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Ongoing uptrends in the Dow
Jones Industrials Average and the Standard and Poor's 500 Index are nearing
their 12 month anniversary. Both indexes reflect robust uptrend development
after wide swinging base building that occurred between July 2002 and March
2003 (actual base completion occurred during May-June 2003). Other than
short, sharp corrections of 2 to 3 weeks, or slightly longer sideways
consolidation, trend development has been notably strong. That is not too
surprising when we consider the length and extent of the preceding 2000-2002
downtrend. Historically speaking, the U.S. stock market has suffered few
declines that are similar. From an all-time high in
January 2000 to the October 2002 low, the Dow Jones Industrials Average
(DJIA) dropped about 39% and the Standard and Poor's 500 Index (S&P)
dropped about 51%. Those losses occurred in a 34-month period. Using
the DJIA as a yardstick, larger percentage declines from an all-time high
occurred in 1929 - 1932 (89%) and in 1973 - 1974 (47%). Longer duration
(secular) bear markets occurred in 1946-1949 (37 months) and 1966-1970 (52
months). In terms of percentage lost and duration combined, none of those
instances measure up to 2000-2002. Therefore, we
should not be surprised at the show of strength that is ongoing in the broad
stock market.
While we are not
about to bet against the prevailing trend environment, we see approaching
overhead price zones as being important with regard to further trend
development. The above monthly charts of the DJIA and S&P show prices
relative to their 2000-2002 downtrends (points 0 to 0'). DJIA values,
currently at about 10600, have surpassed most of the common retracement
levels that analysts focus on when attempting to qualify trend potential. The
only notable level left on this chart is the Fibonacci-related 78.6%
retracement at 10839. The current uptrend high to date at 10795 was made in
the past week. Although nowhere near an ironclad rule, when markets are in
broad trend topping phases the 78.6% area will usually be about the maximum
recovery level that is reached on a test of the high. The 14-period
stochastic indicator is at its upper extreme area (%D value = 89) but it does
not yet show the flattening or sharp reversal that would indicate that
uptrend momentum is being compromised. The S&P chart on the right
illustrates the weaker relative performance that this index has turned in
since 2000. Not only was its percentage loss greater than that of the DJIA on
the way down but also its recovery is lagging considerably. The current
uptrend high to date at 1158.70, basis spot month futures, in the week just
past is still shy of the 50% retracement at 1170.75. Incidentally, that area
has additional importance since the rally high in January 2002 at 1178.50 was
followed by a failed test in March 2002 at 1177.00 (see box on chart). Not
only is the area around 1170 of retracement significance but it is also an
area of demonstrated resistance. As with the DJIA chart, the monthly
stochastic indicator is at elevated levels (%D value = 91) but that does not
suggest an imminent compromise of trend momentum.
Our next two sets of
weekly charts also show overhead price levels that may be significant. The
first weekly charts above illustrate a classic analysis of market action
around the 2002 low. Pattern development in both the DJIA and S&P is
similar. Our interpretation is that price swings from July 2002 to March 2003
represent an asymmetric inverted head and shoulders (annotated S-H-S with the
delineating pattern boundary at neckline NL). Point B marks the pattern's
completion level. In classic technique, we measure vertically from the head
at point H to the neckline, then add that distance to point B. This approach
yields targets at 10907, basis the DJIA, and at 1131.5, basis spot month
S&P. The latter has been exceeded. Oddly, neither index developed
increased volume (not shown) at its neckline violation which is a requisite
in classic head and shoulders development. Yet subsequent trend development
filled or is nearing the fulfillment of the derived target levels. Weekly
stochastic indicator readings in both indexes have flattened at high levels,
are oscillating and are currently in gradual decline despite new highs in the
indexes. This action may be an early warning of both intermediate- and
long-term momentum deterioration but market action does not justify that
viewpoint at this time.
The next weekly
charts above treat all price action since the October 2002 low as being a
potential A-B-C rally that could prove to be a non-trending test of the 2000
high. In this context, to get an idea of the probable length of wave C we are
relating it to the size of wave A. The DJIA wave A was about 1895 points and
the S&P wave A was about 187 points. If we assume that the C-waves will
be twice as long as the A-waves, then doubling those values and adding them
to the respective wave B lows at 7397 and 788 yields targets at 11187 DJIA
and 1163 S&P. Of course, rather than being 2 times the size of wave A,
the respective C-waves could be a Fibonacci-related 2.618 times the size of
wave A. In that case, the upward target levels would be at 12358 DJIA, a new
all-time high, and 1278.8 S&P which is only slightly beyond its 61.8%
retracement level (1265.9). While we acknowledge the potential for that
scenario, our preferred alternative is as stated above because of the
clustering of other nearby levels. Therefore, combining retracement levels,
classic pattern analysis and price swing relationships, we now have potential
overhead target zones for the DJIA at 10,839 - 11,187 and for the S&P at
1163 - 1171 plus its proven resistance a little higher around 1178. Long-term
monthly momentum is constructive while intermediate-term weekly momentum is
questionable.
The S&P daily
continuation chart below provides some near-term perspective. The daily
stochastic indicator turned abruptly down on Thursday February 19, 2004. That
confirmed a pronounced negative divergence. Compare the indicator peaks
(declining red line) versus rising price levels. That divergence is so
exaggerated that we would have expected the market to show downside price
dynamics. On February 23, 2004 prices did violate the illustrated 3-point
uptrend line that is drawn from late November but without consequence. Therefore,
at this time the minor bounce back to the trend line may be an indication of
uptrend resumption or it may be a classic throwback that occurs at a change
in trend. Trading in the very near-term should clarify which of those
scenarios is playing out. However, even minor chart damage would require a
break below the point 3 low area that is at 1123-1121, basis spot month
futures.
In summary, stock
market behavior, as seen in the Dow Jones Industrials Average and the
Standard and Poor's 500 Index, has been a low-key but powerful tour de force
in the past 11 months. This comes as no surprise when we consider the length
and depth of the price decline that occurred during 2000-2002. Long-term
momentum remains positive and market action has not shown the increased price
volatility that we might associate with a change in ownership prior to a
change in trend. Nonetheless, both senior stock indexes are hovering below
areas that should demand a show of commitment by the bullish contingent if
the ongoing uptrend is to retain its integrity.
Eidetic Research
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