange Semiconductor Index suffered what technicians call an "outside day" or "engulfing day" on Thursday, when the index produced a higher high than the previous day but closed at a lower low.

"This is a reversal pattern that can signal an end to the short-term trend," according to Schaeffer's Investment Research in Cincinnati, which also commented that the SOX is short-term overbought while sentiment is overly optimistic. Additionally, the index faces resistance at its 10-week moving average of 550, which had been an area of support from December 2000 through September, according to Schaeffer's.

Sources note the S&P 500 and NDX each suffered "outside" days on Oct. 17 and rallied sharply thereafter. But other technicians view the broader market as facing similar obstacles as the SOX.

Thursday's intraday reversal occurred "almost exactly at the outmost point of resistance, suggest

ing that this overbought market is due for a pullback," according to Richard Williams, strategist at Summit Analytic Partners.

Williams, formerly a technical analyst at Jefferies & Co., said the "most likely" scenario is for the S&P 500 to pull back into the 1050 area, and he recommends traders short the S&P 500, with a stop at 1137 and a target of 1050. He also recommends long positions in the Philadelphia Stock Exchange Oil Service Index, with a stop at 73 and targets of 90 and 105.

"With the war and the uncertainty of terrorism, higher oil prices seem logical if only to adjust for the heightened risk premium required by investors," Williams wrote, arguing that the OSX broke its downtrend this week, during which it rose 6.6%.

On the sentiment front, bullishness fell to 41.7% from 43.3% in the latest

Investors' Intelligence

poll. Bearish sentiment rose to 33.3% from 32%, which should be viewed positively as sentiment is considered a contrarian indicator.

But while newsletter writers are getting more cautious, Jacob Bernstein, president of Daily Sentiment Index (DSI), said his firm's index of retail investors shows bullishness at about 90%.

"The bottom line is the trading public is bullish, which usually signals a short-term top," Bernstein said.

Since 1987, the daily index has been compiled via surveys of retail traders and their brokers, as well as online forums (more recently). The index is particularly effective at calling short-term tops and bottoms when the index hits extremes of 90% or more bullishness or 10% or less, Bernstein said. Both he and the index are new to this column, but Steve Hochberg, co-editor of the

Elliott Wave Financial Forecast

mentioned Bernstein's index as a reason he, too, is expecting a short-term reversal.

"I expect another leg down into next week," Hochberg said, suggesting the market would then "probably rally off" what shouldn't be a "huge decline at this point." But "it could turn into something" worse because of the aforementioned rise in retail investors' bullish sentiment, he said.

On the other hand, my (highly) unscientific survey of professional traders showed many remain upbeat.

"The market has been more than resilient, all factors considered," said Bob Basel, director of listed trading at Salomon Smith Barney. "Right, wrong or indifferent, the feeling is we're moving to

Dow 10,000," albeit not in a straight line upward.

The rationale for such an outlook is twofold, Basel said: One, many money managers failed to anticipate the market's sharp rally from the Sept. 21 lows and are "chasing some performance now." Two, "there's no other place to put your cash."

The trader referred to the decline in interest rates following the Fed's persistent rate cuts this year and -- more specifically -- the Treasury Department's decision to eliminate future issuance of the 30-year bond. Indeed, long-term Treasury yields fell again this week -- by eight basis points on the 30-year and six basis points on the 10-year -- despite the aforementioned signs of economic improvement.

By driving rates ever downward, the government is seemingly trying to force Americans to spend and/or invest money in an effort to keep the economy afloat until various stimuli begin to generate a real recovery. This week, the gambit seemed to pay off, the albatross of some troubling technical developments notwithstanding.