Market Internals Suggest Nasdaq is Far from Healed

by Martin Goldberg CMT. June 17, 2004

The Nasdaq three-week rally from about 1,865 to over 2,023 may have been the mother of all sucker's rallies. While many in the media proclaimed the previous Nasdaq swoon to 1,880 as just an aberration in the new long-term Bull Market, the lack of any serious conviction during the subsequent rally from average or better-than-average trading volume, suggests that the rally is probably not sustainable. Tonight will look at some key market internals, along with technical analysis of three closely related speculative indices that support my conclusion that this is a Sucker's Rally.

Lower Highs, Lower Lows

The chart below presents a 6-month daily chart of the Nasdaq.

Note that although the last rally was quite impressive in terms of price action, it was not as impressive as the previous rally. The Nasdaq failed (so far) to take out the 2,079 and 2,059 highs of April 2004, and has not broken the downward trendline shown in the chart. The trading volume, shown in the histogram below the chart, indicates even less conviction than the rather lackluster volume during April rally. Since the Nasdaq topped in January at 2,154, most of the "conviction" shown by trading volume was downside. Note that since topping in January, there were 22 trading days where the Nasdaq was down and traded more volume than the 60-day exponential moving average volume, and only 5 such days where the Nasdaq was up. The lower-highs and lower-lows, coupled with higher downside volume suggest that the Nasdaq is under distribution and the rally is not sustainable.

Several Other Tulips Fail to Confirm Nasdaq Rally

In the recent past, Nasdaq rallies were accompanied by rallies in other liquid speculative issues, such as biotechnology, semiconductors, and Internet stocks. Two of these indices are showing technical weakness, while one is at a critical juncture that may have implications for the broader Nasdaq index.

Biotechnology

The 2-year daily chart clearly indicates that the Amex biotechnology index has made a double top, and is now in a downtrend, having broken its 200-day moving average to the downside (although not decisively). It appears that if the downtrend in biotechnology stocks is not reversed soon, the Nasdaq will have to rally without the help of the biotechnology stocks. This would be something new.

Semiconductors

The semiconductor sector is in a similar predicament as biotechnology as indicated in the one-year weekly chart below.

As you can see, there are lower highs and lower lows, and the volume seems to favor the downside. The accumulation/distribution chart below the volume also confirms this.

If we take a look at the daily chart we can see a massive head-and-shoulders (HAS) pattern in the semiconductors index. It may be a bit too early to get excited about yet, but if the neckline (NL) is broken at about 35, the target price from the HAS measurement principle (near the bottom of the blue vertical line) would have severe implications for the stock market in general, and especially the Nasdaq.

Internet Stocks – Critical Juncture

Unlike the biotechnology and semiconductor indices, the Philadelphia Internet index has yet to break down and appears to be quite strong technically. However, the Internet stock index is at a critical juncture:

The Internet index sits at about 168.5 as I write this. It appeared to have broken out of its trading range (indicated on the chart) last week. However, unless a foothold above 170 is established soon, this may turn into a bearish failed upthrust. According to Nison, in Japanese Candle Charting Techniques, 2^nd edition page 200, (emphasis by Martin is bolded) "This is when there is penetration of a horizontal resistance area and then the bulls fail to sustain these new highs. This is another way of saying a false breakout. To use an upthrust for trading, when the market gets back under its former resistance area, one can consider selling. If the market is indeed weak, it should not return to the most recent highs. A downside target is its most recent low or the bottom of a recent trading range."

Note that if the trading range is broken upside, then the near term target would be about 190. If it is broken decisively downside the near term support would bring the index to just below 160, and probably to the longer term support at 150. So clearly, the Internet index is at a critical juncture which will determine whether the next 12 percent move will be up or down.

Is there a clue as to which way the index will break based on Yahoo, the Internet stock leader? The weekly chart below seems to suggest that Yahoo has made a parabolic upward move on decreasing weekly volume. While it is difficult to establish a top for such parabolic moves, they generally are not sustainable in duration. If Yahoo breaks back into its former trendline that would show technical weakness and suggest that the index may resolve to the downside.

Technical Indicators – Bullish Percent Index - Bearish

Murphy defines the bullish percent (BPI) index. "The Bullish Percent Index (BPI) is a popular market breadth indicator that is calculated by dividing the number of stocks in a given group (an exchange, an industry, etc.) that is currently trading with Point and Figure buy signals, by the total number of stocks in that group. Bullish Percent levels that are above 70% are considered overbought, whereas levels below 30% are considered oversold. Strong buy signals occur when the Bullish Percent Index falls below 30% and then reverses up by at least 6%. Conversely, promising sell signals occur when it goes above 70%, and then reverses down by at least 6%."

The chart below includes the bullish percent index for the Nasdaq.

Clearly, the bullish percent was above 70%, and reversed down by more than 6% in March of 2004. Murphy calls this a "promising sell signal". Note also that the 50-day moving average crossed below the 200-day moving average in March and is currently in free-fall, another bearish technical sign. As presented in the chart above, the recent low volume rally has done little repair to the Nasdaq BPI.

Below is a similar bullish percent chart of the Finance index. This chart shows similar bearish implications for the Finance index, and no healing in the last stock market rally.

New High to New Low Ratio - Bearish

The amount of Nasdaq stocks making 52-week highs divided by 52-week lows has shown strength through the rally. However, it is was showing weakness in April as indicated by the moving average convergence divergence (MACD), which produced a series of lower highs. Although the values in the chart are volatile, support was been broken in March. In addition note the cross of the 50-day moving average below the 200-day moving average, also a bearish sign. Very little improvement was observed in the overall trend was made during the last rally as shown in the chart below.

Here is a similar chart for the NYSE Index. The trend break was very clear. Although the new high/new low produced a sharp recovery in the last rally, it appears to have broken down again in the last few days, as it has failed to break its 50-day moving average decisively to the upside. A comparison of the Nasdaq chart above to the NYSE chart below suggests that the NYSE is the presently stronger.

Suzie Orman (Of All People!) Promotes Market Crash

Caption: Suzie Orman

Get on your crash helmets! Best-selling author, Suzie Orman, perhaps one of the few CNBC financial personalities that provide any good information to their audience, is promoting crash behavior. Her generally good message is geared to the "average" investor who may be socking money away in a 401K or IRA, and may have an Ameritrade account on the side. Her message includes getting out of household debt, saving, and investing as well as responsible financial planning. Her saving and financial planning advice is obviously good, but her recent article, "Exchange Traded Funds, Mutual Funds of the 21^st Century", advocates the use of exchange traded funds for plunge protection. She touts the liquidity of the ETFs as a major advantage: (Note: emphasis added in bold, and parenthesis inserts for clarity)

"Imagine this scenario: It's 10 a.m. and you hear that the market is tanking. You have been on the fence for a few weeks, wondering if it's time to get more defensive, but this latest market slide pushes you into action. You quickly call your fund company or discount brokerage and sell your aggressive funds. Then you sit back and watch the market fall another 200 points, with the calm satisfaction that you got out before the damage was done. That would be premature gloating, my friends. Despite the fact that you called your fund company or emailed your 401(k) plan administrator to make the change at 10 a.m., your 'trade' isn't put through until the close of the trading day, which is 4 p.m. Eastern. In technical terms (unlike exchange-traded funds), mutual funds don't trade 'intraday.'"

While it is true that ETF's offer excellent liquidity and advantages over under performing mutual funds, is use of ETF's by amateur investors for plunge protection good for the stock market? In addition to a host of professional fund managers hitting the panic button when the stock market begins to crash, we may now have the rank amateurs such as readers of Suzie Orman trying to do the same darn thing with ETFs. With everyone, professionals and amateurs alike, considering their escape route, a true crash is a realistic and perhaps likely possibility. If individuals and institutions are all bailing out at once, I wonder just how successful Orman's ETF strategy will be versus relying on the professional fund manager to "get them on a life boat". You may be wondering, if the potential for a stock market crash is so great, what has kept it from crashing for all this time in spite of your thus far, incorrect views? My personal opinion is that the Nasdaq is one high-volume 80-point "down" day, from the crash scenario which is described by Orman. A consistent reader asked me a similar question and also questioned me as to when I think such a crash would occur. I replied that it would probably happen on the day when it is least expected (that would be tomorrow).

There is one additional notable comment from the Orman article, which I'll quote:

"The same problem exists when the market is on an upward tear. Let's imagine you again are watching the market and see that a major policy change by Fed Chairman Alan Greenspan has sent the S&P 500 on a huge run (UP). You place a buy order with your fund right when the market opens. But once again, your purchase price isn't going to be set until the close of that trading day. (Unlike ETFs) If the market jumps a few hundred points that day, you're not going to make a penny from it."

It's difficult for me to imagine what "major policy change" by Fed Chairman Alan Greenspan, could occur at this point that would send the S&P 500 on a "huge run up." I think the day of surprise rate cuts to goose the stock market to a huge run up is over for good. To elevate the stock market, all the Fed has left is talk and carefully crafted statistics. In any case, it’s disturbing to see Suzie Orman suggesting mid-day moves into and out of the stock market by her largely inexperienced readers.

Market Leadership / Lagardship Update (Source Barron's 14 November 2004)

Most Performance Improvement YTD, Last Year Versus This Year

Oil Field Drilling and Services
Retailers Broadline
Cosmetics
Soft Drinks
Distillers and Brewers
Food

Most Drop Off in Performance YTD, Last Year Versus This Year

Other Nonferrous Metals
Mining, Diversified
Automobile Manufacturers
Electrical Components
Home Construction
Transportation Equipment

Best Performers YTD

Internet Services
Wireless Communications
Cosmetics
Casinos
Consumer Services
Oil Cos. Secondary

Worst Performers YTD

Precious Metals
Aluminum
Other Non-Ferrous
Technology Services Ex. Internet
Semiconductors
Airlines

Today's Market

With a backdrop of positive economic data, the Nasdaq posted an insignificant 14-point loss, while the S&P, Dow and Russell 2000 were near the flat line. Here are the charts of the three major indices that are the most followed:

Clearly the downtrend lines, which are all intact, are those that should be respected for many reasons. For those who subscribe to a conspiracy theory, you can bet that, as with the 1,900 level on the Nasdaq that was so important to protect, the trendlines shown above are equally as important. Manipulated markets or not, it doesn't take a genius to see the technical importance of the downward trendlines. If the trendlines are decisively broken to the upside, it will carry the market positively for some very critical time.

The 10-year note closed up 0.30 (108.48). Short-term trendlines as shown on the weekly chart below are very much intact.

The dollar is still following its very orderly decline, up slightly today.

Good day for gold ($388.60/ounce), great day for silver ($5.91), as shown on the short-term daily's below. The HUI was up 1.45% and the XAU up 1%.

Have a great evening!

Martin Goldberg

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Martin F. Goldberg CMT | Market Commentator
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