"Pennant" Fever

By Daniel Kadlec

Technical analysts are right up there with lawyers, the opposite sex and people from New Jersey when Wall Streeters start cracking wise. Poor souls, no one understands them. Least of all me. Technicians draw lines through stock charts, studying trading volume, new highs and lows and other esoterica to divine whether the market will go up or down. They're right--half the time. (Sorry, I couldn't help myself.) Still, that record makes technical types just as bankable as the more respected fundamental analysts, who study things like earnings and interest rates.

So stick with me while I take a chart gazer's look at the Dow. It's in a classic "pennant" formation that in the end tells us nothing about whether the market is going up or down but leaves us with one valuable tidbit: we're due for a breakout--soon. And when it comes, up or down, the market should continue in that direction for a while.

Naturally, even technical analysts can't agree exactly on what the Dow chart is saying. But any amateur can see that since the start of the year, virtually every Dow rally has stalled just short of the previous high and sell-offs have abated just short of the previous low. Draw the lines, and you get a sideways triangle, or pennant shape, that reveals schizoid investor psychology. On one hand, investors do not believe the market can sustain a rally--so as stocks near their previous highs, sellers charge in early to beat the crowd. But investors don't see a big downdraft coming either--so as stocks approach their previous bottoms, they swoop in to bargain hunt before others get there. Everyone is playing the trading range, which gets narrower with each reversal.

None dispute that this cannot last. Where technicians quibble is the exact future points of resistance on the upside and support on the downside. Is the pennant symmetrical, ascending or descending? Let them quibble. Suffice to note that as the range narrows, we get closer to declaring a winner in the bull-bear tug-of-war. A textbook reading, says Richard McCabe, chief market analyst at Merrill Lynch, is that by late August, the pattern will be broken, the Dow's new direction evident.

Curiously, some technicians put more weight on the Dow's inability to rally past old levels than they do on its ability to hold firm on declines. Hence they tend to be bearish. The NASDAQ slide since mid-July bolsters that view. And McCabe notes that speculative fever remains high, evident in a vibrant IPO market. John McGinley, editor of Technical Trends, worries about the recent slide in margin debt--money borrowed to buy stocks. You'd think a decline in that figure would be healthy, signaling that investors are more cautious. But McGinley reads the decline from the March record of $279 billion to June's $247 billion differently. "People have been wiped out," he says. "They have no money left to be buyers. It's another nail in the coffin of the bulls."

As always, there is a case the other way. The cycle of rising interest rates seems about over. The second half of presidential election years tends to be a good time for stocks. And technically speaking, the S&P 500 looks healthier than the Dow. So don't read too much into this chart chatter. But be you bear or bull, get your ducks in order now. We're close to finding out who's boss.

See time.com for more on technical analysis. E-mail Dan at [email protected] See him Tuesdays on CNNfn at 12:20 p.m. E.T.