The resistance line connecting the December and February tops has literally become a magnet for the market this week. It has toyed with the line each and every day, but so far there has been no upside breakout. There is a second important line on the chart, of course, and that's the rising trend line from the October bottom (see Figure 1). This is really the more important line, and it is the one that controls the fate of this market, in our opinion. If the trend remains intact, there will eventually have to be new highs, for the rising trend will force the market through the current resistance line. In fact, that is what we expect to happen. On the other hand, if the market falls and breaks below that uptrend line, then all bets are off and a more bearish stance would be warranted.
In classic technical theory, the pattern that has been churned out by the major indices is called an ascending triangle. Also, in theory, that pattern is supposed to resolve itself with an upside breakout. Stated in non-technical terms, all that's saying is that the uptrend dominates the resistance (eventually) and the market continues on its way it the direction of the trend that was already in place. That makes sense, of course. However, there is a corollary: if it takes too long for the upside breakout to occur, then the pattern might not fulfill itself. In other words, if the market trades into the tip of the triangle and the uptrend can't assert itself in the form of an upside breakout, then perhaps no breakout will be forthcoming (and a bearish outcome is the possible). This market has not reached that stage yet, but it probably will in another week or so. Hence it is imperative that the bulls get their act together if they plan to fulfill the bullish implications of this formation.
As for the other technical indicators, they are mixed. The equity- only put-call ratios remain our most bullish indicator. The buy signals have persisted since late January and show no signs of abating.
Breadth has been more of a problem. It has swung back and forth
with the market, and sell signals have been registered recently. By itself, a sell signal in breadth has not been that effective recently, but it is certainly worth noting.
Finally, there is volatility ($VIX). $VIX nearly touched another 9-year low last Friday. Since then, however, it has moved steadily higher all week -- even as the market had a generally bullish tone. This is atypical action, for $VIX usually falls during a rising market. There are two ways to look at this: 1) it is a warning sign of an impending
decline (that's what happened right at the very end of December, 2004, as a rising $VIX preceded the sharp market decline at the beginning of January), or 2) the market is anticipating a volatile move no matter which way the breakout comes -- on the upside or the downside.
The bottom line is that with the indicators mixed line this, it is best to rely on the price charts for guidance, and as long as the uptrend is intact, we'll retain a bullish bias.
