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Breaking Out to the Upside

By Mark Arbeter So much for September being a weak month for the equity market. The S&P 500 broke out of an almost three-month price consolidation on Sept. 2 -- the first day back from summer vacation -- and looks headed for further gains.

The breakout above the top of the trading range at 1,015 confirms the recent breaks by the Nasdaq and the Dow Jones industrial average to new recovery highs. The strong move was accompanied by a large pickup in trading volume, which is exactly what most successful breakouts exhibit. The advance also displayed very good breadth statistics as well as advancing versus declining volume numbers.

Once a major breakout occurs with an index or individual stock, there are three scenarios that can unfold. The first is that the security continues higher without looking back. This is somewhat rare for a well-diversified index such as the S&P 500. The second possibility for the index, and the one we deem most likely because of the strength in the other indexes and the pickup in volume, is a retest of the breakout point of 1,011 to 1,015, and then another leg higher to new recovery highs.

The third potential development and one that has to be monitored carefully is a price failure. This would occur if the S&P 500 fell back below the breakout point and into the old price base. In other words, a failed breakout, and many times this has implications of a major break to the downside.

There are a number of levels the "500" could achieve if our call of a successful test is correct. The first potential for the current move would be the 1,050 area, which is where the first pieces of chart

resistance lie. A measured move, based on the width of the most recent consolidation, would target the 1,070 level.

Chart resistance gets very thick beginning in the 1,075 area and runs all the way up to 1,175. This last area, if or when the index gets that high, will be a formidable challenge. Fibonacci retracement levels that the "500" may have to deal with are 1,063 and 1,152. These would be 38.2% and 50% retracements of the decline from the closing high in March, 2000, from the closing lows seen in October, 2002.

An interesting observation we can make when examining many individual chart patterns, especially those from the hot technology sector, is that they look great from an intermediate-term perspective (one-year daily chart) but basically remain in long-term bases with massive overhead resistance on our long-term charts (three-to-five year, weekly chart).

This can also be seen on the Nasdaq, but the overhead supply is not as dramatic as some of the indexes components. During a major part of 2001 and some part of 2002, the Nasdaq traded between 1,750 and 2,300, with the thickest part of that overhead supply starting at 1,950. The first Fibonacci retracement zone that the Nasdaq will encounter, from the low in October, 2002, to the peak in March, 2000, would be a 23.6% retracement, which would target the 2,043 level.

One of our recent concerns about the advance off the March lows was the deterioration in the number of new 52-week highs on both the NYSE and the Nasdaq. During the latest market advance, these divergences have been alleviated. New highs as a percentage of issues traded slowly eroded from the peak in the beginning of June until late August. However, there has been explosion of new highs on both indexes during the past week. New highs on the Nasdaq were 14.5% of issues traded on Sept. 3, exceeding the early June numbers. On the NYSE, 14.4% of issues traded hit new highs that day, closing in on the 16.8% level we saw in June.

After a bear market, high levels of new highs have been consistently seen during the early stages of a bull market. However, after a strong, longer-term advance, high levels of new highs can represent an exhaustion-type move and signal the end of a move.

Other internal measures of the market reasserted themselves last week, including advance/decline figures as well as up/down volume statistics. Both the daily advance/decline lines on the NYSE and the Nasdaq hit new recovery highs, signaling continued broad participation in the advance. Our up/down volume models on both the NYSE and the Nasdaq also moved to new recovery highs, demonstrating that institutions were fully involved in the buying spree.

We have talked about some of the components usually seen during the beginning stages of a major bull market and it is a good time to revisit some of them. One definite characteristic during an early advance is that the market moves very quickly, maintains these gains, and along with that, gets extremely overbought.

Looking at the S&P 500 during the early bull markets in 1975, 1982, 1991, and 1998, the 50-day price rate-of-change hit at least 20% while the 100-day price rate-of-change was at least 27%. In 1932, the 50-day ROC for the DJIA was 92% and the 100-day ROC was 64%, but we will ignore those. During the advance since March, the 50-day ROC for the "500" hit a peak of 17.6% and the 100-day ROC reached 23%. While these are not as high as the price momentum seen during the other examples, they are close and pretty impressive.

Looking at the same early stages of past bull markets, the S&P 500 moved to very overbought conditions. This can be measured by looking at the relative strength index or RSI. The other bull markets pushed the 14-day RSI between 79 and 86, and propelled the 14-week RSI to the 71 to 81 zone. During the latest advance, the 14-day has peaked out at 75 with the 14-week RSI moving to 67. Once again, not in the zones of the other bull markets, but nonetheless, pretty notable readings. Arbeter is chief technical analyst for Standard & Poor's

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