Stocks Could Still Get Uglier, Technicals Suggest

By Steven Russolillo

BespokePercentage of stocks above 50-day MA (through 11/22). Click for big image.

While the stock market is mired in another steep selloff, chart watchers see reasons for more pain ahead.

Major stock indexes have shot lower in recent days, falling more than 7% since early last week as investors have fretted over Europe’s sovereign-debt crisis and the failure of Washington’s Super Committee.

Wall Street’s technical analysts — who comb through price and volume charts looking for clues of future market direction — also aren’t finding much evidence to suggest stocks will change direction anytime soon.

One bearish signal the chartists are gleaning from the data is related to market breadth — which measures the ratio of advancing stocks versus declining ones. While breadth has dipped as the broader market has moved lower, it has yet to drop enough to signal a market bottom.

The percentage of companies in the Standard & Poor’s 500-stock index that are trading above their 50-day moving averages is about 37%, according to Bespoke Investment Group. The figure has dropped from above 80% last month when stocks soared higher.

But this percentage hasn’t fallen low enough to suggest stocks have reached a near-term bottom.

“There’s still room to run on the downside,” said Justin Walters, co-founder of research firm Bespoke Investment Group. “The market’s definitely not oversold yet.”

Walters said the measure of companies trading above their 50-day moving averages would need to dip below 20% for him to believe the market has become oversold.

Delving deeper into the S&P 500 shows some of the traditionally defensive sectors, such as utilities and health care, are trading at some of the lowest levels below their 50-day moving averages, according to Walters. Conversely, some of the cyclical sectors, like financials and technology, have held up better during the market’s recent downdraft and could be poised for a bigger move higher when the broader market regains its footing.

In addition to companies moving below their 50-day moving averages, technicians are finding other indicators that are creating cause for concern.

The S&P 500 as a whole fell below its 50-day moving average on Monday, which many chart watchers signaled as confirmation of the market’s short-term direction.

“We believe this is a warning of further losses,” Ari Wald, technical strategist at Brown Brothers Harriman, wrote in a note earlier this week.

To be sure, Bespoke’s Walters said the market’s action in October is evidence that stocks should be able to withstand any short term blips and eventually resume their march higher. The percentage of companies trading above their 50-day moving averages had consistently been making lower highs throughout the year until October, when it zoomed higher.

The S&P 500 gained 11% last month, its best monthly performance since December 1991.

“The more pertinent part of the yearlong chart is how strong breadth got during the recent rally,” Walters said. “From a longer-term perspective, that’s a positive. The current pullback isn’t extreme by any means, right now.”

The S&P 500 was recently down 1.8% at 1167, on pace for a sixth straight day of declines. It has dropped 7.2% during the streak.

John Kosar, director of research at Asbury Research, pointed to another indicator of market breadth that also suggests additional declines could be in the offing. The 26-week new highs/new lows ratio for the NYSE Composite sits at about 20%, according to Kosar. Most of the bottoms in the S&P 500 over the last two years have occurred when the ratio declined below 12%.

“From a market-breadth standpoint, the market is not yet washed out enough for a bottom to emerge,” Kosar said. This “clears the way for m