The Nasdaq 100

The Smart Profits Report: Issue #460
Thursday, September 27, 2007

The Nasdaq 100: As The Nasdaq 100 Hits 6-Year Highs, Can The Other Indexes Follow?
By Jim Stanton
Quantitative/Technical Analyst, Mt. Vernon Research

So much for September and October historically being the worst time of the year to own stocks. The indexes scoffed at history last year when stocks sets lows in July, then bolted upward until February.

And stocks are heading down the same path this year. The only difference is that rather than set lows in July, the indexes notched up their highs for the year during the month. This set up the perfect scenario for a September-October selloff.

But the subprime and credit markets had other ideas. As the bough broke in August, the cradle fell - and fell hard. The markets sold off ahead of schedule, slumping 12%.

Since then, however, stocks have rallied, with the Nasdaq 100 (^NDX) climbing to new highs for the year. The question on Wall Street now is: Can the other indexes follow suit, or will we see the sellers back in action?

The Nasdaq 100 Leading The Market Rebound

As the market has rebounded, the tech-laden Nasdaq 100 has led the way, impressively surging to new 6-year highs this week.

Obviously, this is a bullish development that should lead to higher prices. But an important piece of the puzzle is missing. None of the other indexes have joined the party. While the Dow Industrials (^DJI) and S&P 500 (^SPX) are within striking distance of setting new all-time highs (the Dow is 1% shy of doing so and the S&P needs to tack on 2%), they need to do so in order to confirm the rally.

Of greater concern, though, is the performance of the Dow Transportation Index (^DJT) and the smaller-cap indexes, which are lagging the others. This could become a problem later on if they don’t pick up the pace, but for now, the bulls have the upper hand.

So let’s turn to the charts and see where stocks are headed next…

Nasdaq 100 Resistance Levels Are Up

Okay, let’s get the simple stuff out the way first. By setting new highs for the year, the Nasdaq 100 is having itself a fine Indian summer. Its next intermediate-term resistance level is up around 2,155 (to recap, a resistance level is a higher point on a stock/index chart that is seen as a temporary “barrier” to a further price increase - i.e. a level that a security can hit before falling back as sellers outnumber buyers).

Taking a look at the S&P 500, the index’s intraday high in July was 1,555, so if it can close above that level (and it’s 24 points away right now), it should be well-placed to continue to the 1,626 area. I generated this upside target using a Fibonacci calculation (see today’s “Related Articles” for more on Fibonacci) from two completely different points - and both projected 1,626. As you can see from the chart below, trendline support comes in around the 1,495 level.

Fibonacci Calculation of the S&P 500

Chart Courtesy of Trade Navigator Software: http://www.genesisft.com

Small-Cap Indexes Rally Large-Caps

As I mentioned above, while the large-cap indexes have performed well over the past month, they need some help from the smaller-cap indexes and the Dow Transports, in particular. This is because Dow Theory (you can read more about this in today’s “Related Articles”) states that in order for a rally to continue, both the Down Industrials and Transports need to set new highs together, within a reasonable amount of time (1-3 weeks).

Simply put, if the larger-cap indexes (Nasdaq 100 and S&P 500) reach the resistance targets mentioned above and the smaller-cap indexes and/or the Dow Transports fail to make new highs, it will trigger a Dow Theory non-confirmation and the rally could stall.

And as far as the Dow Transports are concerned, the outlook doesn’t look too great…

Take a look at the index’s daily chart below. As you can see, it’s been trading sideways for about six weeks now and appears to be stuck in a bearish consolidation pattern. It’s actually closer to its August lows than to its July highs.

The Dow in a bearish consolidation pattern

Chart Courtesy of Trade Navigator Software: http://www.genesisft.com

If the large-cap indexes continue to rise, the smaller-cap indexes would have to rally about 5% in order to make new highs, while the Dow Transports would need to surge more than 13% to do the same. That would be one heck of a rally!

The Bulls Are In Control, But The Bears Are Lurking Again

Having analyzed all the index charts, along with various technical indicators, the odds are that the bulls will maintain control over the intermediate-term and the indexes should head higher and approach the resistance levels mentioned above.

A close above 1,555 on the S&P 500 will confirm this analysis. However, if it fails to accomplish this and closes below its trendline at 1,495, a test of the August low around 1,380 will be in play. In addition, if the lagging indexes don’t improve, the longer-term health of the market comes into question.

Good investing,

Jim Stanton

Today’s Smart Profits Action Center

Today certainly wasn’t the best day for stocks to gain much momentum - not with yet another batch of poor housing numbers. The Commerce Department reported that new home sales flopped by 8.3% in August to the lowest annual rate since June 2000. Home prices continue to fall, too, with the average sale price slumping by 8% to $292,700 in August, compared with August 2006. It was the biggest decline in 17 years.

The U.S. dollar also set another record day - a bad one. For the sixth straight day, it hit a new low against the euro, with the euro coming within a whisker of the $1.42 mark. While the recent 0.5% Federal Reserve interest rate has damaged the dollar further, some want another one in the face of the weak housing data. The Fed faces a conundrum. While second-quarter U.S. GDP growth hit 3.8%, the bankers still want to control inflation after giving consumers some relief. However, the growth figure doesn’t factor in the main impact of the housing slump and credit crisis this summer - an impact that will be truly reflected in the third quarter, which ends on Sunday. Current estimates peg third-quarter GDP growth at an annual rate of around 2.5%.

Any reference to Dow Theory (as Jim mentioned today) wouldnt’ be complete without talking about Richard Russell. For 50 years, he’s written the Dow Theory Letters, and used the theory to make some remarkable predictions. In December 1974, for example, the Dow was set to post a crippling 35% loss for the year - the culmination of a 12-year malaise. But using this highly reliable, time-tested theory, he issued a “buy” on the index. Result? It shot up by 75% over the next 18 months. Visit this link to find out how he called the move - and how you can use this powerful theory, plus 30 other secrets direct from the pros, to increase your wealth many times over.

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