3 reasons why S&P 500 will breakout. What to buy

Published Mon, Mar 23 20152:05 PM EDTUpdated Tue, Mar 24 20157:34 AM EDT

Analysts who study charts are pointing to a number of reasons why the S & P 500 will join the other major U.S. indexes at record highs before the quarter ends this week and break out further over the next three months. CNBC Pro highlights some of the top picks to ride this big-cap move. First, when the small-cap benchmark, the Russell 2000 index , hits a new 52-week high—like it did last week—the S & P 500 typically follows suit, with average gains one year out of 16 percent, according to data from Oppenheimer technical analyst Ari Wald going back 30-plus years. "A Russell 2000 breakout is usually followed by above-average S & P 500 performance, not a major top," wrote Wald. "Our indicators argue for a continuation of the bull cycle and consequently new highs in the coming weeks to months." Fundamental analysts would say that the rise in smaller stocks typically signals an increase in risk-taking that eventually follows through to bigger stocks. In the past four weeks, small caps doubled the returns of the S & P 500, up 3 percent, lifting the Russell to a record price of 1,267 on Friday. In comparison, large caps trailed behind the group, and have failed to reach a new high since Feb. 25. "Breakouts by both the Russell 2000 and European indexes decreases the risk of a correlated rollover and increases the probability of the next broad-based market breakout," according to Wald. Read More Is a 30-year dollar weakness trend finally over? Our next bullish indicator, from Brean Capital's Frank Longman, is breadth, which measures the number of stocks rising in the S & P 500 during this recent comeback versus those that are declining. "Last week was the best week for breadth since the move off of October's low," wrote Longman in a Monday report to clients. Source: Brean Capital Using an indicator called the "McClellan Oscillator" (lower part of chart above), Longman can show how the rate of change in the advance-decline line is accelerating. Simply put, when more stocks are participating, the further that rally has to go. The next reason that technical analysts are talking about was also highlighted by Oppenheimer's Wald in his report. He points to the bearish sentiment in the put/call ratio as a contrarian indicator that may fuel the next leg up in the rally. The ratio of put buying to call buying measures the different types of trading volume in the options market. When trades in put options outpace the number of trades in call options, it provides a bearish signal. But when that bearishness gets to an extreme, investors often take a contrarian position in hopes of a reversal. The fundamental strategists clearly agree with the chart analysts. A survey by CNBC among 15 top market strategists from major banks shows the S & P is expected to reach 2,220 by year-end, a 5 percent increase from the current level. To be sure, if the S & P 500 closes out this week little changed, it will form a classic "double top," which could mean a downturn is ahead. But investors thought a double-top pattern spelled trouble for the market back in December and the S & P 500 went on to new highs in February anyway. The money play: CNBC Pro ran a screen among the top breakout candidates at Oppenheimer and ranked those stocks according to their upside potential based on consensus price targets from fundamental analysts.

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