Summer Rally Heats Up

What a great week for the bulls, we're back in greener pastures again! So far, those forecasts of fantastic earnings have proven true and investors have been in a buying frenzy. Question is, is this bull young and frisky or getting old and tired?

You could argue that this rally has legs, because we have several more weeks of income reporting to go and there is no reason to expect that the majority of remaining earnings will be any less spectacular. What's more, the rally was broad based this week. The S&P 500 increased 2.2%, the Dow Industrials average was up 1.7% and the NASDAQ Composite screamed forward by 5.2% on increasing volume. Each of those indices has broken out of their respective trading ranges. In other words, this rising tide is lifting all boats, a good sign for an extended rally.

On the other hand, bears may have an argument that we are in the waning days of a rally. The NASDAQ Composite and NASDAQ 100 are both very near a key resistance area that could signal profit taking (no - not the 4500 level that CNBC talks about, but we'll get to that later). Also interesting is that we have seen BUYING on good earnings news, instead of the usual selling after earnings. That's likely to change this week because many stocks are now beginning to post large gains in advance of their report, setting up the typical buy the rumor, sell the fact scenario.

Either way, the current broad-based rally is likely to narrow and become more of a stock picker's market as we head deeper into earnings, so be sure to double check the earning schedule for stocks that you own, as well as those of leading competitors. As usual, any rising market will climb the proverbial "wall of worry'.

Friday's Numbers

Retail sales, the Producer Price Index and Industrial Production, the only economic reports worth noting last week, were out Friday and had little effect on the market, other than on financial stocks. Retail sales were stronger than the expected 0.3% increase, coming in at 0.5%, most of that was from strong auto sales. PPI was in-line with estimates, but core PPI was actually weaker than expected at a 0.1% decrease. Industrial Production was the slowest increase in nine months at 0.2% compared to the expected 0.3%.

Benign economic numbers aside, the markets continued their push to the upside. The Dow Industrials (INDU) finished up 24 points to close at 10813. Volume at the NYSE exchange was moderately heavy at 951 billion shares traded and advancing issues led decliners 1586 to 1280.

The NASDAQ Composite (COMPX) gained 71 points to close at 4246. Volume is looking better and better here, at 1.66 billion shares traded Friday. Up issues trounced losers 2183 to 1787.

The S&P 500 (SPX) scored a break above the 1500 resistance area to close at 1509, up 14 points or 0.94%. Friday's rally did not cover all the bases though, since the Russell 2000 (RUT) finished off 0.02%. Not to worry, the RUT was still up 2.6% for the week.

Treasury yields jumped higher Friday and that may have implications for the equity markets if rates continue moving up. With stronger than expected retail sales and rallying technology stocks, bond traders are sensing an increased risk that the Fed may still have another rate increase in store for us. The yield on the 10-year note was up 10 basis points to close at 6.09%. The 30-year bond yield gained 6 basis points to close at 5.87%.

Sector Movements

For an almost unbelievable third consecutive day, Internet stocks have outperformed all other sectors on a percentage basis and lighted the fire on the tech rally. Salomon Smith Barney raised estimates for Amazon.com (AMZN) Friday in a "ride the wave" move to capitalize on momentum in the sector. During those three days, the Street Internet index gained 14% while the CBOE Internet index gained a whopping 25%.

The Philadelphia Semiconductor Index (SOX) reasserted itself Friday following great earnings news from a number of companies, including PMC Sierra (PMCS), Motorola (MOT). Industry leader Intel (INTC) closed at a record high. The Index has now broken out of a short downturn and may reassume its role as the tech bellwether.

The Networking index (NWS) was definitely the overall leader of the tech sector last week, but can it continue? Three consecutive record closes put the polish on a 9% gain for the week. News of the JDS Uniphase (JDSU) acquisition of SDL Labs (SDLI) turned up the heat in what was arguably the hottest sector already. Chasing these stocks in the short term may be a risky move unless you can watch them closely, because they are overextended at this level.

Biotechs rotated out of favor after Tuesday last week. Now they are at trendline support, but have lost support at the 700 level on the Biotech index. If we see weakness in Internets and Networking, we may get a rotation back to Biotechs because the sector is still in a strong uptrend. Otherwise, if they slip further past trendline, next support is at 650.

In the old economy, slow growth, or whatever you wanna call-it arena, drug stocks sunk on profit taking, at least last week. The Pharmaceutical index has violated trendline support, but did stop on the 50-dma so we could see an upward bounce if the tech stocks weaken. Keep in mind though, that we have an ugly looking spread double top in place on the weekly chart, which is bearish for the long term unless the drugs can rally sharply past the 425 level once more.

In other notable sectors, Financial stocks reasserted themselves in a close over 800 on the BKX index, Transports continue to rally (especially airlines), and the Utility index is near a key resistance area at 500, by closing at 498 Friday.

And finally, I would be remiss not to mention that tobacco stocks took another hit with a Florida jury ruling to pay out $145 billion in punitive damages. The news was pretty much priced in these stocks; nevertheless, Philip Morris (MO) was off 0.38 and R.J. Reynolds (RJR) was down 0.94.

Next Week:

Last week I said that it's earnings, earnings, earnings. This time I should say that its earnings to the 10th power. There are far, far too many to list, but the biggies are IDPH and NOVL (Monday), JNJ, MER, TWX, AAPL, BRCM and RMBS (Tuesday), F, EMC, UAL, AMD, EXDS, IBM and QCOM (Wednesday) and AOL, BVSN, SDLI and SUNW (Thursday). Please do not fire off an email chastising me for leaving something out here - there are hundreds! Be sure to double check on stocks you own, and be sure to confirm if they report BEFORE or AFTER the market!

Economic reports will be secondary to earnings news, but there are some important ones this week. CPI will be reported Tuesday morning, Balance of Trade is Wednesday and Housing Starts will be out Thursday.

Going back to those key resistance levels I mentioned in my introduction, both NASDAQ Composite and the NASDAQ 100 charts are sitting just under a 62% retracement. That's a standard Fibonacci level, which is often difficult to break through on the first try. Also note that Stochastic is in an overbought signal which may trigger some profit taking. On the other hand, Momentum, MACD, and volume are very strong and building, which could power the COMPX forward.

The INDU closed above 10,800, which is a level that has been problematic in the past. It also closed above the 150 day moving average. MACD is moving over the zero line, which is bullish. Since this index is composed of so many sectors, the key to continuing this rally will be continued strength in the old growth stocks, which will rely on inflation concerns. Also key is a reasonable (translate methodical) rally in technology. If a frenzied rally develops over in the NASDAQ, the INDU is likely to suffer.

For the next week, bulls are likely to have the better argument, at least for technology issues, because earnings will remain the focus of attention. If profit taking does develop, buying on the dips will probably be rewarded. Be careful not to chase the overextended sectors unless you can watch your stocks closely. Remember that when everyone becomes too bullish, that's often a contrarian indicator that a top is nearby.

Good Luck!
Steve Pekarek
Editor