When the Federal Reserve cut interest rates by another 50 basis points on May 15, the stock market yawned. But the next day, after probing a bit lower, the Dow Jones Industrial Average rocketed up 343 points (see chart 1).
Resistance at the widely followed 11,000 level (specifically, 11,037) was soundly broken, and the market was supposedly in a major long-term breakout. Technology stocks were back in rally mode as the Nasdaq Composite index had broken out from its four-week consolidation (see chart 2). All seemed well in the markets.
Within days, the Nasdaq completed a reversal pattern and the Dow had run out of gas. All major indices saw their gains steadily eroded. Once again, the market had a blunt message about lower interest rates: no big deal. It needed another ingredient to fuel further gains.
Was the economy still in worse shape than everyone believed? Perhaps the recovery would take longer than expected.
But the charts were saying something else.
Pundits might point out that a 10% drop in the Nasdaq in five days left it oversold but more importantly, chart support across the board held firm. All the bad economic news was met with rallies. When good news is perceived as good news and bad news is perceived as at least not so bad, it means that the market has discounted a good deal of the problems now in the headlines.
Not so fast. Just as the charts show technical health, they also point to technical roadblocks. The first is the major declining trend that began September 1 of last year (see chart 3). A weekly chart using logarithmic scaling shows that the Standard & Poor's 500 balked when it made its first attempt at crossing this resistance. A big reversal bar was formed, suggesting that it was not yet time to turn bullish for the long term.
Why not? According to the chart, the declining trend from the September top was not yet broken: From a long-term perspective, it could reassert itself and send prices the equivalent of hundreds of Dow points lower, and there was nothing in the S&P's reversal bar at this resistance to say otherwise. The resilience of the market after this reversal is very encouraging. But until it can move above this trendline (as it did Tuesday) -- and stay there -- the long-term condition of the market remains questionable.
Still, we may be approaching an inflection point where the so-called bear market bounce turns into a bull market. If the market can hold its ground over the next two or three weeks, then we can start to fill out our portfolios.
But just to keep us honest, there is still resistance overhead. The 200-day moving average coincides with last month's peak, providing a dose of double trouble. Beyond that, both the S&P and the Nasdaq have formidable ceilings at their January 31 highs of 1383 and 2872.
Consider some of the potential bombs ahead.
First, the bears have retreated back into their caves. It seems that almost every analyst in the media is once again touting stocks, apparently convinced the market will not go lower. The Fed is on our side, bad news is being discounted, inflation is under control, etc. The charts bear this out as the CBOE Volatility Index, the VIX, touched a 37-week low.
The VIX is also known as the "fear index," because it reaches high levels when put options are expensive. Expensive put options means that the public is demanding protection against a stock market decline, amid mounting fear of losses. When this fear reaches an extreme, the market is usually washed out and begins to rise. Conversely, when the VIX is at an extreme low, bullishness is rampant, suggesting that all who were going to buy stocks have already done so.
The VIX last bottomed at extreme low levels 40 weeks ago at the major September 2000 top in the market.
What's more, some concerns are starting to appear in key sectors. While natural gas and unleaded gasoline prices have fallen back to earth and crude oil itself has remained fairly stable, oil stocks have broken out. From big international companies such as ExxonMobil (see chart 4) to smaller drillers such as Triton Energy (see chart 5), these stocks are on the move.
Stocks often lead their commodities and when natural resource stocks begin to lead the market, inflation suddenly creeps into analyst thoughts. That does not mean that inflation is here, but why are alternative energy stocks, such as FuelCell Energy rising, too (see chart 6)? Are they telling us something about an energy crunch on the horizon?
The bottom line, as always, is that stocks are risky and that means that you can't just buy whatever is in the news. The major indices are not yet in clear bull markets. Beneath the surface, though, some sectors never ended their individual bull runs. These are the place to nibble until the major indices declare that the market as a whole is back for the long haul.
When the Federal Reserve cut interest rates by another 50 basis points on May 15, the stock market yawned.