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The stock market had one of its biggest weekly advances in years last week with SPX rising over 37 points and Nasdaq rising over 100 points. The FOMC Minutes, released last week, gave only a scant indication that the monetary tightening cycle will end soon. However, that was enough to spark a rally and generate waves of panic short-covering, which drove the market even higher, after the heavy short-selling the previous week.

Monetary policy has been stimulative for about five years, since the Nasdaq bubble burst in 2000, the recession of 2001, and 9/11. The FOMC has been removing its policy of accommodation over the past 18 months, and may be near a neutral stance, where monetary policy neither stimulates nor slows the economy. However, I suspect, more tightening is needed to slow the economy and maintain price stability, although the FOMC may pause in 2006.

The first two charts below are SPX and Nasdaq weekly charts over the past two years. Both SPX and Nasdaq developed rising wedges over most of that period. However, both closed the week near major resistance, i.e. SPX near the upper line of the rising wedge and weekly upper Bollinger Band, while Nasdaq broke above the rising wedge, for the second time, and closed just below the weekly upper Bollinger Band.

The second two charts are SPX and Nasdaq monthly charts. Both SPX and Nasdaq are just below their monthly upper Bollinger Bands, and just short of previous multi-year highs (see circles). Consequently, there may be little upside, and the risk of a big pullback within the next month or two is high. The low volatile large advance last week suggests greater volatility for the rest of the month.

Economic reports next week are: Monday--Consumer Credit, Tuesday--Wholesale Inventories, Wednesday--Oil Inventories, Thursday--Unemployment Claims, Export & Import Prices, Trade Balance, and Treasury Budget, and Friday--PPI, Retail Sales, Business Inventories, and Michigan Consumer Sentiment. The Friday reports will be big market movers, although the market may pullback on anticipation of those reports. Also, earnings season starts next week.

Some January Max Pain expirations are: SPX 1,260 with the value of puts roughly 60% greater than the value of calls. SPX closed at 1,285 1/2. OEX 575 with the value of calls about eight times greater than the value of puts. OEX closed just above 585. QQQQ 41 with the value of calls about 10% more than the value of puts. QQQQ closed at 42.68. January options expire in two weeks and Max Pain expirations indicate a pullback.

Perhaps, SPX will rise a little Monday to complete the short-squeeze. Then shallow pullbacks may turn into deeper pullbacks. Consequently, SPX may fall to the previous resistance area around 1,275, or the 20-day MA at 1,265, before Friday`s economic reports. Volatility may pick-up on the completion of the short-squeeze, and the earnings and economic reports. Also, the following week is options expiration week, which is typically volatile.

Charts available at PeakTrader.com Forum Index Market Overview section.

Arthur Albert Eckart is the founder and owner of PeakTrader. Arthur has worked for commercial banks, e.g. Wells Fargo, Banc One, and First Commerce Technologies, during the 1980s and 1990s. He has also worked for Janus Funds from 1999-00. Arthur Eckart has a BA & MA in Economics from the University of Colorado. He has worked on options portfolio optimization since 1998.

Mr Eckart has developed a comprehensive trading methodology using economics, portfolio optimization, and technical analysis to maximize return and minimize risk at the same time and over time. This methodology has resulted in excellent returns with low risk over the past four years.

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