Monday, October 04, 2004 | 01:18 PM

Mount St. Helens flipped her lid last week, and the markets, apparently not willing to be outdone, joined her as the new quarter began. It looks like the reallocation trade rotated money out of fixed income and into equities. Bonds – unlike stocks – had a terrific third quarter, essentially going straight up from June through nearly all of September. Equities merely flailed about, with a bias to the downside. Fixed income profit-taking could pressure rates upwards.

The Nasdaq gained 2.4% on the session, and looks to tack on another 1.5% today. Importantly, volume spiked 9% to over 1.83 billion shares. Last week saw four out of five trading days where Nasdaq advanced on increasing volume. Is this the beginning of the year-end rally? Are the markets “rested” enough to power through? Or might they fail at that line, setting up a retest of the lows. The evidence, as we shall see, is mixed.

Of the three major indices, only the SPX has broken above its downtrend line. The Dow and Nasdaq must now contend with overhead resistance in the form of a downtrend line. Right now, we are wondering if the SPX can pull the other indices up. If not, then when the Nasdaq and Dow get turned back at their own trendlines, they may weigh on the SPX, dragging it down.

Looking at some of the other indicators, we see a bullish bias within an overall mixed picture. The up/down volume ratio and the advance/decline line have both been very positive. On Friday, the Put/Call ratio hit 97% – a traditionally bullish contrary indicator. Plenty of cash is on the sidelines, and the short interest has risen appreciably over the past quarter. Seasonality factors also favor the Bulls. Lastly, we should not underestimate the impact of "performance anxiety" among those who are under-invested.

Still, several issues of concern linger: Oil is hovering near $50; Iraq continues to present a parade of horrors. The preannounce season was fairly negative; earnings are not likely to surprise to the upside. Several commentators have pointed out that the VIX dropped briefly below 13 (although we must point out that the VIX traded below 10 throughout much of the 1990s).

As we surmised a few weeks ago, SPX support in the 1100-1105 range held. It traded down to that range, bounced smartly off the low of 1101, and has since rebounded to 1140. Whether that 1101 level is the final low of the year remains unknown at present. We now reset our watch levels as follows: SPX 1145, Nasdaq 1980, and Dow 10,350.

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