Heading Higher, Markets Pause for a Breather

Reading between the lines of the Fed meeting transcript may have prompted some caution.
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SAN FRANCISCO -- The TVs are on the blink here but somehow I suspect Al Goldman of A.G. Edwards is using the term "pause that refreshes" to describe today's action. I'm being facetious, but it says something about the market's recent performance and the state of market psychology that there was little concern evident as major averages fell noticeably from intraday highs.

But fall they did. Once as high as 9721.75, the

Dow Jones Industrial Average

closed up 0.4% to 9587.52, failing to sustain a move above its Sept. 10 close of 9605.51. The

S&P 500

finished up 0.3% to 1118.54 after trading as high as 1135.75, while the

Nasdaq Composite

shed 0.5% to 1827.77 after trading as high as 1888.30.

As I noted in

RealMoney.com's

Columnist Conversation, no excuse was necessary for the market to shed some of its recent gains. Still, the downturn appeared to be timed to the release of the

minutes of the Federal Open Market Committee's Oct. 2 meeting. Apparently, some market participants were taken aback by the following: "Looking ahead, the members generally saw a relatively mild and short contraction followed by a gradual recovery next year as a plausible forecast but one that was subject to an unusually wide range of uncertainty, notably in the direction of a potentially much weaker outcome in the nearer term."

The

Fed

minutes also noted that monetary policy "could be reversed in a timely manner later should stimulative policy measures and the inherent resiliency of the economy begin to foster an unsustainable pace of economic expansion," perhaps causing some investors to think about Fed tightening down the road. But the Fed would do so only if the economy were to begin overheating, which it's a long way from doing.

Another potential catalyst for the reversal was

Advanced Micro Devices'

(AMD) - Get Report

midday announcement that its return to profitability is likely to be delayed until the second quarter of 2002. AMD, which had rallied 43.4% from Oct. 30 through yesterday, slid $1.10, or 8.3% today.

Notably, the Philadelphia Stock Exchange Semiconductor Index fell 2.3% to 507.45 after trading as high as 545.19. Early on, the SOX was (dare I say it?) en fuego after the Semiconductor Industry Association forecast industry revenue growth of 4.7% for the fourth quarter and 6% for next year. Additionally, Salomon Smith Barney added

Intel

(INTC) - Get Report

(INTC:Nasdaq - news - commentary - research - analysis) to its recommended list, replacing

Texas Instruments

(TXN) - Get Report

. (Still, Texas Instruments is also a SOX component and actually has a bigger weighting in the index, which is price-weighted.)

Indeed, the semi index proved an apt example of what transpired in the market overall. The session had all the earmarks of another day of solid gains in the wake of rate cuts from the European Central Bank and Bank of England, an unexpected drop in weekly jobless claims, the aforementioned SIA news, plus some not-as-horrid-as-feared retail sales data.

But it seemed that after rising recently despite an avalanche of negative news, the market simply couldn't stomach positive developments. Still, it's almost always unwise too make too much out of any one session, and today's action falls well into the category of normal.

"When you have a breakout as we just had, what you typically get is a pullback to the level at which we broke out," said John Bollinger, president of Bollinger Capital Management in Manhattan Beach, Calif. "The expectation should have been that the rally would run into a little trouble, and the most logical place is shortly after the breakout."

Bollinger mentioned the S&P 500's break above 1100 on Tuesday while the Dow's temporary eclipse of its Sept. 10 close also fits the bill.

After falling back, a stock or index that has recently eclipsed a key level typically heads back into its trading range and then will resume its rally, he continued.

However, "nothing about this market requires rushing in," Bollinger said, because "we have not had a single sign of strength since the lows" on Sept. 21 from a technician's point of view, price appreciation notwithstanding.

Specifically, he defined a "sign of strength" as:

A day of greater than average price gain and/or range (i.e. a big recovery from an early selloff);

A day in which advancers wallop decliners and/or up volume bests down volume by a 9:1 ratio;

A "psychological event" such as the indices moving above key moving averages and/or taking out downtrend lines.

Of course, the latter has indeed occurred (see above), and the S&P's move above 1100 caused Bollinger to up his allocation to stock to 60% from 50%. But "we've only had pieces of the puzzle," he declared. "The reason we haven't been more aggressive is we're worried about the idea of a retest. Typically markets do not bottom in the shape of a capital letter V."

The last time the market did pull such a trick, in the fall of 1998, Bollinger recalled, there were two "monstrous up days" that signified strength that has yet to assert itself in the current cycle.

Bollinger's comments support the outlook I expressed

yesterday (though it was apparently lost on some readers): that a short-term advance should not be confused with the start of a new, sustainable bull market.

Similarly, that remains the view of John Roque of Arnhold & S. Bleichroeder, about whom several readers have inquired.

"I think what we've encountered is an eye-opening, amazing rally but I still don't think it's the beginning of a bull market," Roque said, though he admitted being "too cautious" heading into this move.

Looking ahead, the technician (and occasional

RealMoney.com

contributor) said how the markets (and investors) react to today's pullback will be telling. Still, he believes the next "corrective phase" will be "rotational" rather than all-encompassing.

As originally published, this story contained an error. Please see

Corrections and Clarifications.