Market Shoots Off Fireworks Early - TheStreet

Market Shoots Off Fireworks Early

Bulls still rule, as the Nasdaq hits a 52-week high and the volume is solid.
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Stocks started strong and finished solidly higher Wednesday, another demonstration of the market's underlying strength heading into the July Fourth holiday weekend.

The

Dow Jones Industrial Average

rose 1.1% to 9142.84, the

S&P 500

gained 1.2% to 993.76 and the

Nasdaq Composite

climbed 2.4% to 1678.77, its highest close since May 23, 2002. The Comp bested its June 18 closing high of 1677.14, although it couldn't surpass its June 19 intraday high of 1686, which is now the next upside target for the index.

At nearly 1.5 billion shares on the

NYSE

and more than 1.8 billion in over-the-counter activity, trading activity was solid, especially given the forthcoming holiday closure. Reflecting traders' continued bullishness, up volume was 82% of the Big Board total and over 86% of over-the-counter trading.

A key to the rally was ongoing relief on Wall Street about Tuesday's decision by a federal judge to dismiss a class-action lawsuit against Merrill Lynch.

The decision is not good news for investors who felt burned by tainted research of bubble-era icons such as Henry Blodget and Mary Meeker. But Wall Street rejoiced, as the decision lessens the risk of firms having to pay billions to settle similar lawsuits. Such payouts inevitably would lead to more layoffs, which most traders find unpalatable. Brokerage stocks advanced for a second consecutive session, with the Amex Broker/Dealer Index rising 1.5%.

Merrill gave the market another boost Wednesday by more conventional means, upgrading shares of Dow components

Microsoft

(MSFT) - Get Report

and

Wal-Mart

(WMT) - Get Report

. Shares of Microsoft rose 2.8% and Wal-Mart gained 1.4%.

Big Cap on the Rise?

In the rally since last October's lows, mega-cap stocks -- especially Microsoft -- were laggards compared with rampaging small- and mid-caps. The next phase of the rally, assuming it continues, may be led by the market's so-called generals, especially because many small- and mid-sized companies have become technically overextended after some huge percentage gains. Furthermore, money managers -- especially pension fund administrators -- may crave the relative safety afforded by large-caps.

"That might happen, there's nothing to preclude it

and it's valid speculation," said John Bollinger, president of BollingerBands.com in Manhattan Beach, Calif. "But there's no evidence of it yet."

Bollinger, a

longstanding bull on small- and mid-caps, noted the market's so-called soldiers have outperformed the generals in the past three or four weeks, "and again today." The newly reconstituted Russell 2000 Index rose 2.2%.

That said, Bollinger noted how savvy investors always look for alternative scenarios to what's currently happening. Outperformance by big-caps is one script he's currently looking out for. In that light, he noted Microsoft "has been behaving pretty well, not fabulously, but pretty well." A close significantly above $27 -- vs. Wednesday's $26.88 -- would establish a midterm breakout for the stock, he said.

Another scenario Bollinger is watching for is one in which the market, after suffering a bit of consolidation the past week or so, "takes off for a couple of weeks and then flounders."

Such an outcome would fit Bollinger's own analysis of seasonal factors, which is a bit more nuanced than the "best/worst six-months" time frame popularized by

The Stock Traders' Almanac

. According to Bollinger's work, the market's historic seasonal weak point begins in mid-July, and flattens out in September before accelerating down again in October.

Late-Summer Swoon
A look at the S&P 500's seasonal patterns from 1960 through 2002 suggests weakness most often occurs from late July until late October. In other words, pretty soon

Source: www.bollingerbands.com

As the chart demonstrates, Bollinger found the market's weakest period from 1960 through 2002 occurred from around the 200th day of the year through just past its 300th. (Today is the 184th day of the year.)

So, "July is a good time to think about exiting

stocks and late October is a good time to think about entering," he said. By comparison, the best/worst six-month strategy recommends being long stocks from Nov. 1 to April 30 and out from May 1 to Oct. 31. (Notably, both methodologies suggest weakness ahead for major averages.)

Seasonal issues aside, Bollinger's scenario of another few weeks of strength followed by late-summer weakness also would provide the market with an opportunity to do what it does best: frustrate a majority of participants.

Many traders are expecting shares to roll over (and play dead) after the July Fourth holiday weekend. More strength beyond that would frustrate those betting against the market. Such an outcome also would likely embolden the optimists, setting them up for disappointment later this month.

Speaking of optimists, Chartcraft.com's

Investors Intelligence

survey found bullish sentiment fell to 52.1% from 59.4% the prior week. Bearish sentiment rose to 20.9% vs. 17.7%.

Kibbles & Tid-Bits

In other news,

PeopleSoft

(PSFT)

announced it will beat guidance for the second quarter, and its shares rose 0.9%. Conversely,

Baxter International

(BAX) - Get Report

fell 2.2% after warning its result will miss expectations.

On the macro front, a better-than-expected factory orders report helped further the rally in shares, although Treasuries managed to close higher in tandem. The price of the benchmark 10-year note rose 4/32 to 100 24/32, its yield rising to 3.53%.

In a note very much related to recent weakness in Treasuries and strength in stocks, Goldman Sachs reported on its new "equity-credit premium," or ECP, Wednesday. The metric compares returns on equities vs. corporate bonds and Treasuries, rather than just Treasuries, as is common in equity-risk premium calculations.

"For the first time since 1996, the ECP is back around its historical averages, suggesting that much of the valuation gap that opened up between credit and equity markets over the last five years may now have closed," Goldman reported.

In other words, stocks are attractive relative to fixed income.

The report didn't address the issue of

absolute

valuations, and many contend that both stocks and bonds are expensive. But it did ask the burning question: Can policymakers "successfully underwrite a growth recovery while preventing a spike in yields?"

If that mission proves impossible -- as many bears contend -- "then delivering further positive returns on both equities and corporate bonds would become harder," Goldman concluded.

In the meantime, the possible negative effects of rising bond yields seem lost on equity traders, who again expressed their desire to own shares on Wednesday.

Tune-In TaskMaster

I'll be participating in a discussion of recent stock market activity on Boston public radio's "The Tom Ashbrook" show tonight at approximately 7 p.m. EDT/4 p.m. PST. Other participants include Yale professor Robert Schiller and Bret Swanson, executive editor of

The Gilder Report

.

Check out

www.WBUR.org for Webcasting and other details.

Also, I'm doing the one-minute market wrap for "Jim Cramer's RealMoney" radio today and tomorrow.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task