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Bounce Back in Rally's Step

Falling bond yields and overall bullish sentiment send major averages sharply higher.
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An impressive afternoon bounce in stocks on Thursday showed the rally off the October lows still has some juice. And there is growing hope that strong holiday sales will justify all the rising hope for a full-blown fourth-quarter rally, as discussed


Heading into the session "rallies appear(ed) to be having a difficult time at making upside progress" and "remain(ed) vulnerable to pullbacks over the next few weeks," Mark Newton, technical analyst at Morgan Stanley, wrote Thursday morning. But, he added, a close above Wednesday's highs would suggest further gains.

Well those higher highs materialized Thursday, spurred by a successful auction of 10-year Treasury notes, which alleviated pressure on stocks from rising bond yields.


Dow Jones Industrial Average

rose 93.89 points, or 0.89%, to 10,640.10, above Wednesday's intraday high of 10,637. The blue-chip average was originally pressured after

General Motors

(GM) - Get Free Report

said it would restate its earnings.

But support was found for the Dow and the

Nasdaq Composite



(INTC) - Get Free Report

raised its dividend and added $17 billion to its share-buyback authorization. This also helped counter

Cisco Systems'

(CSCO) - Get Free Report

lackluster guidance. The Nasdaq gained 20.87 points, or 0.96%, to 2196.68.


S&P 500

, meanwhile, rose 10.31 points, or 0.84%, to 1230.96. Having rallied 4.6% from its Oct. 13 low of 1176, the S&P is now well above a key technical resistance at 1220 and slightly above 1228.81, where it stood on Sept. 30.

The Nasdaq rebound has been even more impressive. It's now 7.8% above its Oct. 12 low of 2037.47. It's also well above its Sept. 30 level of 2151.69. The Dow, for its part, is now 4.1% above its Oct. 13 low of 10,216.59 and also well above 10,568.78, where it stood on Sept 30.

In "rally mode," which the market has been in since mid-October, former reasons to sell -- such as inflation fears and a hawkish

Federal Reserve

-- are turned on their head. Now, the market is showing a not-as-bad-as-feared response to the news, as was evident Thursday.

Stocks rallied after news that the Treasury's auction of 10-year bonds showed strong participation from indirect bidders, which include foreign central banks; the 10-year demand contrasted weak indirect bids at auctions of three- and five-year notes earlier this week. Bonds, which have been headed down for two months, rallied sharply in reaction. The 10-year Treasury gained 20/32 while its yield, which moves inversely to price, dipped to 4.56%.

Bond yields had been rising convincingly in recent weeks, on expectations that the Fed will lift rates further than thought previously. Despite the stronger premium for buying bonds, the current bounce in stocks was not derailed, evidence of the bulls' willingness and eagerness to buy. As yields fell sharply, such emotions were unleashed Wednesday, as reflected in strong market internals.

Advancing stocks led decliners 19 to 13 in Big Board trading, where 2.4 billion shares changed hands. Gainers led 3 to 2 in Nasdaq trading where 2 billion shares were exchanged.

But "the bounce has about run its course," says Woody Dorsey, founder of Market Semiotics. Thursday's advance notwithstanding, he notes the major indices had begun to show flattish action in recent days.

There should be more of the same over the coming weeks, Dorsey says, as seasonal market expectations of a fourth-quarter rally continue to battle structural concerns such as rising interest rates, inflation and a likely resurgence of energy prices as we head into the winter heating season.

"The twist is that December is not bullish this year," Dorsey says. "Investors will try to hang on but it will disappoint people who think we'll get the same rally as we did last year."

The founder of Market Semiotics had forecast to the day the bounce from the October lows, as reported

here. He had also forecast that crude oil prices would trade in the "high $50s," which would also serve as somewhat of a catalyst for stocks. Crude futures closed down $1.13 to $57.80 a barrel Thursday, its lowest price since July.

But the S&P will not breach its 2005 high of 1245.03, Dorsey says, repeating a forecast first made

here on Aug. 19.

Not all is dark for stocks in the medium term, as the 2005 highs will again be tested during a rally in January of 2006. But beyond this, Dorsey sees "a serious collapse."

The decline, he says, will be something in the range of 10% to 15%, which is "something to write home about." Just like there was a March and April "avalanche" in 2004, this will be another huge drop, according to Dorsey, but the market won't bounce back as robustly this time.

"You do have rising interest rates, increasing inflation, some slowdown in the economy, we still have an energy crisis, increased deficit spending, and we're waging two wars," he says. "This is not the kind of environment where you get great stock returns."

So much for doom and gloom: there is still hope to be found next year if one invests in commodities, including energy, which remain in a bull market, even though the smart money is "blase about it" at the moment, Dorsey says.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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