Stocks: A Fed-Fueled Breakout

With market sentiment turning more favorable, S&P thinks equities could register nice gains by the end of the year

by Mark Arbeter From Standard & Poor's Equity Research

The stock market posted one of its best days in quite some time on Sept. 18, and we can thank the Federal Reserve for that. The Fed cut rates more aggressively than many expected, with both the Fed funds target rate and discount rate falling 50 basis points. Many times, when the Fed is in a rate cutting cycle, the stock market tends to do well. We see no difference this time.

The S&P 500 closed up 2.92% on Sept. 18, its largest gain since March, 2003, just when stocks were finally coming out of the bear market. The Russell 2000 jumped 3.97%, its biggest advance since October, 2002. The S&P Financial SPDR (XLF) rose almost 4%, and we believe is very close to reversing its nasty downtrend. The Materials SPDR (XLB) was the strongest of the ten S&P sectors, up 4.7%.

Most important, in our view, was the technical breakout by the S&P 500, and many other indexes. The "500" broke strongly above stiff chart resistance in the 1490 to 1504 zone, and finally completed a complex head-and-shoulders (H&S) reversal formation. The index now sits in a zone of chart resistance that runs up to the 1540 area, but we think this will be overcome with little problem. Then the index should have its sights set on the July 19 all-time high of 1553.08.

With the completion of the inverse H&S, the S&P could have a measured move to the 1600 level. This is based on the width of the pattern.

Other indexes that completed their bases and broke out on Sept. 18 include the Dow Jones industrials, the Nasdaq composite, the Russell 2000, and the S&P MidCap 400. Volume on the NYSE and the Nasdaq was not explosive, as the market had less than two hours to react to the rate cuts; however, it was a lot heavier than recent days. In addition, advancing volume vs. declining volume was very strong on both exchanges as was advancing issues vs. declining issues.

With the sentiment backdrop favorable for stocks for the next couple of months, we think the typical seasonal strength during the last quarter could propel stocks to very nice gains by the end of the year.

Arbeter, a chartered market technician, is chief technical strategist for Standard & Poor's .