Restrained Rally Slowly Emerging

To anticipate trading over shorter periods, I rely on both the market's internal quantitative data as well as other technical signals. These have been modestly encouraging, with only a few exceptions -- including weak market breadth, which Helene Meisler has examined in detail.

This buying juncture is not ideal. Although it hasn't fully gelled yet, I am becoming increasingly more comfortable shifting toward a bullish posture, for however brief a time period that may be.

I would become even more aggressive if not for several fundamental factors that counterbalance these quantitative improvements. These include more restrictive monetary policy and increasing fiscal budgetary pressures, which suggests a rising likelihood of either higher taxes or less deficit spending, or both.

Despite this not-quite-perfect floor, most of the elements are slowly coming together to support at least a modest year-end rally. My analysis suggests that traders and index buyers can get long over the next few weeks, with a projected top in mid-December.

What's the basis for this? My key positive factors include:

Nasdaq short interest: This hit a record high last week. Historically, extremes in shorting -- most especially when done by odd-lotters -- occur fairly close to intermediate bottoms.

NYSE thrust sessions: A thrust session occurs when the New York Stock Exchange's decline-to-advance ratio is 2-to-1 or greater, and simultaneously has a similar ratio of up/down volume. Present thrust session levels are similar to those previously reached in May of this year, June 2004, and March 2003 -- all high-fear junctures that were near intermediate-term bottoms.

Nasdaq 52-week high-lows: As the chart below shows, the cumulative high-low index has reached levels that in the past have been good buying junctures. Do note, however, that this most recent peak is much less severe than prior periods that formed better bottoms. That implies a more modest bounce off of the lows.

Going to Extremes The spike in Nasdaq 52-week lows has reached levels that in the past have been good buying junctures.

Click here for larger image.

Source: Redwood Technimentals

Moderating bullishness: One measure of bullishness I like is the American Association of Individual Investor's sentiment index. It was 51.4% a month ago, sliding to 43% and then 32% this week. Ideally, I like to see this in the teens or even low 20s, but it is still apparent that some of the excesses have been rung out. The moderate number is why I can imagine the bottoming process taking a bit longer, and also why I am not looking for a monster rally.

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