The Stock Markets

The Smart Profits Report: Issue #466
Friday, October 19, 2007

The Stock Markets: Using ESP To Chart The Next Move As The Indexes Race To All-Time Highs
By Jim Stanton
Technical & Quantitative Analyst, Mt. Vernon Research

So much for history… September is historically supposed to be the worst month of the year for the stock markets. But for the second straight year, it defied the trend and posted gains for the month.

Overall, the September-October period is supposed to be sluggish for stocks. But the Dow and S&P 500 don’t care about convention. Both indexes have raced to new all-time highs this month, with the Nasdaq indexes setting new highs for the year, too.

Great news, right? Well, yes and no. While plenty of folks are profiting, it’s also important to know how long this bullish action could last. And in order to confirm the higher prices over the intermediate-term, the smaller-cap indexes need to join their large-cap cousins in making new highs. They came fairly close to doing so recently, but if they don’t, we could see a meaningful correction.

Let’s see what this market has in store for us, fresh off yet another batch of poor housing data and oil prices blowing their way to $89 a barrel this week…

Dow Transports Out Of Gas… But Is Relief On The Way?

It’s not just the small-caps that need to pick up the pace here. According to Dow Theory, the Dow Industrials and Dow Transports need to move in unison in order for the rally to continue.

Problem is, the Transports have lagged the other indexes badly. If this continues, it sets up a potential longer-term downside issue. Right now, the Transports would have to rally more than 10% to join the Industrials at new highs. And right now, that’s a pretty tall order.

But it might get a little relief. While the market action since the August lows has seen the Dow Industrials and S&P 500 make new highs, it’s also moved the indexes into overbought territory. This is why they’ve pulled back recently and are currently trading below their July peaks. So it’s not yet clear if the correction is complete.

Throughout all this, one index has performed strongest…

Resilient Nasdaq Now At A Key Juncture

Since the August lows, the Nasdaq 100 has blazed forward and has shown more resilience than the others. And because it’s set the trend recently, I’ve put the index through some rigorous analysis, using the ESP Profit System (more on this below). So take a look at its daily chart below…

The Nasdaq 100 blazes trails for the stock markets

With the market having waffled its way through July, the ESP system generated a sell signal on the Nasdaq 100 on July 24. As the chart shows, it projected a minimum downside target of 1,880. The index hit that level on August 15, just one day before the index staged a reversal.

The sell sentiment didn’t last long. As the index headed north again, the ESP system triggered a new buy signal on August 24. This projected a minimum target of 2,066. However, since that was above its July high of 2,061, a new, longer-term target of 2,160 came into play. As you can see, the index reached its minimum target recently and the next week or so should give us a clearer picture of where it’s headed next.

The Stock Markets Race To All-Time Highs… Are They Out Of Breath?

While the Nasdaq is humming along smoothly, the Dow and S&P 500 have also traded above their July highs. This now projects longer-term minimum upside targets of 14,596 for the Dow and 1,626 for the S&P 500.

For now, however, both the Dow and S&P have moved into overbought territory and a correction may be in the cards.

If that happens, the S&P has trendline support around the 1,500 area. This would also represent a typical 38% Fibonacci retracement level (see today’s “Related Articles” for more on Fibonacci retracements). A move down to that level would probably set up a great buying opportunity, assuming that any sell signals have reached their downside targets.

Stocks Enter Bullish Period… But Here’s Why A Pullback Could Be Beneficial

Having navigated the tricky month of September and finished in positive territory, then sprinted its way into October right from the gun (if you remember, the stock market enjoyed a mammoth day on October 1 to kick off the fourth quarter), this time of year is usually bullish for stocks.

If the indexes, including the small-caps, can make new highs for the year, the Dow and S&P 500 should work their way up to the targets mentioned above.

However, not to rain on the parade here… but a pullback might not be so bad. That’s because with the stock markets having enjoyed a solid run recently, you can get better buying opportunities when stocks with bullish chart patterns pull back to support levels. On the flip side, it’s often possible to get better entry points when short selling or buying put options when stocks with bearish chart patterns rally up to resistance. This method reduces risk and increases the reward in a trade, but as we know, the market doesn’t always comply with our wishes!

Good investing,

Jim Stanton

Today’s Smart Profits Action Center

Breaking news: There’s no stopping Google (Nasdaq: GOOG). After the closing bell, the tech giant said third-quarter profits bulldozed through the $1 billion mark to $3.38 per share. It was a whopping 46% surge over the same period in 2006. The news cushioned the heavy blow that Bank of America (NYSE: BAC) dealt this morning, announcing that its third-quarter profits slumped 32%, due to damaging losses and write-downs totaling more than $770 million and a $607 million loss from its investment bank division that actually offset strong earnings elsewhere. Expect major restructuring. Chairman and CEO Kenneth D. Lewis declared: “What I can’t say is that we’ll stay the course. The probability of changes and eliminations of some businesses and infrastructure… is very high.”

Why do the Dow Industrials and Dow Transports have such a symbiotic relationship? The answer lies with Dow Theory - one of the most reliable stock market trends in history. As Jim mentioned in today’s column, for a rally or pullback to be sustained, both indexes need to move in the same direction. Originally based on the work of Charles Dow, the actual logic behind the theory was later credited to his William P. Hamilton, Robert Rhea and E. George Schaefer. And it’s the theory on which Richard Russell has written the influential Dow Theory Letters for the past 50 years - and used it to make some remarkable predictions. To find out more about how to use this powerful theory to your own advantage, click here to continue.

Jim Stanton is the Investment Director of the ESP Profit System (ESP), a powerful, computerized trading platform that nails down the movement of stocks and indexes with pinpoint accuracy. Not only will you learn what’s going to happen, you’ll also find out when it will occur, and how much the asset could move, so you know exactly what action to take.

The trading platform is based on two separate proprietary systems. The first one identifies when buy and sell signals are triggered and the second uses a chart pattern recognition program that projects price targets once buy/sell signals are generated.

Not only that, Jim is also incorporating a new feature into the system: Market “cycle” analysis that will help identify even more investment opportunities. Stay tuned… we’ll bring you further announcements on ESP very shortly.

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