Powerful Short-term Rally Ahead

Editor’s Note: Sam Collins will be on vacation�through June 25. Filling in for him�are two other top technical analysts, Chris Johnson and Jon Lewis.

A little foreign tailwind appears ready to blow in the market’s favor today with the news that the Chinese central bank announced plans to loosen the yuan’s de-facto peg to the U.S. dollar. The news should help to provide the market some additional juice as this action has been long-pressured by the United States.

In addition, the euro appears to be gaining a little relative strength lately. As with other analysts, we were concerned with the euro’s continued weakness as it was a sign that investors weren’t willing to move beyond the sovereign debt issues that had clouded the market more than a month ago. The latest strengthening in the euro shows some willingness of the market to begin rebuilding after the shockwaves that were created by the European debt crisis.

Back home, we’re excited to see the week’s trading begin, as our outlook remains relatively bullish. You’ll recall that, on Friday, we spoke about the large amounts of overhead call open interest that was set to expire. As we predicted, the market saw little to no volatility on Friday, as the overhead call open interest kept a cap on any rally potential.

We will say, though, that we were off by 27 cents on our forecast for the SPDR S&P 500 (NYSE: SPY) shares to end the day’s trading at $112. You have to admit that it was uncanny the way that the SPY traded above $112, only to be instantly sold back below the strike. Like we said, there’s a reason we watch the open interest data closely.

With the overhead call open interest out of the way until July’s expiration, which is four weeks away, we expect that this market will flex its muscles this week. We’re forecasting the S&P 500 (SPX) to make an advance to the 1,150 level this week, providing even more reason for investors to start believing in the latest bottom and thus moving more capital back into equities.

In addition to the technical strength, the fact that earnings season is less than a month away will start to entice investors to move back into stocks. Last quarter’s positive results were enough to get investor’s attention. We expect that most investors will want to be in the market as the season approaches, instead of on the sidelines in cash.

Finally, the CBOE Volatility Index (VIX) has broken below the 30 level that we have been identifying as a must for stocks to start another climb. The chart below indicates the range that we expect the VIX to trade within over the next month or so. The bottom of this range is captured by the 17.5 mark.

Our expectations are that the unwinding of the negative sentiment that is indicated by the latest highs in the fear index will help move the SPX and other benchmark indices toward the top of their 2010 ranges, providing the bulls with a powerful short-term rally.

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