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Can January’s Rally Continue?

February’s record of dismal performance will be put to the test


On Friday, positive economic data and earnings gains drove the Dow Jones Industrial Average to its highest level since May 2, 2011, and the highest level on the S&P 500 since July 21. The news that got the most attention was from the unemployment index, which fell to 8.3% — a three-year low. The market responded positively to this catalyst, but by mid-morning stocks hit their highs of the day and spent the remainder of the session in a very narrow band.  Technically one important index has broken out while the others are still setting the stage for what could be a major thrust higher.

The Dow closed at 12,862, up 157 points, the S&P 500 rose 19 points to 1,345, and the Nasdaq gained 46 points at 2,906. Volume rose to 904 million shares on the Big Board and 544 million shares on the Nasdaq. Advancers led decliners by 4-to-1 on both exchanges, but a more significant statistic was that Nasdaq up volume versus down volume was in favor of the buyers by 21-to-1.

Nasdaq Chart

Trade of the Day Chart Key

The Nasdaq broke to an 11-year high on Friday, demolishing the highs of May and July and doing it with the panache of a classic bullish signal — the trend changing “breakaway gap.”

Moreover, the Nasdaq set the new high as its Relative Strength Index (RSI) came within a fraction of a sell signal, which can be ignored as long as momentum remains high. I noted the change in behavior of the banks in Friday’s Daily Market Outlook, and it was chiefly that group, along with the continuing desire to own technology stocks, that led to the big breakout. The breakout blew through a huge double-top with the left top at 2,861 made in late October of 2007.

Nasdaq Break Chart
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The financial press has been reporting the strength of technology stocks in the Nasdaq for two weeks. Techs have been strong, but they are also overbought and, as noted on Friday, the real reason for the Nasdaq’s breakout is the turnaround of the financial sector and especially the banking group, which has been a drag on the broad market for almost two years.

KBE Chart
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Friday’s breakout by the banks in the Nasdaq is as important as technology’s run because the banks are a large sector in virtually every major index and could have an extended struggle before becoming overbought. They are one of the most fragile of the major sectors, and so we should monitor them closely. If they falter from the current level, we could see a correction before the other indices follow through with their breakouts.

SPX Chart
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Note that the S&P 500 is on the cusp of a major breakout, but like the Nasdaq, to keep it going requires broad participation, which must include the banks, to push it through the final band of overhead first at the July 21 high at 1,347, then the July 7 high 1,357, and finally the May 2 high at 1,371.

Technically, Friday’s strong bullish volume (on balance) is a plus and momentum is on the side of the bulls. Even the AAII bullish sentiment number has fallen from a high of 49.14% on Jan. 12 to 43.81% on Feb. 2, which indicates that fear is increasing among the public — a plus sign. The CBOE Volatility Index (VIX) closed out the week at a very complacent 17.1, and that too is a positive.

Finally, there is one more bullish signal on the S&P 500’s chart — the break from an inverse head-and-shoulders formation (dark green) that formed in November and December. A neckline break occurred at 1,268. This provides a short-term target of 1,378.

Other bullish factors are having an impact on the broad market. The Fed is still pumping money into the market. They bought $14.6 billion in mortgage-backed securities and sold $6 billion in U.S. Treasuries during the week ending Jan. 19. The Fed’s balance sheet has expanded by 4% or $106 billion, according to Ciovacco Capital Management.

Conclusion: Despite February’s record of dismal performance, there are enough fundamental, political, and technical reasons to support the continuation of January’s rally. Any corrections will likely be short-lived and should be used as buying opportunities.

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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