Good News Bounty Lifts Shares

The S&P finally breaks resistance at 1225 while the Nasdaq hits a new 2005 closing high.
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Strong earnings from

Apple

(AAPL) - Get Report

and

Advanced Micro Devices

(AMD) - Get Report

, along with strong retail sales and tame inflation, helped power the

S&P 500

to a four-year high and the

Nasdaq Composite

to a new closing high for 2005.

Big gains were seen at the opening of trading. But the upside remained capped through midday trading, and it took sheer will from the bulls -- and the weight of selected large-cap stocks -- to push the major indices to finish convincingly higher.

Perhaps in a sign of changing times, the biggest gains were seen on the

Dow Jones Industrial Average

, which rose 71.50 points, or 0.7%, to 10,628.89 after trading as high as 10,657 intraday.

Large-cap stocks are making a comeback in this rally. Apple's and AMD's earnings helped lift the big-tech names on the Dow, such as

Hewlett-Packward

(HPQ) - Get Report

,

IBM

(IBM) - Get Report

,

Intel

(INTC) - Get Report

and

Microsoft

(MSFT) - Get Report

.

The S&P 500, meanwhile, closed up 3.21 points, or 0.26%, at 1226.5, finally breaking through the key resistance level of 1225. However, the index ended off its intraday best of 1233.

The Nasdaq Composite advanced 8.71 points, or 0.41%, to 2152.82 after trading as high as 2164.

Volume was solid, with over 2 billion shares traded on the

Big Board

and 1.9 billion on the Nasdaq, but declining stocks outweighed advancers while small- and mid-cap indices ended in arrears -- a negative technical divergence given the positive fundamental data.

The decline of crude oil -- which closed down $2.21 to $57.80 a barrel on Nymex -- took the steam of energy shares, such as

ConocoPhilips

(COP) - Get Report

. Meanwhile, many investors dropped the safer dividend-yielding stock to join in the party in techs and big-cap shares.

Big Cap Bonanza

The resurgence of big-caps can also explain the limited participation, as reflected by the negative market breadth. The S&P Small-Cap 600 index fell 0.6% while the S&P MidCap 400 shed 0.3%; both indices recently hit all-time highs.

As mentioned

here Tuesday, J.P. Morgan market strategist Abhijit Chakrabortti believes the valuations of small-caps are now less attractive than their large-cap counterparts. He predicts, however, that a full reallocation into large-caps will need a catalyst. This catalyst, he says, could be the market's realization that the

Federal Reserve

will need to continue raising rates past current market expectations.

Historically low interest rates have helped fuel interest in smaller companies, which rely more on debt than their big-cap counterparts. But as the Fed continues to raise rates, "risk appetite is reduced and sector allocation preference becomes less cyclical, small caps should cease to outperform," Chakrabortti wrote.

Perhaps the shift is already starting to happen. Traders had been on the lookout for a catalyst to push the S&P 500 to new highs, and on Thursday, they received plenty of catalyzing candidates.

If Apple and AMD's earnings weren't enough, the market also got a perfect combination of economic data -- strong retail sales and tame consumer price inflation in June.

Friday brings

General Electric's

(GE) - Get Report

earnings, which are often used as a broad market benchmark, and consumer confidence data for June. Both could serve as catalysts for more gains, according to Marc Pado, market strategist at Cantor Fitzgerald.

And next week, key earnings from more tech giants such as

Yahoo

(YHOO)

,

Google

(GOOG) - Get Report

, and Microsoft should take the relay from the feel-good effect from Apple and AMD, he says.

A Convincing Case

All this makes a convincing case for the S&P 500 to continue powering ahead, instead of succumbing to "performance anxiety," as it did back in March, the Cantor strategist believes.

When the S&P 500 first tested four-year highs in early March, the market had come off a long uptrend from the previous year and was really running out of reasons to push higher. It started heading south two days later, having received no "confirmation from the Nasdaq," Pado says. And March through May is usually a period to make new lows, so these new highs weren't in keeping with normal seasonal patterns, "creating some anxiety," he says.

This time it's different. As the market enters the second-quarter earnings season, expectations for S&P 500 earnings growth at 7.5% are fairly low, and "so far, we're not really seeing anything in the way of disappointments," Pado says.

Under the spell of the current momentum, big questions such as the Fed continuing to lift rates, oil prices at $60 per barrel, and trade tensions with China "are on the backburner during earnings season," the strategist says.

With enough catalysts to fuel further gains for the next several weeks, these issues may come back to haunt the market in late July and August, he predicts.

Thursday's economic data, as with other June data, are very positive but are not taking into account the renewed surge in oil and gasoline prices.

June retail sales rose 1.7%, almost twice the rate economists had predicted. Excluding auto sales, retail rose 0.7%, also beating the consensus estimate of 0.5%. "We need now to see how surging gas prices affect July and August," says Ian Shepherdson, chief U.S. economist at High Frequency Economics.

Similarly, consumer inflation may worsen as crude oil prices have bounced back since late June. The June CPI was unchanged, and the core CPI, which excludes energy and food prices, rose 0.1%. Both numbers were expected to rise 0.2%. Headline inflation was depressed by a drop in gasoline prices and unchanged food prices. "The former will rebound in July," Shepherdson says.

And even if core inflation remains very tame -- it was unchanged in April and rose 0.1% both in May and in June -- "current inflation is not the Fed's main concern," the economist says. "The issue is what 4% unit labor costs will do for core inflation next year."

The bond market, it seems, has caught up to the Fed's plans after a flurry of Fed speakers hammered home that message since last week. The benchmark 10-year Treasury bond fell 4/32 in price while its yield advanced to 4.18%.

To view Aaron Task's video take on today's market, click here

.

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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