Securities Research Services

Monday, July 02, 2007

Tops Aren't Built on Fear

We start off the week faced with an extremely mixed situation. As noted in our last report, the SPY is set up exactly the same way the XLU was on June 01, right before its slide. That is, it made a trend breaking leg down, bounced back up to its falling 20-day average, and then made a sharp leg down during the next week. The SPY, and also the DIA, have both bounced back up to tag their falling 20-day averages in similar fashion. Will they also now slide? That's the big question.

Frankly, we don't have an answer. Sentiment readings tell us that there are too many betting on a slide for it to occur. The S&P (or SPY) have seen consistent overly bearish put:call ratios over recent weeks. In fact, on Friday, the SPY had a ratio of 3-1 and the SPX had a ratio of 2-1. Two to one is considered overly bearish and contrarians start looking for a bounce at that point.

While we don't know what is going to happen, here is what we think will happen:

Take a look at the weekly QQQQ.

The QQQQ has broken out of a large cup and handle formation and has been base building above the breakout for the past 6 weeks.

The SPY broke out in similar fashion last October.

In other words, the QQQQ is now playing catch up with the broader market.

Now, take another look at the two charts. The QQQQ, on top, has trend support at roughly $47. We could potentially see the QQQQ maintain its current trading range for another few weeks as it moves horizontally over to its uptrend line.

The SPY, on the other hand, is further away from its current trend, and has broken its more immediate and sharper uptrend. We could then see the SPY make a minor correction back to the $147 area while the QQQQ trades relatively flat.

The bottom line, we have been reading whispers of a major market top forming, but the long term charts just do not support this at this time. Likewise, overly bearish sentiment does not support this either (remember, market tops are not built out of fear, but on enthusiasm). Most likely, based on the charts, we are looking at another few weeks to flat, to slightly negative trading, followed by a resumption of the major trend.

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