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Stocks Should Head Higher After a Modest Pullback

Market is somewhat overbought, but a breakout has been confirmed


Following one of the best weeks of the year, stocks headed lower on Monday. The September Empire Manufacturing Survey reported its worst reading since April 2009, and several steel-related stocks were downgraded by JPMorgan analysts.

Rumors that President Obama was ready to release the strategic petroleum reserve were denied late in the day. But the damage had already been done to oil stocks and the materials sector.

At Monday’s close, the Dow Jones Industrial Average was off 40 points at 13,553, the S&P 500 fell 5 points to 1,461, and the Nasdaq fell 5 points to 3,179. The NYSE traded 666 million shares and the Nasdaq traded 363 million. Decliners were ahead of advancers on the Big Board by 2.2-to-1 and by 1.6-to-1 on the Nasdaq.

Nasdaq Chart
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Trade of the Day Chart Key

There is no doubt that the Nasdaq has broken out. We have to go all the way back to 2001 to find the next resistance (and that is too far to have much meaning), and so we are not able to provide an immediate target for the breakout.

However, it is clear that the first support is at the breakout line at 3,122. Measuring the distance between the low at 2,727 and the breakout point at 3,122 is 395. Added to 3,122 we get a rough target of 3,517, or more than 10% from Monday’s close.

SPX Chart
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Like the Nasdaq, the first support for the S&P 500 is the breakout line — in this case the close at 1,418. May 2008’s peak at 1,440 could be a target for the current breakout. But if we use the same reasoning we did to establish a target for the Nasdaq, the target is much higher: 1,418 – 1,267 = 151 + 1,418 = 1,569, which is very close to the all-time high at 1,576 made in October 2007.

Conclusion: Last week’s move by the Fed of purchasing $40 billion of mortgage-backed securities each month for an indefinite period resulted in a dramatic breakout. However, near term it left the markets somewhat overbought. But it was a meaningful breakout with all of the volume needed to confirm it as genuine. Following a modest pullback stocks should head higher.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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