Stocks Look Primed for Breakout

NEW YORK ( TheStreet) -- July's rally, especially the impressive move seen this week, may have laid the technical groundwork for the S&P 500 to surge to new highs.

"With Tuesday's strong stock market rally off of multiple pieces of technical support, and the nice follow-through buying on Thursday, we think it is possible that the major indices are finally setting up for a breakout to the upside, and at last, breaking from the price consolidation that started back in February," writes Mark Arbeter, chief technical strategist at Standard & Poor's, in a research note Friday afternoon. "Looking back, the market has been hit with a fair amount of bad news in recent months, but the bears were unable to take prices below the key lows we saw in March."

Arbeter explains that the S&P 500's bounce since pulling back to the 1,295 top of its June base this past Monday was a positive sign, as that level represents a nearly 62% retracement of the rally the index saw from June until early July. He says that to complete the price base, the S&P 500 would need to exceed its April closing high of 1363.61 on April 29, as well as the intraday high just north of 1370 at the beginning of May.

"We think an upside breakout would open the door for a move to the 1,450 to 1,475 area some time in the fourth quarter," he writes. "This, in our view, would complete a five-wave structure off the March 2009 bear-market bottom."

The recent action in two downtrodden sectors -- the financials and the semiconductors -- is also heartening, according to Arbeter.

"While these areas are still in a downtrend, we are starting to see some early signs that they may be bottoming," he says. "Both the SOX Philadelphia Semiconductor index and the XLF Financial Select Sector SPDR recently went to new corrective lows, but daily momentum put in a higher high, so we finally have a bullish momentum divergence."

Year-to-date, the Dow Jones Industrial Average, while turning lower on Friday because of a disappointing quarter from Caterpillar ( CAT), has appreciated the most among the major U.S. equity indexes, rising 9.6% vs. gains of 7% for the S&P 500 and 7.7% for the Nasdaq Composite.

The 2011 peaks for each index occurred on May 2 with the Dow climbing to 12,928, the S&P 500 reaching 1370.58, and the Nasdaq rising to 2887.75. In recent afternoon action Friday, the indexes were at 12,687, 1345.32, 2860.51 respectively.

Arbeter's observation comes with investor sentiment looking mostly in-line with historical averages. On Thursday the American Association of Individual Investors released its survey for the week ended on Wednesday. The poll asks the non-profit organization's roughly 150,000 members how they feel about the stock market's direction over the next six months.

This week, 39.9% of respondents identified themselves as bullish, up 0.5% from last week, and slightly higher than the long-term average of 39%. The bear camp swelled by 1.4% to 30.6% of respondents, also a tick above the long-term average of 30%, while those identifying as neutral came in at 29.5%, down 1.9% from last week, and below the long-term average of 31%.

The survey also threw in a question about the likelihood that the Federal Reserve may embark on a third round of quantitative easing. Most respondents said the odds of this happening were low, defined as less than a 35% chance, but what the AAII identified as a "smaller but significant" group felt the odds were high, defined as a greater than 65% chance.

Unsurprisingly, responses seemed to hinge on one's view of the health of the economy with sample comments ranging from "High. With the economy continuing to languish, the Fed will likely provide a new round of stimulus" to "I think the chances are low. The economy is improving, albeit slowly. As long as there is improvement, the Fed can't justify QE3."

Despite recent performance hinting that a breakout could be just around the corner, S&P's Arbeter is still somewhat cautious though about how much longer this bull market can continue.

"We still think a major correction or bear market is lurking somewhere around the corner, possibly starting in the fourth quarter; it's just not likely at this point, by our analysis," he says.

-- Written by Michael Baron in New York.

>To contact the writer of this article, click here: Michael Baron.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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