A bit of volatility reared its head during the past week, with the markets enduring another week of notable price swings (the Dow shifted more than 100 points in 3 of last week's 5 sessions). When all was shaken out, the major indices were little changed for the week. The Dow Jones Industrial Average (DJIA 13,357.74) slipped 0.16% lower, the S&P 500 Index (SPX 1,473.99) was down 0.4%, and the Nasdaq Composite (COMP 2,596.36) actually managed to rise 0.76%. For the month, however, the major averages closed in the black for the first time since May. The Dow gained 1.1% in August, the SPX tacked on 1.3%, and the COMP closed August 2.0% higher.

A notable move higher in Friday's trading helped ensure a positive finish for August. Ahead of the open, futures were launched higher as plans leaked of a Bush Administration's proposal to help some beleaguered homeowners. The President's 10:00 a.m. speech confirmed as much.

Meanwhile, Ben Bernanke moves, as the veteran band U2 might say, "in mysterious ways." At his highly-anticipated speech from Jackson Hole on Friday, the Federal-Reserve boss maintained a sense of coy inscrutability ... he didn't exactly promise a rate cut, but investors took his pledge that the Fed was willing to act as an affirmative sign. Fed-funds futures are looking at definitely one, possibly two rate cuts by as early as late September. If these moves fail to materialize, watch out, as Fed inaction is no doubt the predominant Achilles heel of this market.

In the meantime, as we wait to see how the Fed chooses to act at its September 18 meeting, we will continue to keep an eye on important technical levels and interesting developments among the sentiment indicators we track. In the bulls' corner is the behavior of the S&P Depositary Receipts (SPY) Fund with respect to its 40-week and 80-week moving averages. The 80-week trendline (now located in the 138-139 region), off which the ETF rebounded during the August 17 week, supported both 2005 pullbacks in the fund as well as the mid-2006 pullback. As I've mentioned previously, volume near the recent SPY lows certainly qualifies as "climactic." Currently, the SPY's 80-day trendline is perched at the round-number 150 mark (and the SPX's 80-day moving average resides at 1,500). It's not out of the question that these broad-market averages could see speed bumps in this area.

I've frequently pointed out the Russell 2000 Index's (RUT) continuing battle with the 800 level, but I wonder if something different is going on with the current rejection. For one thing, the rebuff has not been as violent as on recent occasions, showing its power as resistance may be weakening. Additionally, we've failed to see as many of the types of intraday breadth implosions that had been occurring with regularity before on the RUT. Also, there remains huge, out-of-the-money put open interest at the September 72 through 77 strikes as well as similar strikes in the October and November series.

The CBOE Market Volatility Index (VIX) rose nearly 13% last week, thanks in large part to the index's 15.8% jump amid Tuesday's market pullback. By the end of the week, however, the VIX had dropped back below its 20-day moving average, usually a bullish sign. As I alluded to last week, the August spike in the VIX was historically significant. And though the SPX failed to take out its March lows, the peak in the VIX at 37 was considerably higher sharper during the recent pullback compared to the March VIX peak at 21. This strongly suggests that the fear generated during the latest pullback far exceeded that of March, which is good news to contrarians.

The ISEE Sentiment Index, like the VIX, is seeing a gradual unwinding in negativity following a sharp spike indicative of widespread pessimism. During the past week or so, the 10-day moving of this index has turned higher from recent lows. As climactic negativity unwinds, it can be supportive for stocks.

Ongoing skepticism on the part of equity mutual-fund investors is evidenced by their continued exodus. According to data released last week from TrimTabs, U.S. equity funds have lost $37.2 billion since early May, marking the highest four-month outflow since July 2002 through October 2002, when the last true bear market was hitting rock bottom. While the outflows are bullish from a contrarian sentiment perspective, we should also put these outflows in the perspective of supply and demand. That is, excessive outflows create forced selling in a real sense, as mutual funds maintain very low levels of cash and must liquidate stock positions to meet redemptions. This puts downward pressure on the market, and as long as the outflows continue they will create their own headwind.

What I also find interesting and potentially quite bullish in its implications is Charles Biderman's point that the action of mutual-fund investors sharply contrasts with what we're seeing on the insider-buying and corporate-buyback front. Insiders have been net buyers of shares on six separate days in 2007, four of them coming in the sessions after August 16. In other words, we're seeing a sharp unsophisticated money/sophisticated money dichotomy, and they don't call it "smart money" for nothing.

Now we're into September, historically the weakest month for investors. Since 1929, stocks have declined an average of 1.2% in September, contrasting with an average gain of 0.59% during the other 11 months of the year. But to the degree that this tendency becomes more widely known, it has the potential to lose its effectiveness, particularly as the framework of the entire market changes due to such 21st century phenomena as the dominance of hedge-fund activity. In fact, during each of the past three years, the SPX has been positive in the month of September, rebounding from market bottoms in July and/or August, and now it can be argued that we bottomed in August of this year. Note that last year, the index rose 2.5% during September. And note also that this trading week is shortened by a day, which could mean a short-term struggle for stocks.

The week upcoming is a lazy one for earnings watchers; other than a few stragglers from the retail sector Jos. A. Bank Clothiers (JOSB) and J. Crew Group (JCG), for example there isn't much on the plate. The Fed's Beige Book data will be released on Wednesday, and economy enthusiasts will be digesting the monthly jobs numbers early Friday. A few Fed officials including Richard Fisher (Dallas) and William Poole (St. Louis) will also be stepping to the podium. These speeches may not provide any better clues as to the future of the federal funds rate, but that won't stop Fed-watchers from looking.

And now a few sectors of note...

Dissecting The Sectors

Sector

Base Metals/Copper Bullish

Sentiment: Southern Copper (PCU) and BHP Billiton (BHP) remain good ways to take advantage of the metals/copper sector. Both stocks are seeing high Schaeffer's put/call open interest ratio (SOIR) ratings, indicating skepticism among the options-trading crowd. SOIR for BHP stands at 1.27, in the 72nd annual percentile; the SOIR for PCU weighs in at 1.44, in the 86th percentile. What's more, between the 2 stocks there are just 5 "buy" ratings, 7 "holds," and 2 "strong sells." Either name could benefit from analyst upgrades going forward.

Outlook: After a modest pullback during August, long-term copper futures are sitting above intermediate-term chart support near the $3.30 per pound mark. The base metal contract is also perched above support in the form of its 10-month moving average. PCU and BHP both appear to have bottomed out in mid-August and are now enjoying recovery mode. Both stocks have now regained control of their 10-day and 20-day moving averages, and both are again on a path to challenge all-time highs.

Sector

Retail Growth Bullish

Sentiment: Though the temperatures would hardly indicate as much, the fourth quarter is right around the bend. This period of the year, crucial to the retail group, includes "Black Friday" and the madness of holiday-shopping season. Among my favorites from what I call the "retail growth" sector remain Amazon.com (AMZN) and online jewelry retailer Blue Nile (NILE), which I analyzed last week. Another name, which is in the restaurant business and therefore retails burritos instead of baubles, is Chipotle Mexican Grill (CMG). The stock has yet to earn the respect it deserves from Wall Street, judging from the 4 "buy" ratings compared with 9 "holds" and a single "sell." Short interest accounts for nearly 14% of the stock's float and would require nearly six trading days for eradication (at CMG's average daily volume). Finally, options players are also skeptical, as the equity's Schaeffer's put/call open interest ratio (SOIR) of 1.15 is higher than 90% of the past year's worth of readings.

Outlook: Shortly after its spin-off from McDonald's (MCD) in early 2006, Chipotle began outperforming its parent and the retailing sector, in terms of relative strength. For the past year, the shares have been riding their 10-week and 20-week moving averages higher, hitting new-high territory in August. To take advantage of the retail growth group, look for names from the retail sector that are outperforming their peers against a backdrop of solid skepticism.

Sector

Financials Bearish

Sentiment: Despite the doom-and-gloom surrounding banking and brokerage names, there is still a contingent looking for a near-term bounce. On the Select Sector SPDR Financial Fund (XLF), for example, options players have never been more bullishly aligned this year its Schaeffer's put/call open interest ratio (SOIR) is currently at an annual low. What's more, the composite SOIR for the brokerage sector stands in the eighth percentile; the banking group's SOIR is lower than all but 3% of the past year's data.

Outlook: A slight bounce higher in recent sessions has merely taken the XLF headlong into resistance at its 10-week moving average. Meanwhile, the fund is still beneath its 10-month and 20-month trendlines, putting in its second consecutive monthly close south of this pair in August. This marked the first time since March 2003 that the XLF has twice closed below these long-term trendlines. Given the credit-market woes dominating the headlines of late, the financial sector is clearly where the risk is. But if this "contagion" winds up being not all that serious for the rest of the economy (and/or the Fed cuts rates), I still see the financial group lagging the overall market amid a broad recovery. This phenomenon is yet another reason to avoid large-cap indices, where financials hold the biggest weight.

Copyright Schaeffer's Investment Research http://www.schaeffersresearch.com

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