2005: A Move Higher, Until...

The Swing Trader's view of the market suggests new highs, followed by consolidation.
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The market should move higher next year, but don't expect a repeat of 2003's bullish advance. The economic expansion may run out of gas in the months ahead, and the next recession could emerge in the next 24 to 48 months. In turn, this might trigger the next leg in the secular decline that began almost five years ago.

Past price action can predict the market's future with great accuracy. As it turns out, the fall rally is sitting just above levels that have triggered key reversals in the past, and despite the current euphoria, it may not be any different this time around.

Let's rewind a few years and examine the crosscurrents moving the ticker tape at that time. I believe that volatile time period holds the key to market direction next year.

The first wave of the bear market dropped the

S&P 500

index to the March 2001 low at 1081. The 22% rally that followed the low had folks thinking the correction was over. In fact, the

Dow

came within striking distance of its bubble high by May of that year.

But the move fizzled out, and the indices began a long decline back to their March lows. I still remember how the S&P 500 bounced strongly on the day it returned to this price level. That was Sept. 10, 2001, and the solid close had traders expecting a rally to start the next morning. Of course, things didn't turn out that way.

The market started a new advance when it reopened on Sept. 17. This move took the averages back above their March 2001 lows, and again raised hopes for a renewed bull run. But the post-Sept. 11 recovery lost its footing in December when the S&P 500 rolled over at 1173.

The S&P 500 retraced exactly 62% of its May to September decline in the post-Sept. 11 bounce. This Fibonacci ratio represents a common failure swing for a rally in an ongoing downtrend. Also note how the three highs at 1173 and two lows at 1081 fit into the broad retracement pivots.

The averages rolled over again in March 2002 and started the worst phase of the bear market. This decline accelerated when support at the post-Sept. 11 lows broke down. In hindsight, we see that this broken level became the upper pivot for a triple bottom that finally ended the bear market.

More importantly, price levels traversed after Sept. 11 are now back in play. The S&P 500's January rally to 1163 was just a few points off the post-Sept. 11 recovery high. The index returned to this pivot last week, hitting 1171 before pulling back. It's likely this major resistance will test the current rally in the same way it did three years ago.

Last January's reversal showed the continuing influence of the post-Sept. 11 highs. But traders should also note how the converging March 2001 and February 2002 lows supported the S&P 500 index throughout this year's sideways market. It's humbling to acknowledge these pivot points now, considering how quickly we forgot about them during the March, May and August selloffs.

Obviously the index took on a bullish appearance when it broke the declining trend line that marked this year's pullback. But it's foolish to expect that we're headed back to the 2000 bubble highs. In fact, folks buying the market at these price levels may find a target on their backs in the next month or two.

Admittedly the big picture has changed considerably in recent weeks. The weekly S&P 500 chart now shows an inverse head-and-shoulders breakout that triggered the next leg of the rally that began off the August lows. But notice how neckline resistance developed right across the 50% retracement of the entire bear-market decline.

This suggests the current bull impulse will reach key resistance between 1250 and 1300. This follows my long-term prediction that the averages will hit new highs in 2005, but this advance will start a long-term consolidation, or even the end of the bull market.

In any case, don't expect this rally to resurrect 2003's sharp uptrend. In fact, it may yield just a modest increase over recent S&P 500 closing prices. This outlook also portends continued weakness in the tech sector, marked by the chip sector's continued failure to overcome the inventory glut that has undermined profits.

Specifically, chip stocks are in bear-market declines that could weigh on the

Nasdaq

averages next year. While inflows into a number of market sectors support their leadership in the months ahead, strong rallies require very broad participation. That may not be in the cards for the semiconductors in 2005.

Alan Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. At the time of publication, Farley did not have any positions in any of the stocks mentioned in this article, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to

Alan.Farley@TheStreet.com.

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