STOCK AVERAGES REACH RETRACEMENT LEVELS -- NASDAQ LEADERSHIP IN QUESTION -- NASDAQ 100 UPTREND MAY NEED A REST

S&P 500 RETRACES 38% OF BEAR TREND... One of the ways we arrive at upside targets is to identify percentage retracement levels. The most popular percentage retracement of a previous trend is 50%. Professional technicians also place importance on Fibonacci retracements of 38% and 62%. It's always a good idea to know when a market reaches one of those levels, because they often function as resistance barriers. At the moment, a number of stock market averages are at or near significant retracement levels. Chart 1 shows that the S&P 500 has retraced 38% of the bear market that lasted from its 2000 high to its 2002 low. The 50% level sits near 1160 which coincides with the peaks formed from late 2001 to early 2002. That may be where the S&P is headed eventually. But it has to get through the 38% level first. Chart 2 shows that the Dow is very close to a 62% retracement level, which is even more significant. The Nasdaq is also close to a percentage retracement level.

Chart 1

Chart 2

NASDAQ NEARS 23.6% RETRACEMENT LEVEL... In the past, I've talked about the fact that the Nasdaq Composite Index was nearing major resistance just above the 2000 level. That matches the price peak formed near the start of 2002. Anytime a market is in a new uptrend, a prominent price peak becomes a logical upside target and a potential resistance barrier. Chart 3 also shows, however, that the early 2002 price peak is a 23.6% retracement of the Nasdaq bear market that bottomed last October. Although it's a lesser known number, 23.6% is part of the Fibonacci retracement series. [23.6% is 62% of 38%]. Since the Nasdaq has been leading the market advance for the past year, the area around 2000 carries significance for the market as a whole. If the leading Nasdaq market stalls there, the rest of the market could stall as well.

Chart 3

NASDAQ LEADERSHIP BEING TESTED... Some of my recent market messages have talked about the importance of Nasdaq leadership. Our research tells us that the market does much better when the Nasdaq is outperforming the NYSE market. Chart 4 shows that the sharp upturn in the Nasdaq/NYSE ratio that started last October was a strong signal of a market bottom. Since then, the ratio has continued to rise which has been a positive market sign. Which brings us to Chart 5, which we showed last Monday. That longer range view shows that the Nasdaq/NYSE ratio has reached a formidable resistance barrier marked by two arrows to the left. If that level is exceeded, that would of course be a sign of strength. So far, it hasn't done that. In my view, that raises a caution level -- at least until it is exceeded.

Chart 4

Chart 5

NASDAQ 100 RALLY LOOKS OVEREXTENDED... The weekly Nasdaq 100 chart also raises some concerns. The weekly RSI, which bottomed last year under 30, recently got back above 70 for the first time in three years. The weekly RSI line also shows a potential negative divergence. Oscillators, however, can be deceiving. A market can get overbought and stay there for long periods of time. That's why it's a good idea to also track the Average Directional Index (ADX) line. When the ADX line is rising, it's better to pay less attention to oscillator overbought readings and negative divergences. When the ADX line starts to drop, however, oscillator divergences take on more importance. The black ADX line has turned down for the first time in six months. That isn't necessarily bearish. But it does suggest that the current market advance may be in need of a period of consolidation or correction. The fact that the green (+DI) line is still above the red (-DI) line means that the major trend is still up. That's also seen by the ability of the NDX to stay above its (dashed) 20-week moving average. Even uptrends, however, need a rest once in a while. Our weekly indicators are suggesting that the Nasdaq may have reached that point.

Chart 6

DAILY MACD SHOWS WEAKNESS... The daily chart of the Nasdaq 100 Shares (QQQ) shows a pattern of higher highs and higher lows over the past three months. That's the standard definition of an uptrend. Unfortunately, our daily momentum indicators aren't following the price action to new highs. The daily MACD lines peaked in early September as the QQQ corrected. Since then, prices have hit new highs during October and November. Unfortunately, the MACD lines are forming a pattern of lower highs. In my view, that's reason to be suspicous of the staying power of the current advance. By itself, that wouldn't be of too much concern. However, the fact that the Nasdaq market is nearing a major resistance barrier -- together with overbought weekly readings -- makes the short-term picture more relevant. At the very least, it's a good reason to be more vigilant to protect existing profits. As I suggested last week, the two key levels to watch are the (blue) 50-day average and/or the mid-October low. That's pretty much true of all the major market averages. Chart 8 shows a similar picture for the S&P 500 SPDRs

Chart 7

Chart 8