BI-WEEKLY MARKET RECAP and TECHNICAL PERSPECTIVE

By: Larry Katz

May 29, 2001

Capsule

The market is in the process of completing a short-term top. This process may involve one more modest new high. However, the position of the indicators are such that if we are to get that new high it needs to occur sooner rather than later. Our current expectations are that this decline  will set the stage for another push higher to complete the medium-term rally that began in the March-April time frame. The bonds are in a position to rally over the short-term but any rally should be viewed as part of a still on going medium-term decline. The XAU completed a five-wave advance from early April and looks to be in the process of correcting that move now. This should allow for further weakness over the near-term. 

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Elliott Wave and Fibonacci

The rally from April 4 has clearly extended in regards to the S&P pushing it well past the .618 retracement of not only the post January decline but also the decline from early November. This is important as it strongly implies that the rally from March 22 is related to the entire decline from either September 1 or as far back as March 24 depending on which of those two peaks ends up being the orthodox top of the post 1898 and 1987 advance. The count from March 22 has not changed in regards to the S&P. I am counting the March 22 to March 27 rally as wave “a” with the post April 4 rally as a “c” wave. The rally from March 22 to March 27 was simple three-wave pattern on the hourly chart supporting the idea that it is an “a” wave and not the first wave of a larger impulse move for a detailed chart see the May 14 report). Now it is possible to count the rally as a five with an extended first wave and the last two small waves as the “a” and “b” waves of an irregular. However, “c” waves always follow and “c” waves are always fives. The decline from March 27 to April 4 was a very clear three-wave pattern on the daily chart, with the first wave down on the hourly chart a three and the latter an extended five. This supports further the idea that the rally from March 22 to March 27 was corrective. Thus I am approaching the rally from April 4 as a “c” wave. The weekly chart from April 4 remains up and until it turns down the pattern on the daily chart could very well sub divide further and allow for more of an extended move. The preferred count shown and discussed in the daily reports and hotlines this past week allows for one more modest new high to complete a five wave advance from April 4. We have discussed two possible counts with one allowing for a the current decline to be wave .4 of 5 of v. The S&P stopped late last week precariously close to confirming this count as invalid. The other possibility is that last weeks high completed wave iii from April 4 and that the current decline is a larger degree fourth wave. This is fine as relates to Elliott, however, as mentioned earlier, the weekly chart holds the key and a move below last weeks low would confirm the rally from April 4 as a completed wave on the weekly chart and as over. Last weeks low is just over a point from Friday’s close so through the process of elimination if we are to get that last ditch rally it has to occur now. In further study of the daily chart it is indeed possible to count a completed five-wave pattern at last weeks high. It is not my favorite count but it is there and is acceptable under the wave principle. The bottom line for the S&P is that a move below last weeks low of 1276.42 would confirm the rally from April 4 and also from March 22 as complete and allow for a fairly sharp decline. While it is indeed possible to count the rally from March 22 as the end of the correction of the post September decline and the next leg down from the peak could be close at hand. At this point I am approaching any decline from here as a “b” wave from March 22 and once complete a move back above the recent high is expected. The main reason for this view is that since we have already determined that the S&P is correcting the entire decline from either September 1 or March 24 of last year we would also expect that correction to have a Fibonacci relationship with the pattern it is correcting. The S&P has moved well above a .383 retracment of the decline so we should expect to see it approach a .618 retracment and that lies in the 1370-1380 area. Our expectations than are for a “c” wave rally to carry the S&P above the recent high, however, if the S&P begins to decline in impulsive fashion all best could be off. Long-term price patterns and Fibonacci relationships in the DJIA unlike the S&P do allow for a modest new high to complete the pattern from 1987 (see the April 30 letter for a detailed discussion. The rally from March 22 to March 27 on the DJIA can, unlike the S&P be counted as a five-wave pattern on the hourly chart with the decline from April to April 4 a “c” wave of an irregular from March 27. This decline on the hourly chart did count well as a five. Thus it is possible that the post April 4 rally is a third wave from March 22. The daily chart of the DJIA can be counted as a completed five wave pattern from April 4 but like the S&P we have to allow for one more slight new high to give the pattern a better look. However, also like the S&P the weekly chart remains the key as it is remains positive from the April 4 low. The DJIA like the S&P closed on Friday 13 points from last weeks low so any minor weakness would do the trick. As such if we are going to get a new high in the DJIA from April 4 it is going to occur sooner rather than later. Since the DJIA may be in an impulse wave from March I am going to approach any decline from here as a fourth wave to be followed by a fifth wave, which should carry the DJIA above the January 2000 peak and complete its fifth wave from 1987. This should correspond with a “c” wave rally in the S&P. The alternate count allows that the current rally is a “b” wave from January 2000 and will be followed by a “c” wave back below the March low. If we begin to decline in impulsive fashion this will become a very real possibility. The NDX moved above the April high turning the monthly chart up and finally confirming the post September decline as a completed wave. The monthly chart shows the decline from March as a three-wave pattern at least so far, so any move from here below the April low may be viewed as a fifth wave from March of last year. In fact, the NDX has not yet come close to even a .383 retracement of the post September decline, which is near 2420. Thus we could rally quite a bit further and still be within the confines of a larger degree fourth wave. In fact a move all the way to 2750 or so would take the NDX back towards a 50% retracement of the decline from September and not come close to overlapping the low of wave 1 (March-April 2000). The rally from April 4 to April 20 can be counted as a five-wave pattern on both the daily and hourly chart but only if wave 5 was very, very extended. However, it is equally possible to count the rally as a simple a-b-c with wave “c” being perfectly equal to wave “a”. The pattern from April 20 is not clear as there are a number of possible counts. The decline from April 20 to April 25 was a corrective pattern as was the rally from April 25 to May 2, which carried the NDX to within a point of the April 20 high. The decline from May 2 to May 16 is also best counted as a corrective pattern. From there we have two distinct waves up on the daily chart. Both of those rallies can be counted as fives but the first (May 16 to May 17 can just as easily be counted as a three. That leaves us with a couple of possibilities in regards to the pattern from April 20. The first is that the May 16 low completed a corrective pattern from April 20 on a small failure. There is also a possibility that the NDX finished off a “b” or X wave triangle on May18. The last is that the post April 25 advance is a large complex “b” wave from April 20. The latter count calls for a move now below the April 20 low. If the triangle is correct then the rally from May 18, which is a five on the hourly chart may be all of the post triangle thrust or only the first wave a larger pattern. If the May 16 low completed a correction from the April 20 high it is possible that we are in the early stages of a large “c” wave. Right now there are just too many possibilities for the short-term and too many options within those possibilities. The weekly chart as is the case with the S&P and DJIA is very important to the short-term. A move below last weeks low of 1927 would turn it down and confirm the rally from May 16 as a completed wave. For now we need to see how things unfold this coming week so stay in touch with the daily reports and hotline. Support: S&P; 1276.42, 1224-1227, 1198-1202, DJIA; 10,993, 10,595-10,610, 10,350-10,370, NDX, 1927, 1880-1887, 1740-1760. Resistance: S&P; 1291-1292, 1301-1303, 1316-1320, DJIA; 11,130-11,138, 11,213-11,223, 11,350-11,400, NDX; 2020-2027, 2100-2120. Trend changes for the next two weeks are as follows: May 30*, June 1*, June 5*, June 8*. *denotes important.

Bonds 

The May 4 to May 17 decline in the bonds can be counted as a clean five-wave pattern on the daily chart. The weekly chart shows this to be a whole new wave from the March 22 peak so the possibility that the bonds are entering the early stages of wave 3 from March 22 is quite high. The rally to May 17 is either all of or only the first wave of a larger corrective pattern of the May 4 to May 17 decline. This allows for a move back above the May 18 peak to complete a more complex corrective pattern. A break of the May 17 low of 98 05/32 would most likely confirm that wave 3 of iii was in progress and could usher in an acceleration of the decline. Until that low is taken out we cannot rule out a rally back towards resistance.  In the last report we discussed the importance of support near the 98 level. That area represented a 50% retracement of the rally from January 2000 to March 22, the .618 retracement of the rally from May of 2000 and is also the area where the decline from May 4 to May 17 is .618 the March 22-April 30 decline. A break of that level then would have additional significance and add further to the bearish count.  The daily range oscillators are oversold and also showing some potentially bullish divergences. The daily trend oscillators are negative but are also diverging leaving the short-term momentum picture as neutral. The weekly range oscillators are at the mid neutral level and have some time before reaching oversold levels. The weekly trend oscillators are negative. The medium-term momentum picture remains very negative. Short-term sentiment is improving but still only neutral with Consensus Inc at 43% bulls and Market Vane at 37% bulls. The commitment of traders reports does show commercial hedgers at a slightly net long position but not enough yet for an important low. Support: 98- 98 7/32, 95 10/32-95 24/32. Resistance: 100 10/32-100 16/32, 101 02/32-101 12/32. Please note that prices are based on a constant bond chart and not any particular futures contract. Currently, the constant chart is trading about 1/32 above the September futures. Short-term the bonds are in a position to rally but any rally would be short-lived and should be viewed as minor in scope. However, there are enough uncertainties to maintain a short-term neutral view. The medium and long-term picture remains negative and lower prices are expected. We are maintaining our bearish medium-term and long-term ranking.

XAU

The rally from April 3 to May 18 can be counted very easily as a completed five-wave pattern on the daily chart. This rally can be counted in any number of easy as it relates to the October 25, 2000 low. The easiest of counts is that it is a “c” wave from October with wave “a” ending in early March. The most bullish of counts is that it is a third wave from either October or a third of a third from mid February. Under the first count the April 3 low would be counted as a “c” wave of an irregular correction from late December of last year that ended on a small failure. Under the third of a third count the April 3 low would be counted as a deep second wave from February 16. Short-term momentum has turned down and the daily trend oscillators have gone negative. The medium and long-term indicators remain solidly up but the medium-term are fairly overbought. Sentiment has weakened substantially. Market Vane and Consensus Inc. have just reported the percentage of bulls in the high 50 low 60% level. Moreover, the commitment of traders reports show a huge drop in longs and even larger rise in net short positions by commercial hedgers or the smart money while the small trader is heavily net long. Support: 58.50-58-60, 56.20-56.30, 53.30-53.40. Resistance: 63.70-63.80, 6750-68.50, 73-74. Wave structure, short-term sentiment and momentum all favor further weakness at least over the near-term. We moved to neutral on the short and medium-term last week and for now we will maintain that ranking. The long-term ranking remains bullish.

Indicator review

The DJIA, with three trading days left in May is up by 271 points or 2.5%. The S&P is up by 28 points or 2.24% and the broad based NYSE Composite is higher by 13 points or 2%. While these gains are not nearly as strong as what we saw in April it does seem likely that the averages will record back to back monthly gains for the first time since December-January. The DJIA did put perform for the month at least so far (there are 3 days left) but the relative strength is only modest, with most of it occurring in the first half of the month. The breakout above resistance on May 16 was accompanied by weak volume with the follow-through to that breakout on contracting volume. This has turned the price/volume relationships to near negative. In addition, most of those gains have been reversed and much further weakness would render that breakout a false one. Breadth has been good the past couple of weeks but nothing spectacular. The A/D line has gained ground both daily and weekly but we have had only one day of better than 2 to 1 positive breadth and that was barely so. The daily number of new highs peaked on May 17. We have had a number of higher highs since with lower peaks in the new highs. The absolute numbers have been OK but we are facing a minor negative divergence. The new lows have been picking up but only modestly so and so far remain not much of a factor. The high/low indicators are positive. The Russell 2000 is up about 23 points or 4.74% for May. It has moved above its January peak but is still well below its all time high seen in March of last year. The short-term is neutral but very close to turning negative. The medium-term is positive. The Value-line is up 72 points or 5.95% for May. It also recorded a new all time high as it moved above its January peak by a very wide margin. The short-term is neutral but very close to turning down. The medium-term is positive. The NASDAQ Composite is up over 135 points or 6.3% and the NASDAQ 100 is higher by 105 points or 5.3%. They are for the first time in a long while doing better than the listed stocks both on a relative and absolute basis. However, it is difficult to say at this point whether this is going to be a medium-term shift or only a short-term development. The short-term is neutral but very close to turning negative. The medium-term is neutral. The DJTA is ahead for May by 102 points or 3.6%. The short-term is neutral but very, very close to going negative. It is also showing a potentially very negative chart pattern, a rising wedge from the March 22 low. The medium-term is neutral but could turn negative. The DJUA and UTY are down only slightly for the month. The short-term is neutral but looks to be completing a top. The medium-term is negative but improving and the long-term remains bearish as an important top looks to be complete.

Momentum

The breadth oscillator has turned down from overbought levels. It is neutral but still close to overbought. It is also the only indicator to confirm the mid May price highs. The volume oscillator is still overbought but is also diverging. The 3-day oscillator is neutral but weak. The McClellan oscillator has moved below zero but only by a very small margin. It did, however, fail to confirm themed May peak by failing to best its May 1 peak. The 10-day and open 10-day Arms are neutral but the simple 10 is closer to oversold. The 5-day Arms has moved back to slightly oversold levels and is positive. The 21-day Arms is neutral but closer to oversold. The new 10 Arms is holding below .80. A sell signal is rendered when it moves below than back above .80. The daily range oscillators are turning down from overbought levels. The daily trend oscillators are negative on the DJIA and the S&P and are close on the NDX. The NASDAQ McClellan oscillator is showing a very negative pattern and is bearish. The NASDAQ 3-day oscillator is also on a sell signal and is bearish. We have not worked long with these indicators and are not sure just how reliable they are but they are negative and they seem to give good signals so time will tell. The weekly breadth oscillators are overbought and beginning to turn down. The weekly range oscillators are neutral and just beginning to rise from oversold levels. The weekly trend oscillators are positive. The technical barometer remains bearish.

Sentiment     

The sentiment composite moved lower and at –6 is now negative. Investors Intelligence has shown very little change from two weeks ago but still is reporting far more bulls than bears. This has now been going on for a record 124 weeks. Market Vane has moved higher but is still no worse than neutral and only mid neutral at that. Consensus Inc, on the other hand has moved sharply higher. The latest 1-week reading was the highest since January 1999 and the 4-week moving average is almost exactly where it was in early September. The American Association of Individual Investors (AAII) has moved back to the excessive levels seen prior to the January top. The bull/bear ratio is the worst since the fall of last year. NYSE members remain strongly on the buy side and this measure of smart money is positive. However, the commitment of traders report for S&P futures showed a large rise in net shorts for commercial hedgers while the small trader is nearly 2 to 1 net long. This is nearly as negative as the member buying is bullish. While the 8-week moving average has eased a bit, corporate insiders are still fairly heavy on the sell side as witnessed by last weeks nearly 4 to 1 ratio. The CBOE put to call ratio, basis the 10-day moving average is slightly on the negative side but not excessively so. The OEX ratio has moved from bullish to neutral. The Rydex ratio is by historical standards quite negative.

Summary and Conclusion  

Bullish expectations have increased dramatically over the past month. Of course, higher prices do tend to bring on bullish expectations, that is to be expected. However, a number of key indicators have moved to levels not seen since late January and early September of last year. The Consensus Inc. survey, which for weeks on end had maintained  very positive readings, has moved up sharply with the 4-week moving average hitting levels seen in early September. Early September you might recall was the secondary peak in the S&P and the NDX and led to the all time high in the NYSE Composite. Market Vane is not nearly as negative and in fact is still low neutral but it too has increased. More importantly though is the latest numbers from the American Association of Individual Investors (AAII). The percentage of bears has been below 20 for three straight weeks and the bull/bear ratio is at its worst level since late summer-early fall of last year as well. Obviously, the public is still very much enamored with the stock market. The Rydex ratio is at levels that have historically marked important tops in the market that is with the exception of last year in the middle of the NASDAQ blow off. Moreover, the asset levels in both Ursa and Arktos, which are funds where traders can participate on the downside of the S&P and NDX respectively, are very close to where they were in late January. The CBOE put to call ratio is not excessive but it is negative. The Volatility Index (VIX) hit its lowest level since late January and remains very close to that level. The QQV and the VXN, the VIX equivalent for the QQQ and NDX options respectively, have moved well below where they were in late January. It is of course hard to quantify just where these indicators will peak or bottom. They could in a blow off get even lower (they did so in September), but they are flashing very serious warnings seen at or near tops not bottoms. Last but not least, the Market Summary and Forecast sentiment composite has moved to negative levels reaching the same reading we saw in mid September of last year. This too could get more negative but at its current reading also strongly implying that risk levels have increased dramatically and that the rally is getting long in the tooth. On the momentum front, the Arms indexes, while not bullish are not close to negative and are about the only positive factor we see for the short-term. Most of our momentum indicators are just turning down from overbought levels and some are still overbought. The breadth oscillator is the only one to confirm the high last week as it moved above its early May peak. The others failed and now have confirmed negative divergences in place. The daily trend oscillators have also turned negative and are also showing confirmed negative divergences. They gave a signal in early May that essentially failed as the market did nothing more than go sideways. These indicators rarely give two failed signals in a row. The short-term wave structure allows for a new high above last weeks peak but if that is to occur we need to see it occur sooner not later as even some modest weakness this coming week would confirm the rally from April and possibly March 22 as complete. The sentiment backdrop is negative as is the momentum backdrop. I am going to remain neutral on the short-term but with a clear negative bias that we are completing a top that could set the stage for a fairly sharp and nasty correction. There are two possible courses the market can take for the medium-term. The first is to correct the short-term excesses now and that could set the stage for another leg of the rally from the March-April low. The latter is to just keep on going now. This would deteriorate the medium-term picture rapidly given the position of the indicators and would likely leads to a blow off in some of the important sentiment indicators. Given those two choices the best place to be for the medium-term is neutral and that is where we will stay for now. On a long-term basis the DJIA and a few other averages do have a shot at new highs above last years peak. The Value-line has already made new highs. If this occurs, and it is still an if but one I expect has a strong likelihood of occurring it should be viewed as the last wave from 1987 and not the start of a new leg to a very old and tired bull market. I am approaching the S&P and NASDAQ with the idea that they have already seen their peaks and the current rally is a large degree bear market affair (for a more detailed discussion of this see the Elliott Wave section of the April 30 report). The bottom line is that on a long-term basis we are either at the end of a large bull market or in the middle of a bear market rally and I remain bearish.

QQQ traders are flat. Make sure to call the early morning hotline for any changes. Rydex switchers are holding a 20% position in Precious Metals and 10% position in OTC. Make sure to call the Noon Pacific hotline for any changes.  The morning hotline will be on at 7:15 Pacific time.   

The sentiment composite has moved back to bearish levels. This is the same reading we had in early September last year. Readings near current levels have, in most instances occurred near or at short to medium-term tops. The one exception was in February of 1999.

The chart below is the 4-week moving average of the Consensus Inc bullish survey. It is not nearly as excessive as it was in 1997 or 1998 but is at levels seen at or close to the last 4 important market tops.

The daily trend indicators have turned back down from lower levels leaving a very negative divergence in place. The first signal in early May did not produce much of a decline. However, the indicator rarely gives two bad signals in a row. 

The daily chart of the S&P below shows the two possible counts discussed in the Elliot section. The first one shows that the delcine last week is wave 4 of v allowing for one more modest new high. The one labeled as alt shows a triangle in the wave 4 of iii position and a completed five from April 4. A move below last weeks low would confirm this count as correct.