FOURTH QUARTER RALLY APPEARS TO HAVE BEGUN -- WHY NASDAQ LEADERSHIP IS IMPORTANT -- UPSIDE TARGET FOR FIFTH WAVE ADVANCE
NASDAQ 100 TOPS 200-DAY LINE... One theme I keep repeating is the need for Nasdaq leadership during any fourth quarter rally. I'm happy to report that on the first day of the fourth quarter the Nasdaq 100 led a very impressive market rally that could carry through the rest of the year. Chart 1 carries three bullish pieces of information. First, the Nasdaq 100 Shares (QQQ) broke through their 200-day moving average. Second, the QQQ did so on the strongest volume in a month. Third, it was the strongest percentage gainer of the major market indexes and continues to show new market leadership. The QQQ/S&P 500 ratio line, which bottomed in mid August, hit a new two-month high today. Let me demonstrate why Nasdaq leadership is so important to the rest of the market.
Chart 1
WHY NASDAQ LEADERSHIP IS IMPORTANT ... Chart 2 is a ratio of the Nasdaq 100 divided by the S&P 500. When the ratio is rising, the Nasdaq is outperforming the S&P which is good for the market. When the ratio is falling, the Nasdaq is underperforming the S&P which is bad for the market. The Nasdaq/S&P ratio bottomed in October 2002 (green circle) which marked the end of the three year bear market that started in early 2000. The Nasdaq led the S&P higher throughout the entire 2003 market rally. The Nasdaq/S&P ratio peaked at the start of 2004 (red circle) which started a downside market correction that lasted until August. The green arrow to the bottom right shows the ratio bottoming in mid-August. [That's the upturn shown in Chart 1]. The main point of the chart is to demonstrate that a rising ratio (Nasdaq rising faster than the S&P 500) is a necessary ingredient if the market is starting another upleg.
Chart 2
NASDAQ WEEKLY CHART GIVES BUY SIGNAL ... The weekly Nasdaq 100 chart is giving an intermediate-term buy signal. Actually, that's coming from two indicators. After bouncing off its lower Bollinger Band during August, the QQQ has closed decisively over its 20-week average (dotted) line. That turns the imtermediate trend higher with an upside target to the upper Band near 38. More importantly, the weekly MACD lines have turned bullish for the first time since February. I talked about this indicator a couple of weeks ago (September 17) when the S&P issued a similar buy signal. A sell signal was given in February (red arrow) which lasted until this week (green arrow). That's a pretty positive sign that this latest upturn in the Nasdaq, and the rest of the market, has staying power and is more than just a short-term bounce. And, what's good for the Nasdaq is usually good for the rest of the market.
Chart 3
S&P CHANNEL LINES REVISITED ... I showed this same chart two Fridays ago (September 17, 2004) and described the two parallel trendlines as "channel lines" that have contained the entire 2004 price movement. I suggested that this "type of pattern more often results in a continuation of the prior trend (which was up) that a reversal of that trend". The weekly MACD lines had just turned positive for the S&P as well. This week's price gain puts the S&P in another test of the upper resistance line. I believe an upside breakout is imminent. Two reasons are this week's impressive upside volume and the fact the weekly RSI line has already broken its down trendline. That earlier update also talks about why upside breakouts by the Dow Transports and Utilities should be bullish for the Industrials (which is still the case)-- and also shows that large cap value stocks are leading growth stocks higher (which is also still the case).
Chart 4
FIFTH WAVE REVISITED ... In a recent update (September 22, 2004), I made the case for one more upleg that was based on a combination of waves and seasonality (Why Another Upleg?). Here's the chart again. It's my opinion that the cyclical bull market that started in October 2002 has completed only four waves (this years downside correction being the fourth wave). Since bull markets usually have five waves, that leaves room for one more upleg before this bull market is complete. The most likely time period for that upleg to take place is during the fourth quarter and probably lasting into January. That's normally the strongest time period of the year. It also fits the historical pattern for markets to rally after a presidential election. The question now is how far can the market rally. The minimum upside target is a challenge of the early 2004 peak (1163 in the S&P). Fifth waves often exceed the top of the wave three. One way to measure the upside potential is to take the height of wave one and then add that to the bottom of wave four. That's because wave one is usually the smallest of the upwaves. Since the first upwave was 185 points (954-769), that amount added to the bottom of wave four (1060) gives an upside target to 1245 (10% from current levels). That's the good news. The bad news is that the next upleg will probably mark the end of the "cyclical" bull market. After that, the outlook for 2005 isn't very promising.
Chart 5
