Can The Stock Market Rally In September?

Includes: SMH, SPY
by: Clif Droke

The tight lateral trading range which represents the ongoing battle between the buyers and the sellers continues on Wall Street. The S&P 500 Index (SPX) is closer to the upper end of its trading range than the lower part of the range, however, and ever since Monday’s late session turnaround stocks have been slowly pushing higher on a daily basis.

There are a couple of questions that need to be addressed concerning the outlook for the next two-and-a-half weeks until the 6-year cycle peaks, so let’s address them now.

The first question investors have been asking lately concerns the prospects of the major indices being able to reach their overhead 200-day moving averages before the 6-year cycle peaks. Traders should be primarily focused on the market’s near term direction as dictated by the cycles and the stock market’s internal momentum, however, with price being only a secondary consideration. It’s my long-standing belief that if you follow the path dictated by the cycles and the internal momentum, price will follow.


Another question investors have been asking is whether it might be a better strategy to short the market after its failure to sustain a rally in the last couple of weeks. Historically, September Triple-Witching Week is dangerous with the week following this options expiration week being pitiful in most instances. While it’s true that in many previous years the current time frame

Most importantly is the present internal momentum situation on the NYSE. Now that we’re about to enter the critical September 16-23 period, let’s have a look at the internal momentum indicators. Although the intermediate-term momentum indicators are declining, with the 6-year cycle currently in its final “hard up” peaking phase the short-term momentum indicators take on increased significance and should temporarily override the bearish influence of the declining intermediate-term momentum.

In the early stage of the August-September bottoming process the stock market was able to establish a pattern of higher highs and higher lows because the dominant directional indicator was rising, as discussed in earlier reports. Although this important indicator is still in an upward trend, it’s no longer rising on a daily basis as it was earlier this month.

However, another very important indicator, namely the short-term bias component of the momentum series, has just started rising on a daily basis. This indicator, which is a rate of change measurement of the daily new highs-new lows, is arguably the most important of the entire short-term momentum indicator series and often can single-handedly help push stock prices higher by itself even when the other indicators aren’t in synch with it. Only when the market is being driven by extremely negative external events (as with the credit crisis of 2008) will the short-term bias indicator be overpowered.

The rate of change in the cumulative new high-new low index shows that this important short-term bias indicator should be accelerating higher in the immediate term. This could provide just the boost the SPX needs to push out and above its 6-week trading range ceiling at the 1,230 level and allow the buyers to regain control over the market until the 6-year cycle peaks around October 1. It should also allow the SPX to test its 200-day moving average shown in the above chart.

Along these lines, another important indicator is the dominant short-term bias indicator for the semiconductor stock group. The semis often lead the broad market higher at critical junctures and this can be seen in Wednesday’s 2.33% breakout above the 6-week lateral trading range in the Semiconductor HOLDRs ETF (NYSEARCA:SMH) shown below. This is an important leading indicator for the S&P 500 and provides additional evidence that the buyers still have an edge over the sellers in this market, short-term. Also worth noting is that the short-term bias indicator for the semiconductor stocks has been rising at a strong rate this week.

Ultimately the anticipated September relief rally may come down to an old-fashioned contrarian play. Investors pulled some $40 billion from U.S. stock mutual funds in the week ended August 10, representing the biggest flight since a month after the failure of Lehman Brothers in September 2008. For the seven months through July, net withdrawals totaled $17.8 billion, following outflows of $280 billion from 2008 through last year.

The extraordinarily large amount of money investors withdrew from mutual funds last month is consistent with past bottoms and is another reason why we should still expect a relief rally before the 6-year cycle peaks at the end of this month. It would be unusual indeed for such a conspicuous example of extreme fear not to manifest in at least one short-covering rally.

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