BI-WEEKLY MARKET RECAP and TECHNICAL PERSPECTIVE

By: Larry Katz

June 25, 2001

Capsule

The decline over the past two weeks has done little to change the technical picture with momentum indicators still in a positive mode while sentiment remains negative. A rally from here would weaken sentiment further while relieving the oversold condition setting the stage for a more serious decline than we have seen so far. A further drop in prices could turn sentiment more positive and allow a more sustained rally. Choose your poison. The bonds are getting stretched short-term but look to have enough to allow for a move above the May 18 peak. The XAU remains under pressure and is approaching important short-term support. We do not see enough to suggests that the decline is over.

Elliott Wave and Fibonacci

The S&P moved below the May low confirming the rally from March 22 to May 22 as a completed wave on the monthly chart. The daily chart and weekly chart are best counted as corrective patterns. Our current view is that the March 22 low completed wave “A” of intermediate wave 4 from 1982. The rally from March 22 exceeded a .618 retracement of the decline from January 31 by a wide enough margin to suggest that the rally is correcting the entire post September or even March 2000 decline.  We have not yet come close to a .618 retracement of the decline from September but the May 22 peak was within one point of a 50% retracement of the decline from March of 2000. As mentioned two weeks ago, it is possible that what we saw on May 22 was it as far as wave “b” is concerned. However, it is our view that the May 22 peak completed only wave “A” of a larger pattern and the current decline is either a “b” or X wave. The decline from May 22 on the weekly chart is showing a three-wave pattern supporting our preferred count that it is a “b” wave. The third wave began on June 5 and on the daily chart is also a three-wave pattern. We have been counting this wave as a “c” wave from May 22 and if it is a “c” wave we will still need to see wave 5 take the S&P below the June 15 low. At last weeks high the S&P stopped right at a 50% retracement of what can be counted as wave 3 so it is possible that the rally into Thursday was a fourth wave. Adding some support to this count is the fact that the rally on the hourly chart was corrective in nature. In addition, the decline from Thursday’s high into the low on Friday has also traced out a clean five-wave pattern on the hourly chart. The fact that we do have a five on the hourly chart from Thursday implies lower prices. Of course, that can occur in one of two ways. The first is that we rally a bit and then begin wave 3 or c and the latter is that we move below Friday’s low immediately and that could allow for the five to turn into a seven or corrective pattern. A move above the 1240 peak of June 21 would invalidate the possibility that the rally from June 15 was a fourth wave from June 5. In so doing it would also confirm that the post June 5 decline as a three- wave pattern leaving the entire post May 22 decline as a double three. What this would do would be to solidify the preferred count that the post May 22 decline is a corrective pattern and all or part of a “b” wave from March 22. However, it would not confirm that the “b” wave was complete as it would also be very possible to count the rally from June 15 as an even smaller “b” wave from May 22. The fact, that the rally from June 15 is corrective certainly supports that view. The bottom line is that we are faced with a number of possible short-term counts for the S&P with nothing really standing out at this time. There are a lot of possibilities, however, and as the pattern unfolds we will be able to keep you updated in the daily reports or hotline. For now we need to be patient and wait for the market to tip its hand. There is important Fibonacci support for the S&P in the 1170 area. First off that is the area of a .618 retracement of the rally from March 22 and is also where the post June 5 decline would be 1.618 the May 22-may 30 decline. A break of that level in our view would be quite negative The DJIA moved below May’s low in June confirming the rally from March as a completed wave on the monthly chart. We have been approaching the rally from April 4 on the DJIA as a third wave from March with the post May 22 decline as wave 4 from March. However, the action of the monthly chart has changed that count as it has left what is clearly a three-wave pattern in place on the weekly chart. This has also put a big hole in the possibility that the rally from March is a fifth wave from 1987 as we presented in the April 30 issue. It is not completely out of the question but if that is to be it will have to unfold as a diagonal triangle and not a conventional five. The pattern from May 22 is unfolding in a very similar pattern as the S&P. The weekly chart from May 22 is so far a three-wave pattern, with the third wave from June 5 also a three at least so far. The rally from June 15 has been confirmed as a corrective pattern on the hourly chart and stopped where it needed to stop for it to be considered as a fourth wave from June 5. In fact it alternated quite nicely with wave 2 as it did on the S&P. The decline from Thursday’s high on the hourly chart has left a five-wave pattern in place and broke well below a .618 retracement of the rally from June 15. In fact, at Friday’s low it stopped about 8 points above the orthodox low of wave .3 from June 5. We say orthodox low as we did see two lower lows but view them as part of wave .4 based on the hourly chart. This does leave open the possibility that Friday completed wave .5 of “c” on a very minor failure At this point we rate this as only a very minor possibility but one we cannot completely dismiss. It is more likely that this five down is either the first wave of a larger pattern or will unfold as a seven. And if the latter it could be a “b” wave from June 15. The NDX is showing a three- wave pattern on the weekly chart from May 22. The May 22-M<ay 30 decline is also a three on the daily chart and is either wave a of a larger a-b-c from May 22 or the first three of a double three from May 22. The post June 7 decline is so far a three on the daily chart. The rally from June 15 stopped two points from important resistance, which would have caused an overlap with the low of wave 1. This would have confirmed the decline from June 7 as a three and the post May 22 decline as a completed double three. As it is, it is still possible that the post June 15 rally is a fourth wave from June 7 and allows for a break of the June 15 low to complete a “c” wave from May 22. The rally from April 4 to May 22 is best counted as a three. It is possible that this rally was all we are going to see but so far the decline from May 22 is also a three, and even if the NDX does take out the June 15 low it will still be a three and as such we are still going with the idea that May 22 completed wave “a” of a larger pattern with the current decline wave “b” from April 4. Thus our expectation is for a rally back above the May 22 high once the decline is over. This in fact is our expectation on all three averages. However, while a move below the June 15 low would still leave only a three wave pattern in place it would also allow for the possibility that the post June 5 decline in the DJIA and S&P, and June 7 in the NDX was not a “c” wave but instead a third wave from May 22.  Support: S&P; 1214-1217, 1198-1202, 1170-1175, DJIA. 10,550, 10,340-10,370, NDX; 1725-1727, 1697-1703. Resistance: S&P; 1233-1235, 1254-1257, 1274-1278, DJIA; 10,688-10,700, 10,835-10,848, 10,960-11,000, NDX; 1752-1754, 1792-1800, 1845-1853. Trend changes for the next two weeks are as follows: June 27, June 29** July 2-4***. * denotes important.

Bonds

While it is not the best of counts it is nonetheless possible to count the decline into May 17 on the bonds as the completion of a five-wave pattern from March 22. That would put the bonds in a larger

degree second wave than anticipated in the previous report. This is supported by the fact that the bonds have retraced far more than a .618 of the decline from May 4 to May 17 making it more likely that the post May 17 decline was a fifth wave from March 22 and not a smaller first wave of a larger pattern.  Thus a challenge or slight break of the May 4 peak is a good possibility before wave 2 is complete. The daily range oscillators are approaching overbought levels are still OK. The daily trend oscillators are positive but beginning to weaken. Short-term momentum is Ok but maturing and is late in the up move. The weekly range oscillators are neutral. The weekly trend oscillators are also neutral but close to turning positive. Medium-term momentum is neutral but improving. Long-term momentum has turned down from overbought levels and is negative. Market Vane and Consensus Inc. have been unchanged for the past three weeks and at 40 and 48 percent respectively are neutral. Support: 100 20/32-100 27/32, 99 18/32-100. Resistance: 102 21/32- 102 30/32, 103 24/32-104 02/32. Please note that the above price projections are based on a constant bond chart and not any particular futures chart. Currently, the constant chart is lagging the September futures by about 2/32. The short-term is still up but maturing as the indicators are getting overbought. We remain neutral. The medium-term has improved enough to move back to neutral while the long-term remains negative.

XAU

The XAU is fast approaching important support in the 5350 area. A break of support could very well confirm that the rally from April 2 to May 18 was a “c” wave from October of 2000 and not a third or a third of a third from that same low as discussed two weeks ago. This would also suggest that the October 2000 low was not the ultimate low of the post 1980 bear market. Short-term momentum is moving towards oversold but has not yet turned up. Medium-term indicators are neutral but beginning to weaken while longer-term indicators are still positive. Support: 53.50, 50.50-51.00. Resistance: 58.50-58.78, 62-62.50. We are approaching important support. The short-term is improving but is not yet positive. We remain neutral on both the short and medium-term  We are going to maintain our long-term bullish view but that position is beginning to weaken so please stay in touch with the daily letter or hotline.

Indicator review

 The first part of June was a non-event as far as the averages were concerned as they showed little net change. That has certainly not been the case the past two weeks as the DJIA, S&P and NYSE Composite are down quite sharply. There is still one week to go but unless we get a substantial rally, June looks poised to be lower breaking a two-month win streak. The DJIA has broken a short-term rising trend line dating back to the March-April low and as of Friday has moved back towards its 200-day moving average. The S&P also broke its respective rising trend line and remains firmly entrenched below its 200-day moving average, which is pointing down. Moreover, the S&P also completed a minor head and shoulders pattern and could be completing a more complex head and shoulders pattern going back to early April. Price/volume relationships have been negative for the most part but did improve late last week. Breadth has been weak with both the daily and weekly A/D lines losing ground but they are still holding up better than the averages.  The new highs on a daily basis are doing OK but we have also seen a sharp expansion in the new lows that did confirm the lower prices with the peak levels the highest since early April. The weekly statistics are neutral but slipping. Our daily high/low indicators have moved to neutral from bullish while the weekly indicators remain neutral. The Russell 2000, which in the first part of the month had been showing a bit of relative strength has sold off sharply the past two weeks putting it in the negative for June. We are neutral short and medium-term but the medium-term is beginning to weaken rapidly. The Value-line has also been weak and is down nearly 4% for June. We are neutral short and medium-term. The short-term is getting very oversold so we could see a bounce soon. The medium-term, on the other hand is beginning to weaken substantially and is not far from turning negative. The NASDAQ Composite and the NDX have been hit hard as well over the past two weeks losing over 8% and leaving them down sharply fro the month as well. However, the past few days they have begun to show some decent relative strength versus the DJIA and even the S&P. We are neutral on both the short and medium-term. The DJTA has also been under pressure and is down close to 9% for June. The short-term is neutral and very oversold so we could get a bounce. The medium-term is negative and just starting to decline. The DJUA and Uty have been hit severely. The short-term is deeply oversold and we are neutral. Medium and long-term, especially long-term we remain very negative.

Momentum

The breadth oscillator came close to oversold levels but did not quite make it. It is neutral but with a positive bias. The volume oscillator is starting to move up but is still oversold. The 3-day oscillator is neutral but weak. The McClellan oscillator is neutral but closer to oversold. The 10-day and open 10-day Arms are starting to ease but remain at very oversold and bullish levels. The 5-day Arms is neutral. The 21-day Arms is oversold and bullish. The new 10-day Arms is neutral but closer to oversold. The daily range oscillators are close to oversold. The daily trend oscillators are negative but improving. The weekly breadth oscillators turned down from overbought a couple of weeks ago. They are neutral but still need work.  The weekly range oscillators are neutral. The weekly trend oscillators are positive but beginning to ease. The technical barometer has moved to neutral in both positions and could support a rally but the outside position remains bearish on a longer-term basis

Sentiment 

The sentiment composite moved lower and at +5 is strongly negative. Investors Intelligence has shown an increase in bulls and is back over 50%. The bears moved lower near 30% with the bull/bear ratio still quite negative. The last couple of weeks has seen improvement in both the Market vane and Consensus Inc surveys and both are neutral. However, the 4-week moving average of Consensus Inc only two weeks ago hit its highest and most negative reading since January 1999 surpassing levels seen at the January, March and September 2000 peaks. It has some time before turning positive. The American Association of Individual Investors (AAII) has eased but is still showing more bulls than bears. It is not excessive but it is still negative. NYSE members continue to be strong buyers and this indicator is very bullish. This is offset by the still high level of net short positions on the S&P futures by commercial hedgers as reported by the Commitment of Traders Report. Moreover, the insider sell/buy ratio has moved higher with the 8-week moving average surpassing the late March peak and the latest 1-week reading the highest in the 8 years of data that we have. The CBOE put to call ratio and the OEX ratio basis the 10-day moving averages are neutral. The Rydex ratios have eased and are neutral but still closer to negative. The asset levels in Ursa and Arktos are up from their lows but still much closer to their lows and remain a big negative factor. The volatility indexes such as VIX, QQV and VXN remain close to or even below their levels seen at the late May early June peaks and are clearly negative.

Summary and Conclusion  

Two weeks ago, the market was in a similar position technically as it is today. Price, however, is considerably lower. We had thought at that point that the position of the Arms indexes really limited the downside risk but in spite of the bullish position of these key indicators, the market did move lower anyhow. We were somewhat surprised that we broke as hard as we did given where the Arms indexes were at the time but looking back some of the more important sentiment measures we follow were as bad as they were at the January and September peaks. So in hindsight we are not as surprised today as we were two weeks ago. One of the most important functions of a correction is to correct the excesses that built up in the previous rally. Of course, the bigger the excesses the bigger the decline both in terms of magnitude and time.  To that end we have in our opinion so far failed. While we have seen some improvement there is clearly not enough given the break in prices to support a solid medium-term bottom as we had expected would occur a couple of weeks ago. The improvements we have seen are mostly from the momentum side of the equation. The breadth and volume oscillators along with the McClellan oscillator have moved lower and are either oversold or close to oversold. Other than the Arms indexes, these are our primary internal indicators and they have improved from two weeks ago but in spite of all that they have not yet turned positive. Where the market has failed is in turning what had been a high level of complacency into some genuine fear. Don’t get us wrong, we have seen some improvement in some of the sentiment polls such as Market Vane and Consensus Inc, but these measures are only at neutral levels. The AAII survey is showing an easing in net bulls, however, the absolute number of bears remains very low and closer to negative levels. Meanwhile, the Investors Intelligence survey has seen the bullish percentage move back above 50% while the percentage of bears is near the lowest level of the year. This key survey has now had more bulls than bears for an astonishing 141 consecutive weeks. aThe CBOE put to call ratio has also improved but it  is not t levels consistent with important lows nor for that matter is the Rydex ratios. In fact the key ratio while down from its late May peak is still closer to levels that pre 2000 led to tops not bottoms. NYSE members remain firmly on the buy side, which in our view is a bullish. However, the Commitment of traders continues to show a huge net short position in S&P futures by the commercial hedgers, which are considered people in the know. Moreover, corporate insiders have continued to step up their rate of selling to very bearish levels. On balance, our smart money indicators are negative. Last but not least are the volatility indexes, which in spite of the sharp drop in price have not only moved higher but are at or close to where they were at the May-June top and well below their levels seen in late January.  We talked about this in one of our daily reports last week but it does bear repeating. The VIX is based on the OEX options, the VXN on options on the NDX, and QQV is based on options on the QQQ’s. High readings indicate fear and are seen near important lows. For example, at the March 22 low the VIXZ moved close to 42 and on April 4 was over 40. On the other hand, at the June 5 secondary high it moved to 21.11 even lower than the reading at the actual price high of May 22. This was below the level seen on February 1 when it hit 22.05. On Friday it closed at 22.55 while at one point it had been below 22 or close to where it was at the tops of early February, and early June. As for the VXN and QQV we are seeing similar if not more negative behavior and in fact both are below where they were in late January and in late May. Thus in spite of the sharp drop in price we are seeing levels of complacency as high as they were at tops with none of these indicators anywhere close to levels seen at important market lows. Now it is true, we have seen the VIX move lower. Last September 1 for example it did move to the high teens. However, it did not stay there long and more importantly that marked the top of the S&P leading to a six- month decline of nearly 27%. Yes, as we have stated in previous reports, they can go lower, we have seen the VIX in particular in the high teens at very important tops. However, a move from 22.55 to the high teens is not very much and could occur well before the averages come close to their late May peaks.  So, where does that leave us currently? Frankly we are in the same position now that we were in two weeks ago but at lower prices. We are still of the mind that the market is setting up for a rally. This rally could occur from current levels, however, in our opinion if it does it will not be sustainable. At best would lead to a test or slight break of the May peak and most likely set the stage for a more significant decline than we have witnessed so far. In fact, we will be bold enough to state that if indeed the markets do rally from here under current conditions it will lead to a serious medium-term top. Why? Two reasons come to mind. First as discussed, the sentiment backdrop is already on the negative side and there is nothing like higher prices to turn more investors bullish. Secondly, the takeaway numbers over the next several days for the Arms and other momentum indicators are so low that they could turn neutral by going nowhere but if we rally a bit they could actually turn bearish. The other course the market can take is to move lower from here. This would keep the momentum indicators in a more bullish posture and hopefully allow the sentiment figures to improve to levels that could support a more sustained medium-term advance. In either case we do see a rally coming and are positioned for it. If it occurs now we will be selling early and if we take the second course we could be adding to our positions. However, while we do see a rally coming we do not see enough from current levels to move from our neutral position for both the short and medium-term. A move lower could, however, turn the medium-term bullish while a rally from here would in all likelihood confirm a medium-term sell signal. Long-term we remain bearish.

We are holding a 50% long position in the SPY from 120.70. They closed at 122.85. Keep your stop at 115. move the stop to break even if the S&P cash moves above 1243.50.  We are flat the QQQ’s. Rydex switchers are holding a 20% Precious Metals, 30% Nova and 10% OTC position. Make sure to call the Noon Pacific hotline for any changes. The morning hotline will be on a 7:15 AM pacific.   

The S&P completed a head and shoulders top on June 16. However, it maybe in the process of completing an even more complex head and shoulders with the first head and shoulders actually the head of that larger pattern. If that is the case we are likely putting in the right shoulder now. A break of the second neck line would confirm  

The chart above shows the VIX (lower chart) and the S&P (upper chart) on a daily basis. Note how high VIX readings tend to occur near lows and low readings near tops. The current reading in spite of the recent decline is near the levels seen in late May and early June near tops not bottoms.

The chart below is our sentiment model and the DJIA on a weekly basis. Over the past two weeks the model has moved lower even though the averages have also done so. Normally the model moves higher into declines. We do not view this in a very positive light.

The chart above shows the two possible counts for the S&P from the May 22 peak. A move above last weeks high of 1240 would invalidate the rally as wave 4 from June 5 and confirm the post May 22 decline as a double three. This decline could be all of wave B or only wave ‘a” of B.

The chart below is a weekly chart of the DJIA. Note that the rally from March 22 is a clear three-wave pattern and has been confirmed by the monthly chart as a completed wave.