Late Selling Takes Some Luster off Big Rally

A potentially stellar rally morphed into merely an impressive one as some late-day selling took some shine off the market's action. Still, major averages rose smartly and market internals were bullish.

After trading as high as 8418.15, the Dow Jones Industrial Average closed up 2.9% to 8274.09. Similarly, the S&P 500 ended up 3% to 859.57 vs. an intraday best of 874.50 while the Nasdaq Composite rallied 4.4% to 1259.55, about 20 points below its earlier high.

The day's gains were fueled by a combination of short-covering, speculation of Fed easing and the dollar's renewed strength, as reported earlier. Additionally, there was anticipation of the post-close earnings announcement by Cisco ( CSCO), which reported pro forma fourth-quarter earnings of 14 cents per share, two cents ahead of consensus estimates. After climbing 6.3% to $12.07 in the regular-hours session, Cisco shares fell initially in after-hours trading but have since rallied to near $12.50 although the company's revenues of $4.83 billion were slightly below forecasts.

Some attributed the late-day selling to rumors of cautious comments by Merrill Lynch ahead of Cisco's results. Additionally, technicians cited resistance for the Dow at 8400 and the S&P 500 at just above 870. Finally, some suggested the advance, which began with strong pre-opening futures buying, merely got beyond what fundamentals, and optimistic buyers, could support.

Still, all but three of the Dow's 30 components finished higher with 3M ( MMM) and United Technologies ( UTX) exerting the greatest positive influence on the price-weighted index. Broader averages were buoyed by strength in a variety of sectors as reflected in market internals.

Advancing stocks bested declining issues by better than 2 to 1 in both Big Board and over-the-counter activity. Up volume totaled about 80% of the Big Board's 1.5 billion shares and nearly 88% of the 1.33 billion shares traded over the counter.

Downside Volume Just Half the Equation

There's been a lot of discussion lately about the absence of a 90% downside volume day, which historically occur at major market bottoms. Yesterday, downside action accounted for about 90% of the volume in Nasdaq trading and over 88% of Big Board activity, leading some to declare that the 90% down day had arrived and thus a bottom was (finally) in place.

Unfortunately for the bulls, that is not the analysis of Paul Desmond, president of Lowry's Reports in North Palm Beach, Fla., whose study on the subject earned him the 2002 Charles A. Dow Award from the Market Technician's Association.

"The historical record shows those kind of days should generally be regarded as not valid 90% downside days," Desmond said in an interview today, noting that 90% downside volume is "just half the equation" of a true bottom-demarcating session. Those are characterized by 90% downside volume in conjunction with 90% downside price action, meaning 90% (or more) of the price movement of all stocks on a given exchange is lower.

"Most people are saying volume is good enough but the result is they end up getting whipsawed," he said.

There have not been any 90% downside volume and price days since April 3, 2001, according to Lowry's. That none occurred during September 2001 was one reason Lowry's said at the time "we could get a rally but it's not going to be a major market bottom," Desmond recalled. Notably, he's been saying the same thing about the current environment: "We could get some kind of rally lasting several weeks but it's not going to be a major market bottom."

Desmond's call is based mainly on two factors:

One, 90% downside volume and price days are evidence of "panic selling" when investors "dump stocks with abandon," he said. Such action "exhausts the overhead supply of stock," meaning the amount of stock that was bought at levels above current prices. Essentially, the 90% down days reflect that "anyone who wanted to sell has sold," the technician explained. "At that point prices have been driven down to extreme, irrationally low levels and buyers come rushing back in and create 90% upside days."

To date, there has been "heavy selling but it has never reached the panic proportion at every other major market bottom back to 1933," Desmond reported. (There have been some 90% upside days recently, suggesting, again, that many investors are more afraid of missing out on the next rally then of additional future losses. Again, that's not something historically associated with capitulation, which is what Desmond is referring to.)

Two, there have been at least five 90% downside volume and price days before the final low at other major bottoms, he reported. In 1974, to which the current environment is often compared, there were 14 90% downside days before the market finally stopped falling. (See "capitulation" doesn't mean a one-day affair -- or breakup between investors and stocks, in this case.)

"If you see the first 90% downside day, that's not an indication we're near the bottom," Desmond said. "It's an indication investors are just beginning to panic. What concerns me is that the worst phase of a bear market is the final panic stage. If we haven't seen that yet, investors who are searching so desperately for a bottom may get caught in the final bottom."

I'm publishing Desmond's views because I share that concern and not (as some will contend) because I'm perennially bearish or want to rain on today's rally. Rather it's to point out that those anxious for a 90% downside day should be careful what they wish for or, at least, know what it is they're looking for and what it means.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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