Looking for Market Leadership

There's been some hope that the software sector can set a positive tone after the Microsoft (MSFT - commentary - Cramer's Take) news. Perhaps the group can mount a charge toward the fourth quarter. As of today, Software HOLDRs (SWH - commentary - Cramer's Take) is still at the same levels it was in August 2003 -- flat for nearly a year.

The preannouncement period this quarter made it clear that too many firms are chasing too few contracts. The sector's best shot is for a flurry of buying in the fourth quarter, as firms race to take advantage of the sun-setting accelerated depreciation rules. There are hopes for a melt-up -- similar to what we saw pre-Y2K -- as companies take advantage of the dissipating tax benefits.

Promising Technical Signs

With the generals AWOL, I've been looking somewhat askance at my favorite technical indicators. They are approaching levels that typically get me all hot and bothered -- yet I've been hesitant to make a call for an impending reversal. Why? Markets need some leadership in order to mount a sustained rally. Here's what I've been focusing on:

The Arms Index: The 10-day moving average has passed 1.7, strongly suggesting that a reversal is imminent. The caveat is that this normally reliable indicator became less so during the heart of the bear market. I usually give this indicator a heavy weighting in my model. Because the most recent selloff is more akin to a retracement than a collapse, I'll say this is strongly bullish.

Consensus Awaiting a Rally: There seems to be a uniform belief that a rally will occur -- but not until after the summer or the Democratic convention. That's exactly the sort of groupthink that the market seems to delight in disproving. If a reversal were to occur, I'd expect it to take place sooner than later, as the crowd expects. That's also bullish.

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At the time of publication, Ritholtz was long Microsoft, although holdings can change at any time.

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].