What a Week: Almost Unbreakable

The rally looked unstoppable until Friday. The Dow has hit record highs in 13 of the past 19 sessions.
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Like the hurricanes in

The Day After Tomorrow

, the stock market grew more forceful every day this week, surpassing technicians' expectations for a natural, healthy, pullback -- until Friday at least.

The weak 1.6% third-quarter GDP estimate wasn't the cause of Friday's decline. The data reflected weakness the market already knew about and reconfirmed investors' belief the

Federal Reserve

won't tighten anytime soon, a view reflected in the fed fund futures market.

Housing data weren't the catalyst either. Housing news this week presented a mixed bag of weak existing-home sales, rebounding new-home sales, stabilizing inventory levels and the largest drop in the median price of a new home in 36 years.

The housing news came Wednesday and Thursday as the

Dow Jones Industrial Average

marched to two more new highs. The selling catalyst couldn't be earnings, which so far show a 17.4% increase in profits year over year, although

Ingersoll-Rand

(IR) - Get Report

was a notable miss on Friday.

The pullback Friday was not huge, but spanned the three major stock market averages. The Dow fell 0.6% on Friday, but still registered a 0.7% weekly gain and remained above 12,000 throughout the week, closing at 12,090.26. Prior to Friday, the Dow had set record highs in four straight sessions and 13 of the past 18 trading days.

The

S&P 500

fell 0.85% Friday, but added 0.6% on the week, closing at 1377.34. The

Nasdaq Composite

fell 1.2% Friday, but gained 0.35% for the week to close at 2350.62.

The market's internals were strong this week. The number of new highs on the

New York Stock Exchange

has been steadily increasing day by day, to reach 431 new highs on Thursday, compared with just nine new lows. The average number of daily new highs this year is 148. Thursday's new-high reading is impressive compared with the usual day in this rally. The 10-day moving average of NYSE new highs is 294. Open interest in the S&P 500 futures contracts expanded every trading day this month until Thursday, when that level dropped slightly.

Whether driven by Goldman Sachs' negative call on semiconductors or just a bit of profit-taking after a big run, the post- 2 p.m. decline Friday might be the pullback some investors have been waiting for.

"Anyone would say there should be a pullback here," says John Roque, market technician at Natexis Bleichroeder. "We've been pretty much straight up since August."

When the market was weak this summer, Friday afternoons were frequently strong as short-covering caused week-ending jumps, notes Michael Driscoll, director of listed trading at Bear Stearns. Maybe with most investors long stocks, the opposite is going to be true now.

Indeed, any weakness in the market has been well-received as a new buying opportunity for those nervous investors who sat out the rally early on and remain hungry for a good moment to get back in.

"I think the frustrating part for someone who's been through the wars is that you tend to distrust the ability of the market to make an uninterrupted move up," Barry Hyman, equity market strategist at EKN Financial, said earlier this week. "I'd just like to buy some pullbacks and they don't come."

Hyman might have a chance right here.

The semiconductors and the tech sector fared particularly poorly Friday on Goldman Sachs' warning of waning demand for motherboards. Shares of technology players fell, including 1%-3% declines in

Advanced Micro Devices

(AMD) - Get Report

,

Intel

(INTC) - Get Report

,

Texas Instruments

(TXN) - Get Report

, and

Dell

(DELL) - Get Report

.

The Philadelphia Stock Exchange Semiconductor Sector Index dropped about 2% on the day and the

Merrill Lynch Semiconductor HLDRs

(SMH) - Get Report

exchange-traded fund fell 2.56%.

Broadly, the market held up well under the week's weak economic news, which was capped by the first third-quarter GDP estimate. The 1.6% growth in the third quarter fell short of consensus expectations for 2.1% growth. The slowdown was contained to drags from a 17.4% contraction in residential investment spending -- a.k.a. the housing market -- and the record-setting trade deficit.

Indeed, many parts of the economy accelerated in the third quarter, which bodes well for fourth-quarter growth if housing shows signs of bottoming. Consumer and business spending as well as disposable income accelerated in the third quarter. Excluding the trade deficit and housing, GDP expanded at a 3.2% pace, writes John Lonski, chief economist at Moody's Investors Service.

"Because the third-quarter slowing of real GDP was not broadly distributed, it probably exaggerated any softening of the U.S. economy's fundamentals," writes Lonski.

The bond market didn't really take that message to heart. Bonds have rallied back again to lower yields since the midweek FOMC meeting. The Fed's meeting was the most uneventful in months, as policymakers kept the overnight borrowing rate at 5.25% and released a virtually unchanged accompanying statement. After more hawkish Fedspeak earlier in the month, bonds had been prepared for a nod to possible rate hikes or at least a more hawkish tone to the statement.

The humdrum FOMC statement sparked a rally. The 30-year Treasury bond ended the week yielding 4.8%, compared with a 4.9% yield at the end of last week. The 10-year note yielded 4.68% Friday, compared with its 4.78% yield last Friday.

The fed funds futures market unwound its bets that a rate hike was more likely than a rate cut, and now prices in a 50% chance of a rate cut as early as May 2007, according to Miller Tabak.

The housing market revealed its sharp teeth this week, and the slowdown feels all the more real to investors with a 1.6% GDP reading. But corporate profits remain on a tear. With 309 companies S&P 500 companies reporting so far, 74% have beat estimates and only 15% have fallen short of expectations, according to Thomson Financial.

With just two days left in the much-maligned month of October, the market's bullish storm could yet blow out to sea or rage on into the winter.

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

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