Stocks Could Trade Sideways into 2009

Major stock indices appear set to retest their recent multi-year lows and we will find out if the lows represent a firm near-term bottom for stocks. But with the year coming to an end in just over a month, it looks like it will be the worst results since the market plummeted during the 2000 technology bubble.

 This bear market has been broad and has impacted numerous areas. The blue-chip DOW is down 37% this year. The S&P 500 is eyeing its recent low of 839, down 41% this year, while the NASDAQ is off 42%. The small-cap Russell 2000 broke back below 500 and down 39%.

 We have seen trillions of dollars disappear from pension funds and personal investment accounts, and if you add in the declining home values and job losses, it has been nothing but downright nasty.

 Technically, investor sentiment continues to be extremely bearish and this will hinder the sustainability of any upside move in stocks. At this point, about 4.97% of all U.S. stocks, as of November 12, are above the 200-day moving average, down from the 7.13% a week earlier, and slightly higher than the 4.32% a month ago. The same goes for the shorter-term moving averages. For me to be positive, I need to see the moving averages trend higher.

 Looking at option volatility can tell us a lot of where a market may be heading. The CBOE NASDAQ Volatility Index or VXN – a barometer of near-term market volatility based on NASDAQ 100 index option prices — is generally viewed as a contrarian indicator. A high VXN indicates maximum fear and a possible market bottom. A low VXN indicates reduced apprehension and a possible market top.

 The five-day VXN to November 11 fell to 58.51 from 60.02 the previous week, the second straight week of declines. The five-day VXN remains above the 200-day MA at 32.45. Continued lower readings could point to a near-term top on the NASDAQ.

 In the broader market, the CBOE Volatility Index or VIX is a barometer of near-term market volatility based on the S&P 500 index option prices. The five-day VIX to November 11 was flat at 59.15 versus 58.53 the previous week and well above the 200-day MA at 29.13. Lower readings would suggest a near-term top on the S&P 500.

 If stocks do hold at the lows, we could be seeing a setup for sideways trading for the reminder of 2008 and into 2009. Holding at the lows would be bullish, as it indicates the downside risk.