Audrey Deschenes
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Despite the Stock Rally, Charts Favor the Bears

Don’t get comfortable: The rip-roaring recovery following the weak jobs report just hit a strong ceiling.

Technically, Friday’s drop and recovery following the weak September jobs report was quite bullish. Unfortunately, there are still too many negatives out there to rely on this one indication, and that means it is far too early to change teams from bear to bull.

To be sure, the big bearish signal of a drop below the August low has still not happened. That leaves the market in somewhat of a funk but with a downside bias.

In previous columns I suggested that the Standard & Poor’s 500 was in a giant head-and-shoulders topping pattern spanning back nearly two years. The neckline, or support line, slopes gently higher but for simplicity let’s just say that it comes in now at 1870 – roughly the same level as the August low (see Chart 1).

Chart 1

Standard & Poor’s 500

With the index trading near 1987 Wednesday afternoon, clearly a major breakdown is not imminent. But it is still within striking distance given the volatility in the market.

The sharp rally from last week ran into serious resistance Wednesday morning. And even as prices rose over the past few days, volume declined. Intraday momentum peaked a few days ago, leaving a condition chart watchers call a “bearish divergence” between price and indicators. As the name implies, it is probably not a good thing.

Leadership was questionable, too. Small company stocks lagged. So did financials, retail, home builders and technology. These four groups are my key indicators for a healthy market, and all of them offered weak bounces. The actual leaders were the most beaten-down sectors this year – energy, industrials and basic materials.

For those keeping score at home, I am using the NYSE Arca Technology 100 index instead of the popular exchange-traded funds tracking the technology sector. The latter are skewed by a few large stocks and hide the fact that many tech stocks are lagging the broad market.

The Nasdaq Composite index itself shows an even more formidable resistance zone just above current trading (see Chart 2).

Chart 2

Nasdaq

In the chart, we can see a nicely formed declining trendline from the July peak and a strong horizontal resistance level meeting in the 4810-4850 zone (the Nasdaq traded at 4780 Wednesday afternoon). The falling 50-day average is also in the area, but even more importantly the 200-day average is still above that.

More from Michael Kahn

The 200-day average represents the long-term trend, and the Nasdaq and all other major market indexes are trading below it. We have to give the benefit of the doubt to the bears under this average, and demand solid breakout signals before we can lean bullish. So far, they have not happened.

The next question: What happens if the S&P 500 and Nasdaq can breach their resistance levels? The answer is that they will run into massive zones of overhead supply that comprised the previous 2015 trading ranges. It is very hard to think that these indexes can get through their zones without quite a battle. And that does not even take into consideration the specter of the Federal Reserve finally raising short-term interest rates either later this year or early next year.

Even though the bulls won big over the past week, I see no reason to change my view that the market is weak. A short-term bounce off a long-term support does not provide enough evidence. The caveat, however, is that all is not yet lost for the bulls because the bearish argument will remain on hold as long as the August lows remain unbroken.

Perhaps the fact that the small-capitalization Russell 2000 did take out its August low before bouncing is foreshadowing the eventual breakdown. But in technical analysis we have to wait for these signals to clearly happen before taking action.

Getting Technical Mailbag: Send your questions on technical analysis to us atonline.editors@barrons.com. We’ll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis atwww.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.