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Monday, December 20, 2004

Stock Market


Friday December 17

Our bullish stance on the market is intact. Nearly all of the technical indicators are bullish, and most of the major averages (with the exception of the Dow) have made new highs this week. That type of price action is particularly noteworthy, and should be respected. Are we getting overbought again? Yes, perhaps, but that's what happens in these strong bullish moves. The key is to understand that pullbacks are limited -- perhaps mostly sideways -- and all they do is alleviate overbought conditions; one cannot expect to find full-fledged buy signals when the market is this strong. In fact, in an ironic twist, it would not be healthy for this continuing bull run to see the market sell off hard enough to make any of the indicators oversold and thus generate 'true' buy signals.

Since the major averages have broken out to new highs, it's imperative that they hold this newly acquired ground. Thus, if they were to slip back below the week's lows, it would not be good. Those levels are 1185 for $SPX and 565 for $OEX (see Figure 1). If the market should fall back that far, it would negate the breakout, and then we'd have to re-assess the bullish move.

The equity-only put-call ratios are split, with the standard ratio making new lows (bullish), but the weighted ratio having given a sell signal -- and stubbornly clinging to it, despite new highs in the major averages. The charts are shown in Figures 2 and 3. At this point in time, we are not overly concerned with the sell signal in the weighted ratio because it is the only sell signal we have, and the averages are at new highs. However, it is probably our most trustworthy indicator and thus we will not remain bullish if it stays on a sell signal and the averages fall back below their breakout levels (1185 and 565,
respectively, as stated above).

Market breadth has been very strong this week as small-cap indices outperformed the big-cap averages most every day but Thursday. Breadth is overbought again, but it was before, too, and is a pattern that can repeat itself a number of times as long as the market is in 'buy mode.'

Finally, volatility indices ($VIX and $VXO) have reached nine-year lows. In fact, $VIX closed today at 12.27 and traded below 12 briefly. It has not done either of those things since December, 1995 -- fully nine years ago. It should be noted that $VIX began to increase during most of 1996, but the market ADVANCED while that was taking place . Thus, it is not necessary for the market to decline if $VIX advances.

Our initially stated target for this move was $OEX 690, although research published in The Option Strategist about a month ago gave an alternate target: a 20% advance from the point when the first overbought condition abated. That occurred in December 7th, 2004, and yielded a target of $OEX 673 -- quite similar to the first target. Of course, these are just guidelines. We will let the technical indicators dictate our moves, but as long as the majority of indicators remain bullish, we will be inclined to retain our bullish positions.


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