Stocks in U.S. May Have Further to Fall, Chart Watchers Say
By Nick Baker
Oct. 30 (Bloomberg) -- The rally that sent the Dow Jones Industrial Average to a record and the Standard & Poor's 500 Index to the highest since 2000 may end, according to some analysts who use price charts to make investment decisions.
Stocks rose too far and too fast, based on so-called relative strength indexes, before slumping at the end of last week. The indicators peaked at their highest readings for the Dow industrials and S&P 500 in almost a decade.
Another gauge, based on comparing an index with its average close for the previous 200 trading days, showed the S&P 500 rose above a level that preceded a slump at the start of 2005.
Surveys of investors suggest they are increasingly likely to be disappointed and sell shares when companies fail to meet their expectations. Optimism about stocks is the highest since the first quarter, according to a poll by UBS AG and the Gallup Organization released last week.
``You're near the end of the move higher,'' said Philip Roth, chief technical market analyst at Miller Tabak & Co. in New York. A market decline of as much as 20 percent is imminent, he said. ``It could start any time.''
Financial companies such as Citigroup Inc. and Bank of America Corp., which account for the biggest percentage of the stock market's value, dropped after both said higher interest rates reduced the profitability of loans.
Last week ended with the biggest decline in almost two months, triggered by a government report that showed the U.S. economy expanded at the slowest pace since 2003. The growth in gross domestic product suggested earnings estimates may be too high, and halted a weeklong advance.
The Dow industrials dropped 0.6 percent to 12,090.26, cutting their gain for the week to 0.7 percent. The 30-stock average reached all-time highs in 13 of the last 19 sessions, including the first four days of last week.
The S&P 500 ended last week at 1377.34 after a 0.9 percent drop from the highest level since November 2000. Its 0.6 percent gain for the week was the fifth consecutive weekly advance, the longest streak since November. Should the index rise this week, the rally would become the longest since September 2004.
Stocks rose last week as the Federal Reserve kept its target interest rate unchanged at 5.25 percent for the third straight meeting. The Nasdaq Composite Index added 0.4 percent to 2350.62.
Economic reports this week may show manufacturing increased in October and the unemployment rate held steady at 4.6 percent, the lowest since 2001.
Procter & Gamble Co., the biggest U.S. consumer-goods maker, and Verizon Communications Inc., the second-largest U.S. telephone company, are among companies releasing profit reports. About 73 percent of S&P 500 companies reporting third-quarter earnings have beaten analysts' forecasts, according to data compiled by Bloomberg.
Corporate profits are used in so-called fundamental analysis, a method of determining whether stocks are cheap, expensive or fairly valued. Technical analysis, an alternative, holds that prices of securities move in patterns that show when investor demand is too high or too low.
The relative strength index, or RSI, identifies possible turning points for a stock or market by calculating the degree by which gains outpace losses in a given time period. The most commonly used interval is 14 trading days.
The 14-day reading for the Dow industrials rose to more than 80 last week for the first time since November 1996. The RSI for the S&P 500 climbed to 79.9, the highest since December 1996. Readings more than 70 suggest to chart watchers that a stock or index is poised to fall.
Relative strength for the S&P 500 is higher than it was before the index's 7.7 percent retreat between May 5 and June 13. Its RSI peaked at 64.3 before the drop.
The S&P 500's position versus its 200-day moving average also signals the benchmark may decline. The index was 7 percent higher on Oct. 26, matching its peak at the end of 2004. In the first three weeks of 2005, it dropped 4.1 percent.
``The indexes are overextended,'' said Michael Sheldon, chief market strategist at Spencer Clarke LLC in New York. ``A better buying opportunity may lie ahead.''
The UBS/Gallup Index of Investor Optimism increased in October to 79, the highest level since March. Many technical analysts see excessive optimism as a sign that the market has peaked, assuming bulls have invested about as much money in stocks as they plan to spend.
Global fund managers have 3.8 percent of their assets in cash on average, down from 4.4 percent in August, according to Merrill Lynch & Co.'s October survey. That's the lowest reading since the first quarter.
When investors are ``already bullish, they're fully invested and they're more likely to be sellers,'' Roth said.
Citigroup, the largest U.S. bank by assets, dropped 0.6 percent on Oct. 19 after third-quarter earnings showed rising interest rates made loans less profitable. Bank of America, the second-largest, fell 1 percent. Financial companies account for 22 percent of the S&P 500's value.
``Financials are giving an early sign that the equity markets may be nearing a peak,'' Mary Ann Bartels, a technical analyst at Merrill Lynch in New York, wrote in a report last week. Declines in shares of banks, brokerages and money managers are worrisome because their industry is the only one that has avoided a ``serious'' loss this year, she wrote.
Stocks have defied technical indicators in their rally. The Dow and S&P 500 have both gained 2 percent since their relative strength indexes first crossed 70 on Oct. 4. Since that date, the Dow's RSI has stayed above 70.
Some investors, including Benjamin Pace and Keith Wirtz, said growth in profits and the economy will slow but not cease, supporting the market.
``Stocks are reasonably, if not under-, valued,'' said Pace, who oversees $17 billion as chief investment officer at Deutsche Bank Private Wealth Management in New York. The S&P 500 is priced at 17.6 times earnings in the last year, about half the highest level reached during the bull market begun in October 2002.
Still, the jump in stock prices that produced the technical readings has given pause even to optimists. Wirtz, who manages $21 billion as chief investment officer at Fifth Third Asset Management in Cincinnati, is one of them.
``It feels like we may be ripe for a selloff,'' he said.