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Several years ago Robert Redford made a movie called The Horse Whisperer about a horse trainer who nursed a traumatize horse back to health. In essence, Redford played the part of a Zen master of the horse world able to listen to the horses’ nuances in order to restore its damage psyche back to normal.

Since the July highs, investors have been in a similar situation attempting to read the tea leaves of market nuances to sense when a bottom may be in place in anticipation of a year-end rally. So let’s take a look at what the indexes and two of the market internals, net advancing volume and volume momentum are telling us about the health of the overall market as we approach the end of October.

The first chart shown below is that of the S&P 500 Index (NYSEARCA:SPY) with a regression channel plotted on the index beginning August 8th after a waterfall like sell-off in late July and early August. The indicator in the middle of the chart is the net advancing volume and volume momentum is shown on the bottom of the chart. Although the index itself has been stuck in a range since the beginning August, both the net advancing volume and volume momentum have developed decidedly bullish readings over the past week. Consequently, there is growing support for the idea that we may be close to a breakout from the range the market has wandered around in since early August.

click to enlarge
The S&P 500 Index

The next thing that any good index whisperer would do is check out the behavior of the NASDAQ, in this case the QQQ which measures the performance of the largest 100 stocks in the NASDAQ on a capitalization weighted basis. As of October 17, 2011, the top 10 components of the QQQ make up close to 48% of the index. The top 10 stocks are shown below:

The largest components of the QQQ

Clearly, any discussion about the QQQ has to begin with the acknowledgment that this index is really just a measure of the performance of some very, very large bell-weather tech stocks.

But, any index whisperer worth their salt knows that the NASDAQ Composite generally leads the market higher and lower, so the performance of the QQQ is a very good barometer of what is happening outside of the financials. So what is the NASDAQ telling us about the direction of the market? As the regression channel plotted on the index over the same period of time, as that of the S&P 500 shown previously shows the NASDAQ is trending higher. Clearly, the net advancing volume and volume momentum of the index have also developed a positive bias over the past week.
The NASDAQ Composite
The divergence of the regression channel of the NASDAQ from that of the S&P 500 along with the positive readings of two important measures of underlying market breadth over the past week point to the fact that we are close to an upside breakout from the sideways channel that the S&P 500 has been stuck in since the beginning of August.

Is this the beginning of a year-end rally? Only time will tell, but the underlying fundamentals of the market along with the leadership being shown by the NASDAQ 100 stocks are pointing to something other than a lump of coal in our Christmas stockings.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: The Index Whisperer: S&P 500 Vs. Nasdaq 100