The stock market fell sharply in October after end-of-the quarter window dressing and on the inflation spike revealed in the September data. Consequently, the stock market no longer believed the Fed's tightening cycle will end this year, and became fearful of stagflation. However, third quarter earnings so far have generally beat expectations, in what was expected to be a slow quarter, because of high energy prices.

Both monetary and fiscal policies remain stimulative. The FOMC raised the Fed's Fund Rate from 1% to 3.75%, on small 25 basis moves, over the past 16 months, along with a steady policy of "jawboning" to keep inflation expectations low. A neutral stance may be above 5%. So, the FOMC may continue to tighten well into next year. The Bush Administration tax cuts are still intact, and the damage by hurricane Katrina will increase government expenditures.

Oil prices fell below $60 a barrel last week, for the first time in about three months, and closed at $60.63 Friday. Economic growth has slowed to a more sustainable rate of around 3% real growth. The summer driving season and the worst of the hurricane season are over. Heating oil prices will be largely dependent on winter weather in the Northeast. The price of oil may stabilize at just over $50 a barrel within the next few weeks.

The chart below is an SPX weekly year-to-date chart. SPX is down for the year, at the lower range of a trading range, and somewhat oversold. The ADX and CCI indicators, in particular, suggest the market will rally into the end of the year. It seems, SPX will continue to consolidate, short-term, above several strong (multi-year) support levels at around 1,165 (explained in previous articles) and then rally.

The high recent inflation data may be a temporary phenomonen caused in large part by transportation bottlenecks in the Gulf region after hurricane Katrina. Also, output and employment should pick-up, temporarily, with a boost in government expenditures. Moreover, lower energy prices will shift consumption from energy into non-energy products and lower production costs.

It seems likely SPX will trade between roughly 1,170 and 1,200, short-term, and then retest the high (for the third time) at about 1,250 later this year. However, a final "wash-out" in late October is possible, where SPX closes the open gaps at 1,143 and 1,138, before staging a powerful rally. So, unless SPX falls below 1,165, it may be best to trade the volatile range with a stop at 1,165.

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