Is There a Summer Rally Setting Up?

JULY 23, 2010
Michael A. Doran
The market appears to be shifting from a more bearish to possible bullish scenario -- the next few weeks should provide much more evidence for being more heavily invested. For one thing, there are not a significant number of quality stocks with great fundamentals breaking out. But there are a number of stocks that appear to be possibly setting up, so we are monitoring and assembling a solid "buy" list.

Our moving average of breadth indicators has shown recent improvement and significant strength the last few days. Consequently, we have more confidence to step in with selective buying of several positions and have closed out our short positions. (A short position is a bet a stock will fall in value.)

I hope to see several things develop technically on the broader index to signal more buying conviction. Essentially, institutional investors must bring more cash inflows into the market, then the technical charts should validate this buying activity.

Dessecting the Market

Two out of three of the major stock-market indexes -- the Dow Jones Industrial Average and the Nasdaq Composite Index -- have begun to poke their heads above bearish territory, or the 200-day moving average. In addition, the overall market is beginning to show signs of breaking through important resistance and trend levels.

The Standard & Poor's 500-stock index has been attempting to break above its 200-day moving average, however there were several distribution days on July 16 and July 21. If more of these distribution days show up, it would be distinctly negative for the index.

Wyckoff Spring: Sign of a Rally Ahead?

What is more impressive is that the market has rallied back above the lows of the major market plunges since May 6. The price action of rallying back above a clear supporting line, after trading below one, is known as a "Wyckoff spring" -- when a stock or market index plunges in panic trading, and then suddenly springs back to its previous trading range. Historically, this type of spring suggests a market rally ahead.

This week we witnessed a significant test of the spring. The broader S&P 500 began to test this spring after stalling at 1098. The price action on July 20 indicates the test was successful, as the market dipped below the lows of the previous two days and then rallied strongly.

I remain concerned that volume was somewhat heavy coming down to the low of 1010. However, the drive below the support level was on less volume than what was seen in previous declines since early May -- that indicates the selling has been drying up. The move off the Wyckoff spring low into the 1100 area has been on generally lighter volume that is typical of pre-earnings season. This type of market behavior paves the way for higher prices.

Friday, we cleared one major hurdle of 1098, a level at which we previously stalled out. A rally above both the 200 day-moving average and the 1131 swing high could pave the way for a retest of the April highs at 1219. On the other hand, a push below the July 20 low would cast doubt on this interpretation and a break below the July 1 low would disconfirm the Wyckoff spring.

We will be watching this market carefully to see how it unfolds over the next few weeks.

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