Wednesday, September 13, 2006
After a weak rally built on poor volume and breadth, volume followed through yesterday and breadth turned utterly bullish as fund managers worried that they had missed the bottom for the year piled in. The head and shoulders pattern that the QQQQ had been putting together was denied after the index sliced through its 200-day average and closed at a new near term high. We continue to believe that the market is very vulnerable for a correction. However, yesterday's rally (based on dropping oil prices and speculation that the economy is due for a soft, rather than hard landing next year) very likely pushes back the expected correction toward the end of the month or even as late as early October. We are looking for the QQQQ to drift lower toward Friday's options expiration as options sellers "park the car" into maximum pain prices. Maximum pain for the QQQQ is $39 this month. The bottom line here is that you can't argue with the market. Has this rally been built on a poor foundation? Yes. Is it possible that yesterday's strong rally occurred based on spurious reasons? Yes. Can the market continue to rally higher than seems reasonable? Yes. Will it eventually correct and come back to build a better base? Yes.