Dow's Doubters Say Market Is on Borrowed Time

Dow's Doubters Say Market Is on Borrowed Time

By JONATHAN CHENG
As U.S. stocks notched their seventh winning week in a row on Friday, unease was growing among some investors and analysts who study the market's patterns to predict where it is going next.

.The Standard & Poor's 500-stock index hasn't seen such a long stretch of weekly gains in nearly four years. For the Dow Jones Industrial Average, it has been nine months. The latest leg of the rally has vaulted the S&P 500 8.7% higher, while the Dow is just 213 points below 12000—and up 78% from its financial-crisis low in March 2009.

The seven-week surge is a sign that many investors are betting that the crisis is basically over. Fears of a double-dip recession have faded, the Federal Reserve is gorging on Treasury securities, and paychecks were helped by the tax-cut extension passed by Congress in December. Companies on the whole have turned in strong earnings; Friday's gains were fueled by an unexpectedly big profit jump at J.P. Morgan Chase.

Yet some technical analysts who've crunched the same numbers and eyeballed their charts conclude that the overall market has gone too far. Despite all the good news, they worry too many investors are shrugging off the latest debt scare in Europe, rising global interest rates and worries about a potential meltdown in the municipal-bond market.

Another trigger could come from the latest earnings season, now in full swing. Some are concerned that heightened expectations could leave investors open to disappointment about companies' views about their future business prospects, triggering a broader decline.

The market is rallying "as if propelled by some mysterious force," says Mark Arbeter, the lead technical analyst for Standard & Poor's, who reckons the market is showing signs of fatigue for the first time in nine months. A stumble could claw back about half of the S&P 500's four-month, 23% rally, he says.

Mr. Arbeter and other analysts point to several technical indicators that portend the return of gravity to the market. In many respects, they say, the recent run-up bears many of the same hallmarks as the market did last March and April. That was the last time the Dow had a seven-week rally. But the jaunt came to a screeching halt because of the onset of renewed worries about Greece's debt woes and the May 6 "flash crash."

One widely circulated observation last week noted that the S&P 500 hasn't closed below its 10-day moving average in more than 30 trading sessions. The moving average softens out volatile daily market movements and is used by analysts and strategists to judge momentum and emerging trends.

Chris Verrone, head of technical analysis at Strategas Research Partners, counts only about a dozen similar instances in the past six decades. The most recent until now: a 42-session streak that ended with the Greek debt crisis last April. The S&P 500 then slid 8.8% in just two weeks.

Mr. Verrone fears a repeat this time around, pointing to a host of other "leading indicators" that have reversed course recently, including the Australian dollar and Indian stocks. Their record-setting gains have leveled off.

"When all these start to align, it's a sign that the rally is getting long in the tooth," Mr. Verrone says, predicting a short-term correction of 5% or 6% before the market resumes its bull run. "We're on borrowed time."

Skeptics also complain that the stock market's roll has been generally unremarkable on a daily basis. Since Nov. 30, the daily trading range of the S&P 500 has been just 0.76%, the narrowest since May 2007. No single day has seen a decline of more than 0.6%. The lack of big, triple-digit-gain days for the Dow could mean that many investors aren't overly confident.

Meanwhile, trading volumes on the New York Stock Exchange remain relatively low. Since late November, volumes have reached last year's daily average just 10 times in 34 sessions.

Even the optimism of investors—and their complacency about the market's current run—are sell signals, according to some technical analysts. The Chicago Board Options Exchange's Volatility Index, the "fear gauge" known as the VIX, closed on Friday at 15.46, lower than in April and near its lowest level in three years. The VIX has fallen 34.3% since the beginning of the rally in late November.

The American Association of Individual Investors' weekly survey has registered above-average bullishness for 19 straight weeks, the longest such stretch since 2004. For years, some investors have looked to the AAII survey as a compelling contrarian signal. An ebullient reading often is a clue that the market is due for a fall.

The VIX can be a contrary indicator, too, reflecting the prices investors are willing to pay for portfolio insurance on the S&P 500. The VIX tends to drop when stocks rise and investors grow less anxious. The last two times the VIX was trading around these levels, the market headed for a tumble—once in April during the Greek debt crisis, and before that in the fall of 2007, just ahead of the subprime crisis woes.

"The ultimate high tick [on the stock market] usually comes when hardly anyone cares, and our client base is the least engaged in the market as I've ever seen," says Christopher W. Dieterich, technical trading strategist at FBN Securities. "They're monitoring it, but they don't seem to be terribly involved. That's usually how a top feels."

But even if the market is stretched based on some historically compelling measurements, it could keep barreling higher. Many analysts still consider stock valuations to be trading at relatively low levels. And with fourth-quarter earnings off to a positive start, market strategists are confident that American corporations will continue to surprise investors with their resilience.

Jeffrey Rubin, head of research at Birinyi Associates, isn't concerned about overexuberance in the market yet, citing the S&P 500's 50-day moving average. For 94 consecutive trading sessions, the S&P 500 has exceeded its 50-day moving average, the first time such a string has happened in five years.

That would typically be a negative signal, as Mr. Rubin acknowledges. However, according to his calculations, the S&P 500 has managed to tack on an average of 3.5% in the three months that follow such long runs. "We are not at extreme levels," he says. "The market has the ability to go higher."

Write to Jonathan Cheng at jonathan.cheng@wsj.com