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Notice the negative divergence. If the indices were going to blow decisively through channel resistance, we would expect to see positive divergences, indicative of underlying strength.
SUMMARY Last week we said, "We want to bring to your attention two important observations: A) All the major indices are back at the top of the trading range that has prevailed over the last 12 months. At the same time, oil is back down at the bottom of the rising channel which has provided price support over the last 12 months. Notice how lows/highs in oil prices have coincided with highs/lows in the Dow. The message from the picture is rather clear; in order for the equity markets to break above channel resistance, oil would need to break below channel support. If oil can stabilize above $60.00, the best the SP can do is 1315, and the best the Dow can do is 11350. Moreover, if the price of oil begins to rally again, then the equity markets can be expected to re-test channel support, which is 1220-1200 for the SP, and 10250-10100 for the Dow. On the other hand, if miraculously the price of oil breaks down, then the equity markets can easily rally 3.5% to 5% from current levels. B) Also notice how lows/highs in bond yields have coincided with highs/lows in equity prices over the same 12 month period. The 4.65-4.75 zone in yield for the 10 year has coincided with 3 bottoms in the equity markets which were followed by multi-week rallies. The message here is also clear; in order for the equity markets to break above channel resistance, the yield in the 10 year bond needs to remain below 4.60. The equity markets are betting that indeed this will turn out to be the case as evidenced by the last week's advance. However, the chart has a distinct "inverted head and shoulders" look to it, and although only 55%-60% of the time the pattern comes to full fruition, it ought to be taken into consideration. In conclusion, we have two possibilities ahead of us: oil prices and bond yields come down further, fueling a rally in the equity markets, or, oil prices and bond yields bottom out at current levels and reverse to the upside, causing the equity markets to retreat back down to the bottom of their range. So, over the next 5-10 trading days, pay attention to the $59-$58 support zone for oil, and to the 4.375-4.425 support zone for the yield of the 10 year bond. If support holds and oil/bond yields begin to rise, then we ought to look for a decline in the equity markets ranging between 4.5% and 7.5%. The opposite holds true if oil and bond yields break down; should that happen, we ought to look for a rally in equities between 4% and 5%." For the week of 2-27-06, the major indices experienced minor pullbacks after making contact with intermediate term channel resistance, which is rather normal. All in all, nothing changed since last week. Oil and bond yields are the areas where investors need to pay attention. The major indices may be able to hang around the top of their range for another 1-3 weeks, but make no mistake, without a retreat in oil prices/bond yields, the equity indices are going nowhere fast. For the near term, a close below 1280 by the SP500, and a close below 2250 by NASDAQ, would indicate that the bears have gained the upper hand and they can push the indices down to support (see table). Conversely, a close above 1300 by the SP500, and a close above 2300 by NASDAQ would indicate that the bulls are in control and they can drive the indices to the first upside targets.
Ike Iossif
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