Stocks Explode to New Highs

S&P says the S&P 500 has a good shot of reaching 1620 to 1650 over the next couple of months

This time, it was the Nasdaq that led the market higher, completing high level consolidation about a week before the S&P 500 and the DJIA, as all the major indexes surged to new recovery highs or all-time highs.

With skepticism and doubts about a sustained rally from here, we think this adds to the probability that there is currently more upside than downside risk. We had one mini-blowoff from March until early June, that sent the S&P 500 up an impressive 11.7%, and we think we could see another melt-up over the next 4 to 6 weeks.

As we said recently, each pullback, beginning with the one last summer, has gotten progressively smaller. What this has done to the chart pattern of the S&P 500 is quite important and, in our view, bullish for stocks. The slope of the bull market steepened after the pullback in the summer of 2006. Then, after the pullback in February and March of this year, the angle of ascent once again became more vertical.

So what's wrong with getting your gains in rapid fashion rather than waiting years for them? Well, the problem becomes when the market slope becomes too steep, and the duration of rallies becomes too long. This sets up the potential for a major blowoff (1987, 1999) as the lack of corrective action on the way up creates little support for the indexes on the way down. We are not at this point yet; however, this is something to think about if we do see another big spike to the upside.

In the very near term, we see the possibility for some testing of the breakout areas for the major indexes. For the S&P 500, this would be in the 1535 to 1540 zone. Many times after an index breaks out to a new high, there will be some backing and filling down towards the breakout point.

One thing that may alter this common pattern is the calendar. Stocks have seen nice gains during options expirations week of late, and with the recent price strength, the heavy level of put open interest for July will be unwound, putting upward pressure on stocks, in our view.

Looking out a bit, we think the S&P 500 has a good shot of reaching the 1620 to 1650 zone over the next couple of months. The index has already reached and exceeded the first Fibonacci extension based on the width of the pullback in February and March.

The next Fibonacci target uses the width of the pullback and multiplies this by 1.618 to get an extension of 158 points from the breakout point. This would target an extension of the move to 1620. There is also trendline resistance, drawn off a series of highs from late last year and early this year that would provide resistance up in the 1620 area.

A more aggressive target for the "500" is a move up to the 1650+ zone. If the steeper slope remains in force, and this of course assumes that the angle of ascent does not once again accelerate to the upside, the top of the current channel would provide overhead resistance up in the 1650 area sometime in the later half of August.

The Nasdaq, which broke out to a recovery high last week, has been outperforming the S&P 500 since the middle of May. The index has exceeded the first Fibonacci extension target, and the next projection comes in at 2855. If the index can run up to the top of the channel that it has been in since last summer, we could see 2900+ sometime in August.

Both the Nasdaq and the S&P 500 were in gradually rising channels during 2004 to 2006, but in October 2006, the "500" broke out of its bullish channel to the upside as its advance become steeper. The Nasdaq, meanwhile, just recently broke strongly above its long-term channel, and this may be an indication that it will start to assert itself on the upside. While the Nasdaq has outperformed recently, it has mildly lagged the S&P 500 since the beginning of 2004.

Before we focused on the technical side of things, our original background was fundamental in nature with concentrations in finance and economics. Like many analysts, our daily reading includes the Wall Street Journal and Investor's Business Daily, Barron's on the weekend and a host of other fundamental and technical magazines. In addition, there are many investment websites we read on a daily or weekly basis.

Our purpose for all this reading, of course, is to keep up to date on the investment world and the domestic and global economies. More importantly, we like to get a sense of what other analysts are thinking and what the media is trying to say about the stock market and the economy. In one way, this is another subjective tool in gauging market sentiment. At times, the media can be obvious in their opinions on business, like when it is put on the front page of a newspaper or magazine.

Lately, there have been plenty of instances where both the media and the analysts being interviewed have taken a decidedly bearish view of stocks and the economy. What struck us this morning (July 13), on our long train ride from Pennsylvania to New York City, was the front page article in the Wall Street Journal. With many stock indexes breaking out the day before, one would think that the major U.S. business paper would write a glowing piece on the market. Just the opposite! The article had very little in the way of hard fundamental data to explain the sharp rise in equities. It was filled with feelings of unease and projections of more volatility.

But we think the most glaring part of the article was the consistent theme that the market exploded because of short covering. While we certainly believe there were some bearish bets being covered, as there is plenty of short interest out there, we certainly don't agree that the entire day was spurred by short covering. Short interest data is released once a month so unless you interview everyone doing the buying during the July 12 rally, it seems like a stretch to attribute most of the strength to the bears throwing in the towel.

When the media is cautious, trying to lead individuals to raise cash, we'll gladly take the other side.

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