Bernanke Breakout Spurs New Bull Run

10/01/2007 12:00 am EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Larry McMillan, editor of the Option Strategist, says the rally that followed the Federal Reserve's recent rate cut looks solid, and a new leg of the bull market may have begun.

Thanks to Mr. Bernanke, the stock market broke out of its trading range on the up side. This breakout was accompanied by positive readings from our technical indicators, so we are inclined to say that a new leg to the bull market has begun.

[Rate cut] Tuesday's massive rally pushed most indices to new relative highs-if not new all-time highs. These rallies overcame resistance on most of the charts, and that is why it's considered to be an upside breakout.

Specifically, the Standard & Poor's 500 broke out over the 1490 resistance level and also exceeded the 1505 closing high of August. We have also been watching the Russell 2000 Index, and it broke out by closing above 804.  Any pullbacks should find support there or higher.

The equity-only put-call ratios are bullish. They gave buy signals a few weeks ago and have remained bullish ever since. They will retain that bullish status as long as the lines are declining on their charts (Figures 2 and 3), and that seems likely to continue for a while.

Market breadth (advances minus declines) reacted very positively to the upside move this week, as you might expect. As a result, both breadth oscillators quickly reached overbought territory. This is to be expected on the first leg of a new bull market-the key is that they continue to be overbought. As long as that is the case, the bulls are in charge. However, if the oscillators fall back to neutral or negative status, giving sell signals, early in the breakout phase, that would not be good.

Finally, the volatility indices (VIX and VXO) collapsed with the rally. Part of this collapse was due in any case, as VIX was very inflated going into the Fed [meeting] and would have thus declined somewhat no matter where the market went on Tuesday. But the fact that VIX broke down to near the 20 level, coupled with the fact that the 20-day moving average of VIX is finally declining once again, are positive signs that place VIX on a Buy signal. Note that there have now been two $VIX buy signals since August, and there are usually two such signals before the market moves strongly higher (the most recent example being last March).

In summary, this breakout appears to be the real thing. There will be naysayers, of course, and the month of October is not often friendly to bull markets, but as long as the S&P continues to close above the 1490 level, the bulls are in charge.

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