Caution at these levels

Setting tighter stops and refraining from adding longs. The rally is in its very late stage. We will hold off hedging with short positions but simply tighten stops. VIX appears to be forming a double bottom; transports are diverging from the Dow's uptrend, and defensives are gaining. While we could see more money enter the market due to seasonal factors, we would rather play it safe.

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Healthy correction so far

Some positive breadth divergences as the major indices correct, coupled with modest volume on the selling, suggest that recent declines are part of a normal corrective pattern and do not comprise a major trend change. Our plan is to identify strong basing stocks with a plan to enter long once the selling finds support.

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Neutral market position while potential correction ensues. We believe the risk/reward favors an eventual resumption of the uptrend into year-end. Market Breadth deteriorated swiftly with the 9/23 reversal. Trend remains up, and a consolidation was much needed.

Targets for SPX, DOW and Nasdaq

Targets are based on Elliott Wave structure, resistance and Fibonacci retracements. We anticipate the rally to continue with a short pause/consolidation likely in the near term. As the indices approach these targets, we will sell covered calls and reduce longs. We will go short on price confirmation of a change in trend.

Overbought for how long?

There are many more technical analysts out there today than at the last bear market bottom. Many anticipating a retracement of the bear market rally (as it has achieved initial targets) have also cited potential seasonal weakeness to support a pull-back (as well as divergences). As major indices are now just entering overbought levels on a daily basis, we may hear that "overbought" can remain for a long time, so don't short "overbought." As Martin Pring frequently states, "an actual buy or sell signal can come only when the price series itself gives a trend reversal signal."

Our strategy is to remain long, add to basing stocks, take some profits and set stops. We expect that we will leave money on the table when this market corrects, and will not pick a top (or bottom).

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Dow Target

Our initial upside target on the Dow is 10,000-11,000, with a secondary target of 12,300.

Uptrend strengthens; transports break out; financials continue to base

Breadth on the uptrend has strengthened. Transports have broken out to the upside, breaking through rectangle resistance and confirming the new high in the Dow. VIX shows signs of bottoming (VIX formed a hammer on Friday), as the fear factor may creep in during Sep-Oct.

Financials were an early relative strength leader following the March bottom. They consolidated that lead in mid-May, then resumed leadership in late July. They have been consolidating again.

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Uptrend gains support; Nasdaq forms a new 2009 high

Nasdaq outperformance (vs. SPX) resumed in late August; breadth moving averages have turned positive as the indices forge higher. Financials continue to diverge (underperform) and RSI pickup on SPX and Nasdaq has been weaker than the price action on the indices. Regardless, the rally continues to have legs; strong stocks will be added on modest pullbacks.

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Staples ready to outperform Discretionaries?

Reviewing the weekly chart of Staples vs. Discretionaries (see chart), the relative underperformance of Staples has gotten quite oversold. Its retracement from 2008 gains hit a Fibonacci 38.2% pullback, CCI and stochastics have formed higher lows, bouncing from oversold levels. Reward-Risk may favor Staples vs. Discretionaries in the short-term.

Mixed Signals

SPX remains above support, Nasdaq improves (and outperformance resumes), both on weaker volume. VIX deflects from resistance and continues to form a base. Financials start to underperform. Indices have hit inital bear market rally targets, so caution is advised as one wonders how much reward there is vs. risk at this juncture.

An interesting find: in reviewing our Dow Theory we noticed that transports have been forming a potential rectangle top, suggesting an upside breakout in the continuation of its uptrend. This may be corresponding to recently lower oil prices, although since the March bottom, transports have been moving more in line with economic recovery signals rather than changes in crude pricing.

We are cautiously bullish based on the past price action since July: the market tends to form mild consolidations during its uptrend; increased seasonal trading activity will be key to clarifying the short-term directions.

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Market stalls; Unemployment report looms

No significant shifts in market perspective following Thursday's activity. Price and indicators are generally pointing to weakeness in equities. Strength in bonds, coupled with weakeness in small caps and financials and improved relative strength in staples, all suggest caution regarding equities.

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Correction underway; targets assessed

Deteriorating technical action (see our recent posts) manifested itself into a correction. At this time price does not confirm a new downtrend (only a correction to watch carefully). 980 on SPX and 1930 on Nasdaq are keey support levels to watch. As the potential that the recent decline is a correction and the uptrend is sustained, we will be seeking stong, basing stocks to add once the dust clears.

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The Dollar looks particularly interesting at this juncture. Long Dollar, Short Commodities may be the current high reward-risk trade.