Rally continuing?

Commentary: We mentioned the likelihood of an oversold bounce last week that could even ignite a year-end rally, but I’m not sure anyone could have expected the bounce in the markets this week. Of course it came on the heels of a coordinated effort to provide support for the European financial crisis. One can always question the lasting effects of market intervention, but the bottom line is that this week’s news sparked a very sharp rally and may be the beginning of a more substantial rally. The end of the year is typically a strong period and there is a chance that the markets correction is over. There is a lot that will need to happen, but this week’s strength was a step in that direction.

One of the key outcomes of this week’s rally was the potential of a higher low being formed in the market indexes. In looking at the S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, notice that the pullback that began in late October ended well short of the October lows. This is setting up the opportunity for a higher low, but SPY will need to rally above the October highs in order to confirm this. Otherwise, it’s possible that SPY trades sideways before eventually breaking the November lows and then heading towards $107. Ultimately, there is a wide range in which SPY can trade in the near term, so traders need to account for this. SPY can easily retrace some of the recent bounce and still not damage the chances for further upside. The two key levels to watch are the November lows near $116 and the October highs near $129. That is a very large range, but breaking out of either of those ranges would have a significant implication.

Much of the same analysis can be applied to the Diamonds Trust, Series 1 (NYSE:DIA) ETF as well. DIA came roaring back to life this week after dropping under its 200-day moving average last week and hitting $112 per share. It is likely that DIA will endure some profit taking after such a strong bounce and with a huge gap underneath towards $116, it may act as a magnet. However, as long as DIA remains above the November lows near $112, the possibility of a higher low being set would be intact.

The Nasdaq 100, as represented the Powershares QQQ ETF (Nasdaq:QQQ) ETF, had been underperforming recently, but this week’s bounce helped bring them back on par with its peers. QQQ is back above its key moving averages and near the congestion area that formed in October and November. If QQQ can stabilize near these levels, it could set the stage for a breakout attempt above the key $59 level.

One group to really keep an eye on is the small caps. This group typically outperforms early in the year, so this sector may start perking up soon. The group, as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF, also had a very sharp bounce from last week’s lows and is back trading near the trading range that was established the past several weeks. Much like the other indexes, IWM is susceptible to near-term profit taking, but it also has plenty of room underneath for a typical pullback.

The Bottom Line
This market has not been easy to game the past two months. It is quite apparent that traders are still on edge after the calamity that occurred in 2008 with the U.S. financial markets. There is still fallout around the globe, and any hints of similar trouble are causing market participants to flee first and ask questions later. As such, volatility has exploded, and the markets are very susceptible to news-driven fluctuations. Looking closely at the index ETF’s, they all stopped near trend lines that were marking recent rally attempts. The markets are likely to suffer through some near-term profit taking, but with the end of the year typically being strong as funds chase performance, it’s likely that the markets will find support before new lows are set. Of course, anything is possible, (and traders should not trade solely based on seasonality) but this week’s strength (and news) may have been the catalyst bulls were waiting for.

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