Last week, we discussed the breakout across each of the major indices. We received a surprising number of questions as to why we should consider this rally any differently than the three previous failed rallies of 2004 – the moves off of the lows in March, May and August. Today’s weakness may be reassuring those who missed the initial lift. However, despite the action today, I do not believe this breakout is similar to the failed rallies we saw earlier this year:
Downtrend: This is the first rally to break the downtrend tracing back to January 26, 2004. That trendline was where each of the prior rallies failed, and its penetration to the upside is a technical event of great significance. It changes the entire tone of the market, and shifts the stance of traders from selling rallies to buying dips.
Higher High: For the first time this year, the Dow, S&P500, and Nasdaq Comp have each made a higher high. A bear market is defined as a series of lower lows and lower highs, while a bull market is just the opposite. Now that we have made a higher high, look for this pullback to lead to the first higher low of the year – another Bullish sign.
Year-to-Date Positive: Sometime earlier this month, we moved to positive territory for the year on the SPX, Dow and Nazz. This places enormous pressure on fund managers. Its easy to beat the averages when they are in negative territory – sit in cash and be down less than the indices. Once the screens turn green, however, it requires deploying capital. That also lends bullish momentum.
200 day moving average: We are above the 200 day ma for the first time since July. This indicator is quite significant for some funds that use it as their “line in the sand.” They cover shorts above it and sell stocks they dislike below it. It is always healthier when the indices trade above it.
Previous Highs: The indices have taken out several previous highs, further adding to the bullish tenor of the markets. First, we are above the January 1st levels. Secondly, the SPX has surpassed the post-9/11 highs; The Dow and Nasdaq are 1% away. If and when all 3 major indices are above that level, it will represent an important psychological gain, revealing strong positive sentiment.
Negative Catalysts: Finally, many of the negatives we have been watching are no longer pressuring investors. The election is resolved, oil is off its highs, the conventions and Olympics went off without incident. Even Iraq, (which we still believe to be a debacle) is off the front page.
We advise using weakness to add to long positions.