A close above this level would be quite bullish for the S&P

The broad market wrapped up last week
with a bullish tone, as the major indices
advanced on higher volume and closed at their highest levels of the week. Stocks
gapped open higher last Friday, traded sideways throughout the morning, rallied
at mid-day, then consolidated and closed near their highs in the afternoon. Both
the S&P 500
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Nasdaq Composite
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Midcap Index
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Russell 2000 Smallcap Index
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occurrence of relative strength, the Dow Jones Industrial Average climbed 2.2%
higher for the week. The S&P 500 gained 1.9% and the Nasdaq Composite rose 1.6%.
The Gold Index ($GOX) gained 4.2% last week and was among the leading industry
sectors of those we regularly follow. GLD (Gold Trust), which we remain long
from September 7, gained 1.4% last week and closed at a new high of the year.
The long-term weekly and monthly charts of both GLD and the $GOX index are
looking quite bullish now.

Total volume in both the NYSE and Nasdaq markets last Friday
increased by 2% over the previous day’s levels. Volume came in just above 50-day
average levels on both exchanges as well. Unlike the previous day, market
internals were firmly positive. Advancing volume exceeded declining volume by a
margin of 3 to 1 in the NYSE, but the Nasdaq ratio was positive by only 1.75 to
1. The higher volume gains means that last Friday was a bullish “accumulation
day” across the board. Another day of institutional buying brought the number of
accumulation days up to three within the past four weeks. Within the same
period, the markets have also seen the same number of bearish “distribution
days.”

In last Friday’s Wagner Daily, we discussed how
(
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(Semiconductor HOLDR) had rallied more than 1% on Thursday, but without other
industry sectors confirming the upward move. Ironically, the opposite happened
on Friday. Despite a 0.8% gain in the S&P and 0.4% gain in the Nasdaq, SMH
actually closed 0.6% lower, putting it just above its breakout of the
four-week consolidation. Reduced quarterly guidance from Intel Corp., which is
heavily weighted within both the $SOX and SMH, was largely to blame for Friday’s
relative weakness in the semis. Many semiconductor stocks such as AMD, MRVL, and
NSM are showing bullish weekly breakouts and sitting at 52-week highs, but Intel
closed at a new four-month low and is poised to break horizontal price support
at the $25.20 level. This has resulted in divergence within the Semiconductor
Index that is correspondingly giving SMH mixed signals. As such, we are now
taking SMH off our long watchlist because the divergence within the $SOX means
that SMH is going to be choppy and indecisive as it attempts to hold its
breakout from consolidation.

The Pharmaceutical HOLDR
(
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broad market for the past several years, is beginning to show signs of
life and relative strength. While the S&P and Dow both remain below their August
highs, PPH managed to close last week just above its August high. More
importantly, PPH may be poised to break out above resistance of its monthly
downtrend line, which has been in place for five years. The daily chart
below shows the relative strength that PPH has been exhibiting by closing above
its August high and its 20, 50, and 200-day moving averages. The long-term
monthly chart below that shows how PPH is nearing the breakout point of its
primary downtrend line:

Ideally, it would be good to see PPH consolidate near last
week’s high for a few more days before breaking out further, but we may not get
that luxury. As such, we are stalking PPH for long entry beginning today.
Regular subscribers can note the trigger, stop, and target prices below. We also
continue to stalk IYR (Real Estate Index Trust) for potential short entry if it
trades below our trigger price. You may also want to keep an eye on
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(Internet HOLDR), which will soon see a large move in either direction based on
converging levels of the 20, 50, and 200-day moving averages. Based on the
bearish looking charts of EBAY and YHOO, there is a fairly good chance that HHH
will break down in the coming days. We will send an intraday e-mail alert to
subscribers if we enter HHH.

As anticipated, last Thursday’s retracement to the prior
downtrend line (from the August 3 high) enabled the S&P 500 to bounce off that
support level on Friday. This resulted in a 1.9% gain for the week, which also
enabled the index to erase most of its August loss. However, the S&P will likely
see a critical test of resistance in the coming week, as it closed last Friday
only four points below its August 3 high of 1,245. The horizontal line on the
daily chart below shows the S&P’s close proximity to this upcoming test of
resistance at the 1,245 area:

Because the 1,245 level is also the 52-week closing high, the
S&P will either “make it or break it” as that area is tested. A confirmed weekly
close above 1,245, especially if it does so on strong volume, would be quite
bullish because the S&P would set a new 52-week high. However, the S&P could
also reverse sharply if traders begin selling in anticipation of a “double top”
at that level. If you’re currently long SPY or other broad-based ETFs, it is a
good idea to tighten your stops now. As always, we will closely track the daily
market action and simply react accordingly. Trying to predict whether or not the
S&P will “make it” or “break it” is not only difficult, but often costly.
Remember it is always safer and more profitable to trade what you see, not
what you think!

Open ETF positions:

Deron Wagner is the head trader of Morpheus Capital
Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com),
which he launched in 2001. Wagner appears on his best-selling video, Sector
Trading Strategies (Marketplace Books, June 2002), and is co-author of both The
Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader
(McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and
Yahoo! FinanceVision. He is also a frequent guest speaker at various trading and
financial conferences around the world. For a free trial to the full version of
The Wagner Daily or to learn about Deron’s other services, visit
morpheustrading.com or send an e-mail
to

deron@morpheustrading.com .