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TO MEASURE THE QUALITY of any stock-market rally, we look at such factors as market breadth and volume.
Technical analysis textbooks tell us that truly healthy and therefore sustainable gains in the stock market are built on substantial participation by a clear majority of stocks. In other words, we need the public and institutions involved in a big way buying almost anything that looks decent.
By these criteria, the February rebound is neither flimsy nor robust. Breadth, in terms of the numbers of stocks making gains, is decent. But the volume has been as weak as it has been over the past year.
It is the absence of the bears, rather than the aggressiveness of the bulls, that has let the market move up from its February 5 intraday low. But the question now is whether there is enough power to take it through the resistance level it is now challenging.
(Resistance indicates the price at which sellers of stocks take control and prevent them from rising higher. The opposite of that is a stock's support level, which is the price at which buyers take control and prevent shares from falling lower.)
To be sure, the entire rally from the March 2009 lows was marked with weak volume. So clearly volume alone does not dictate market direction. I won't get into the argument about how zero percent interest rates have goosed the market in spite of the technicals. The point is that weak technicals leave the market fully vulnerable to shocks from the outside.
Earlier this month, the market completed a bearish chart pattern that suggested a continuation of the 2010 slide (see Getting Technical, "The Bears Are Putting On Weight," Feb. 8, 2010). This week, the market opened up with a jump to the upside to take that pattern off the table, at least on the Nasdaq.
The Standard & Poor's 500 is now trading near key resistance at 1100 in round numbers (see Chart 1). This level stopped the early February rebound and is also where the key 50-day moving average is trading today.
Chart 1
Had the past two weeks of gains come with volume support we might think of this level as just a speed bump on the road to recovery. But without volume, we have to be skeptical.
It is no secret that I have been a doubter on this market. As the market peaked in January, the evidence that the bull run was over mounted to the point where the bearish argument was compelling enough to take action.
But in order to maintain a clear head, I am going to change gears and focus on the bullish argument as presented in the charts. There are several technical events that can turn me around should they all occur.
Chart watchers look at the previous correction from June to July of last year as being very similar to the 2010 pullback. Indeed, they are similar in size both in terms of time and points traveled. If the comparison is valid, then chart 2 shows where the market of today might be in last year's model (see Chart 2).
Chart 2
Following a rather sharp tumble in early July, the S&P 500 stabilized and then began a low volume move higher. About one week into the recovery, the index jumped 3% to break the trendline guiding the correction lower. A similar breakout move happened Tuesday of this week although the net gain was less than 2%.
In both cases, volume was below average. This sets a precedent for the market and is likely based on the idea that the market's train likes to pull out of the station with as few passengers as possible.
Therefore, should the index significantly breach 1100, perhaps by 2%, I will have to pull in my bear claws.
On the Nasdaq, the PowerShares QQQ Trust Series 1 (ticker: QQQQ) exchange-traded fund (ETF) moved above short-term resistance, but it is now at a rather significant level dating back to November (see Chart 3). Here, too, volume has not confirmed the February rally, but a move above 45, again in round numbers, would also command my attention.
Chart 3
While the similarities between the two corrections are clear, so are the differences, many of which I have outlined in this column over the past few weeks.
This market is indeed showing evidence in support of both the bull and bear camps. But until it proves the bull case, I will remain skeptical.
Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
Comments? E-mail us at online.editors@barrons.com
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