Table of Contents


• Broad Market Analysis - A look at the long-term charts
• MTG Stalk of the Week - NCS long
• ETF Trend Tracker weekly commentary
• Third quarter 2006 performance results

Broad Market Analysis - A look at the long-term charts

Stocks continued to flex their muscles yesterday, once again refusing to correct off their recent highs. The Nasdaq Composite surged 1.6% yesterday, while the S&P 500 and Dow Jones Industrial Average gained 1.0% and 0.8% respectively. Small cap stocks outperformed with a 2.1% gain in the Russell 2000 Index. The S&P Midcap 400 Index jumped 1.5%. Each of the major indices trended steadily higher throughout the session, then finished at their intraday highs. The rally was quite broad-based, as none of the 24 major industry sectors we monitor closed in the red. The Retail HOLDR (RTH) and Semiconductor HOLDR (SMH) both broke out above their sideways consolidations that we pointed out in yesterday's newsletter. The streetTRACKS Capital Markets (KCE) snapped back from the prior session's gap down, so it did not trigger on the short side.

Total volume in the NYSE ticked lower by 2%, while volume in the Nasdaq was about the same as the previous day's level. While yesterday's gains were strong, the lighter volume tells us that mutual funds, hedge funds, and other institutional players were not actively behind the buying. The stock market can obviously rally without institutional participation, but the problem is that stocks can reverse sharply when the bears step in if there is not enough institutional demand to absorb the supply. Like we said a few days ago, there is no reason to close your long positions as long as stocks are acting well, but keep trailing those stops higher because each of the major indices remain glued to the upper channel of their uptrend lines. When they eventually correct, it could be fast and furious.

Unless you've been living in a cave, you already know that the Dow Jones Industrial Average has been trading at a fresh all-time high for the past week, but what about the "big picture" for the S&P 500 and Nasdaq Composite? A record high in the Dow generates tons of media attention because the index is a key psychological indicator for the general public. But the reality is that the Dow is narrow-based index consisting of only thirty blue-chip stocks. Historical charts have shown that relative strength in the Dow without the S&P and Nasdaq keeping pace is usually short-lived. So, let's take an updated look at the long-term monthly chart of the S&P 500 to see how it compares with the record high in the Dow. The best way to do this is by using Fibonacci to measure the distance from its high:

Measuring the amount of the S&P's retracement from its March 2000 high down to its October 2002 low, notice that the index has rallied right into the 76.4% Fibonacci retracement level. When using Fibonacci, the 76.4% retracement is considered the last line of defense that prevents a stock or index from completely ripping to a new high (or falling to a new low if measuring a downtrend). Typically, the 38.2%, 50%, and 61.8% retracements are where most stocks will reverse and continue their prior trends. However, stocks and indexes will sometimes rally all the way back to the 76.4% level if the primary uptrend is strong enough. Because the S&P is sitting right at this pivotal 76.4% retracement, there is minimal long-term technical resistance if the index manages to break above its current level. Even though stocks may be a bit extended in the short-term, the S&P will likely follow the Dow by blasting off to a new all-time high if it can overcome this 76.4% re tracement level.

The Nasdaq has rallied a whopping 112% off its October 2002 low, but even more amazing is that the index has not even made it back to its 38.2% retracement of the selloff from March 2000 high down to its October 2002 low:

If you were involved in the markets in the late nineties, you surely remember how insane those days were, and the drop that followed was just as crazy! As such, it's not surprising that the Nasdaq is still 54% off its all-time high. Though the Nasdaq is finally nearing its 52-week high, many of us may never even live to see a new all-time in the Nasdaq.

While we're looking at the monthly charts, let's not forget everyone's friend, the Dow. When an index or stock is at a fresh record high, there is absolutely no overhead supply from people who bought at higher prices and are selling into strength. This, of course, is the reason that stocks and indexes at new 52-week highs can easily go higher without much buying pressure. However, we can use a Fibonacci extrapolation beyond the 100% retracement to predict an upside price target and the next major band of resistance in the Dow. In doing so, you will see that the 123.6% retracement is the next price target in the Dow, assuming it holds at its new high:

Comparing the monthly charts of the "big 3" indices, the divergence is pretty interesting. We've got the Dow at an all-time high, the S&P trailing with a rally into its 76.4% Fibonacci retracement, and the Nasdaq still in the bottom third of its range. As short-term traders, these monthly charts don't matter much because the time interval is too long for it to matter much. Nevertheless, understanding the "big picture" helps you to maintain an overall healthy perspective on your short-term trading activities. Noting the divergence between the major indices also tells us which ones are likely to lead the way lower when we reverse back down. Buy sectors and indexes with relative strength and sell short those with relative weakness.

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In this column, MTG presents you with a FREE, actual trade setup that we are stalking for entry at some point during the week. Note that, unlike the daily guidance that regular Stalk Sheet subscribers receive, this free Stalk of the Week does not take into account overall broad market conditions that can easily affect the trade over the next several days. This week's setup is: