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Wednesday Look Ahead: Stocks Could Drift as Historic Rally Runs On

Tuesday, 25 Aug 2009 | 11:53 PM ET

As if adrift at low tide, the stock market could make another shallow move Wednesday in quiet, late summer trading.

Stocks rose Tuesday, while the dollar slipped against the euro and yen, and Treasurys rose after the auction of $42 billion in 2-year notes. The 10-year note was yielding 3.450 percent and 2-years were at 1.024 percent.

Commodities were mostly lower, but the decline in oil was most dramatic. Crude first rose to $75 per barrel but did an about face, burning off its gains and ending the day 3 percent lower at $72.05 per barrel.

The Dow rose 30, or 0.3 percent to 9539, its highest close since Nov. 4 but well off its intraday high of 9620. The S&P was up 2 points at 1028, its highest close since Oct. 6. The best performing sector was consumer discretionary, up 1.2 percent and the worst was energy, down 1.4 percent.

The big news Tuesday was the reappointment of Fed Chairman Ben Bernanke by President Obama, who took a break from his vacation to make the announcement. It came the same day that the government revealed its programs to rescue the economy could push the U.S. budget deficit to nearly $20 trillion in the next decade.

Some good economic news came from the S&P/Case Shiller index, which showed housing prices improved for a second month. There was also an unexpected improvement in consumer confidence which reached a reading of 54.1 in August, from 47.4 in July.

The economic news was positive. Yet, traders said it was discouraging when Robert Shiller, the Yale professor behind the home price index, commented on CNBC that he doesn't necessarily think housing has bottomed and that there was a false turn a year ago. "I didn't say we reached a bottom. This is very suggestive of a major turning point, but we've seen other corrections like this that were reversed," he said.

Wednesday's data includes durable goods, released at 8:30 a.m. New home sales are at 10 a.m. and there is an auction of $39 billion in 5-year notes at 1 p.m.

As stocks turned away from their highs, traders continued to debate Tuesday whether the market is ready to give back some gains. They point to the fact that it didn't close at its highs, and the reappointment of Bernanke should have put more pop into stocks. They also are watching the thin volume trading, where three financial stocks, Citigroup , Fannie Mae and Freddie Mac continued to dominate about a quarter of the volume.

"Oil hit $75 and imploded, and that cast doubt on everything else," said UBS director of floor operations Art Cashin. "...Oil and commodities and the Dow seem to be running together. I think everybody's going to wait for Thursday and they want to find out about unemployment. It's all about jobs." The weekly unemployment claims are released Thursday, ahead of the opening bell.

Mike Fitzpatrick at M.F. Global said oil sold off after it failed to hold the $75 level. Shiller's comment on housing was also a negative, and there is concern China is tightening lending, which would contain commodities prices, he said.

Brian Edmonds, head of interest rate trading at Cantor Fitzgerald, said the 2-year auction Tuesday was fine, but the 5-year could prove more difficult, as it did last month. "5s have been a lot harder to auction than 2s, especially at $39 billion. I think the market's got to go lower," he said.

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On Tuesday, "There seemed to be some good buying activity (in bonds). The commodities are down. Everybody's talking about the Baltic Dry index going down in the last couple of weeks...But stocks continue to trade great, as if there's a great V-shape recovery underway..I'm not really sure why," he said.

Historic Rally Runs

Wells Capital's Jim Paulsen is more bullish than many Wall Street strategists. His year-end target is 1250 on the S&P 500.

Paulsen believes the current rally, which is making historic progress, is similar to rallies in 1933, 1975 and 1982. "If I look at 1975, the Dow is under 600 in September, and it touched 900 by mid '75," he said. "The same thing happened in 1982."

"Investors' perception of this rally, and how they're approaching it, and how they feel about it is really being heavily influenced by the lows that were set in early March, and I think that low was a fabricated low. That was a low that never had to happen because the reason it went there in the first place proved to be false," he said.

"The only reason we fell from 870 on February 9 to 676 on March 9, the only reason was because our leadership... created a run on the bank stocks by making the mistake of having a public disclosure on whether they should nationalize the banks," said Paulsen.

The S&P has retraced 52 percent since March 9, which puts it on track for its best six months since 1933. The Dow is up 45.7 percent in that period but would have more than 103 percent to match the 1933 level. The Nasdaq 100 is up 57 percent since early March, its best six months since April, 2000 when the tech bubble was peaking.

"We've had six 50 percent plus collapses since 1900, and every one of them recovered at least three quarters of the losses within a year of the low and five of the six got it all back within 18 months," he said.

Paulsen said while it's possible the market could sell off, he also thinks it's likely there's another leg up before the end of the year that will take it toward 1200. One reason he believes that is the large amount of uninvested capital on the sidelines.

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"I still think there's a predominance of doubt. When everybody perceives risk, the reality of risk is low," he said.

Paulsen said one concern he has for stocks is the volume remains very light. "It is something that bothers me. I admit that I'm bugged by that, but what I think it tells me is this market is going up not because people are buying but because people stopped selling," he said. "..There's no conviction in it. There's nothing but doubt and there's no volume. That doesn't make it less legitimate. That just means there's a lot of people in a lot of pain because they missed it."

Questions? Comments? marketinsider@cnbc.com

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    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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