BI-WEEKLY MARKET RECAP and TECHNICAL PERSPECTIVE

By: Larry Katz

August 6, 2001

Capsule

The decline that began late last week should have further to go and at this juncture we are approaching it as being related to the rally from July 24. Once complete a move back above the August 2 peak is expected but given the position of most of the indicators that should lead to a more serious medium-term sell signal. Long-term the bear market remains firmly in force and in control. The bonds are neutral short-term but should head a bit lower following a modest bounce. The medium-term picture is still OK but is beginning to weaken. The XAU has turned negative short and medium-term. A move back towards or slightly below the October 2000 low is not out of the realm of possibilities but should be viewed as part of the long-term bottoming process.

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Elliott Wave and Fibonacci

Two days after our last report the S&P moved below the July 11 low and did so in what can be counted as a five-wave pattern on the hourly chart This five follows what is clearly a three-wave pattern from July 2 to July 11. Although the Fibonacci relationships within the post July 2 decline and also back to the May 22 peak were not satisfied, the rally last week above the July 19 high seems to confirm that the post July 19 decline was in fact a “c” wave From July 2. This also supports the idea that the post July 2 decline was in fact a second three from May 22 and that the entire post May 22 decline was a corrective pattern. The fact that this decline was corrective in and of itself does not imply that a move back above the May 22 high is eminent or for that matter going to occur at all. It could be that the March-May rally is not a “b” wave but instead an X wave and as such the May-July decline could very well be the initial wave of a second or even a third three from the September or March 2000 peak. The other possibility is that the March-May rally was an “A” wave of a possible large “B” wave triangle and that the decline into July either wave “b” of this triangle or only wave “a” of “b”. There are, however a couple of important factors relating to the long-term pattern that need be pointed out.  The first is that the March-May rally is best counted as corrective. That is a strong argument supporting our view that the post 2000 intermediate wave 4 pattern is not complete and that the rally into May is part of a larger pattern that in all likelihood will lead to an ultimate break of the March 22 low. The one exception to this is the possibility that intermediate wave 4 itself take on the form of a triangle. If that is the case then it is conceivable that the March low was in fact wave “a” of that pattern. This is a long shot but the fact that it is a fourth wave leaves it open as a potential count. The bottom line long-term is that wave 4 is not complete. We could be in the early stages of a second or even third three now or we could hold up in a trading range for a while longer before thrusting to new lows below the March low but other than the remote possibility that the entire post 2000 pattern evolve as a triangle before it is over the odds favor a break below the March low. The rally from July 24 is best counted as corrective on the hourly chart and as of Friday last week has been confirmed as a completed wave on the daily chart. The rally did carry past a .618 retracement of the July 2 decline making it more difficult to count it as a b wave from that point. It may be an X wave and that would allow for a third three from May 22 to unfold but again the move above the .618 retracement of the second three from May 22 makes this a less likely count. The rally did stop right near the .383 retracement of the post May decline and that suggests that the rally from July 24 is most likely related to the entire decline from May and not any of the minor waves within the pattern. The fact that it is a three argues strongly that it is not the beginning of a “c” wave back above the May highs although it is possible that the July 24 low was an X wave and that the entire post March rally is to unfold as a double three. However, the technical indicators are not really in a position to support a move back to the May highs. Our preferred count short-term is that the rally is an “a” wave of a larger pattern related to the post May decline and that the decline that began on Friday is a “b” wave related to the post July 24 advance. The decline on Friday stopped close to a .383 retracement of the rally and so far looks corrective. It is possible that wave “b” ended on Friday but it is more likely that if indeed the pattern is corrective it was only wave “a” wave “b”.  In the July 23 report we showed that the rally from March into May and so far the decline from May to July are both three-wave patterns on the DJIA basis the weekly charts. Thus in our view the rally from March is not the beginning of a final fifth wave from the 1987 low unless it is going to unfold as a diagonal triangle. As such it is much more likely that the January 2000 peak did in fact mark the completion of intermediate wave 3 from 1982 and that we are in the throes of a larger degree fourth wave. Since it is a fourth wave it may ultimately unfold as a triangle and if so it is possible that what we saw in March was wave “a” of that triangle. But as is the case with the S&P we are art this time anyway of the view that the triangle is only a very remote possibility and that the March lows will ultimately be broken before wave 4 has run its course. As discussed the decline from May 22 on the DJIA is so far a very clean three-wave pattern on the weekly chart. We can count a five wave decline from June 5 to June 26 on the daily chart with the subsequent action from June 26 and irregular completing at the July 11 peak. This leaves open the possibility that the action from June 26 on the DJIA is all part of a large fourth wave from May 22. The decline into July 24 could be a “b” wave of a very complex fourth wave triangle from June 26 or a B wave of a complex flat or double three. The bottom line is that we could still get a five on the DJIA from May on a move below the July 24 low. Meanwhile, the rally from July 24 has been confirmed as a corrective pattern and a very clean flat with waves “a” and “c” near perfect equality. This could be the first wave of a larger pattern and a move above the July 11 high would not eliminate the possibility that the DJIA was in a fourth wave from May as the entire pattern could still be counted as a double three with the July 24 low wave X.  The decline from Thursday is so far corrective but could still unfold as impulsively, however, that would require an almost immediate move lower today. A failure to do so would likely confirm the decline as corrective but since it is still possible that the DJIA was in a triangle that would not necessarily indicate a move back above Thursday’s high. The monthly chart on the NDX is a three-wave pattern into the April low. The rally from April to May was corrective as was the decline into the July 24 low. It is possible to count those as waves “a” and ‘b” of a larger pattern. This pattern could involve a move back above the May high to complete a large flat. There is also the possibility that they are waves “a” and “b” of a still developing triangle from April. However, the most important point to keep in mind is that the April-May rally was corrective and not the beginning of a new impulse wave. As such, the decline from March 2000, whether it ultimately develops as a three or a five is not the end of a pattern but only part of a larger pattern. The rally from July 24 can be counted as a five but with a high degree of difficulty. It is best counted as corrective but where it fits within the post May 22 decline is another story. Thursday’s peak did slightly penetrate the .618 retracement of the decline from June 29 but not by enough to be conclusive. At the same time, it stopped right at the .383 retracement of the decline from May 22. As it stands at this time nothing is conclusive but a move through last weeks high would imply that the rally was related to the entire post May decline and not the June 29 pattern. The hourly chart from Thursday’s high is so far corrective but the daily chart remains down so it may still evolve as impulsive. However if that is to be the case then the NDX would need to begin to move lower almost immediately today. As it stands now we are of the view that the rally from July 24 was an “a” wave and the current decline a “b” wave that should be followed by a move back above the recent high. Support: S&P; 1203-1204, 1188-1191, DJIA; 10,455-10,463, 10,355-10,368,  NDX;  1693-1698, 1647-1655. Resistance: S&P; 1218-1220, 1240-1243, 1258-1263, DJIA; 10,540-10,550, 10,600-10,620, 10,680-10,700, NDX; 1738-1742, 1758-1765, 1826-1838. Trend changes for the next two weeks are as follows: May 6-7*, May 9-10* May 13*. * denotes important

Bonds

The bonds moved slightly through resistance given two weeks ago but failed to follow-through, The rally from the May 17 low is so far a very clear three-wave pattern on both the daily and weekly charts. This goes a long way in supporting our view that this rally is part of a correction of the decline from March and not a new wave to new recovery highs.  The pattern from May 17 is beginning to overlap a bit and also shows a possible wedge or diagonal triangle in development, We are giving some thought to the idea that it is a “c” wave diagonal triangle of a larger irregular flat from April 20. If so then last weeks decline is part of wave “d” of the diagonal and that allows for one more modest move above the July 31 peak to complete the pattern. The daily range oscillators have turned down from near overbought levels leaving negative divergences in place. The daily trend oscillators have also turned down and short-term momentum is negative. The weekly range oscillators are neutral. The weekly trend oscillators are positive but not real strong. Medium-term momentum is slightly on the plus side. Market Vane is now negative at 63% bulls. Consensus Inc is neutral at 47% bulls while the commitment of traders report shows that commercials are now net on the sell side and negative. Sentiment is now on the negative side of the equation. Support: 101 19/32 +/- 4/32,100 8/32 +/- 11/32. Resistance: 103 02/32 +/- 3/32, 104 3/32 +/- 10/32. Sentiment has turned negative and the short-term indicators have turned down. Further weakness over the short-term is expected and we are moving from neutral to negative on the short-term. The medium-term picture is mixed. We can make case for one more push higher and the trend oscillators are positive however, the overall picture has weakened enough to move to neutral from bullish. Long-term we remain bearish.

XAU

The XAU rallied right to initial resistance levels and failed. The decline from May 18 to July 2 is still best approached as a corrective pattern but so too was the rally into July 24 and the failure at resistance on as corrective advance buts the XAU on the defensive. Short-term momentum reached overbought levels and has subsequently turned down and weekly momentum remains negative. On a long-term basis we still believe that the XAU is in the process of completing an important bottom. However, that bottoming process may in fact require a move below the October 2000 low. Support 51-51.50, 47-47-70, Resistance 57-57.50, 61-61.30  We moved to bearish on both the short and medium-term and remain there for now. Long-term we are neutral with a bottoming bias.

Indicator review

The month of July ended with mixed results with the DJIA gaining about 20 points while both the S&P and NYSE Composite closed with modest losses. The markets tendency to rally early in a new month continued in August as all three averages, in spite of Friday’s modest losses are showing small net gains. On July 24 we did see a modest bullish divergence as the DJIA held above its July 11 low while both the S&P and NYSE composite moved below their respective lows. The rally so far has been uninspiring. The DJIA is spite of being positive is still trading right around its flat 200-day moving average. The NYSE Composite is below its 200-day moving average, which is beginning to roll over a bit. The S&P is in the worst shape with its 200-day line moving at a very sharp angle downward and is a major negative force on this key average. Price/volume relationships started out OK from July 24 but quickly faded and have become slightly negative. Breadth has remained positive as both the daily and weekly A/D lines managed to move higher. The high/low statistics are OK but the number of new highs did slip late last week and set off a minor negative divergence. The weekly numbers with last week showing an expansion in new highs and contraction in new lows. The high/low indicators are neutral but weak. The Russell 2000 ended July down about 5%. It is up so far in August but only slightly so. The short-term chart patterns and indicators are neutral but with a slightly positive bias. The medium-term picture is also neutral but weakening and is not too far from turning negative. The Value-line lost about 2% in July and has recouped about 1/3 of that so far in august. The short-term is neutral but with a slightly positive bias and higher prices are likely. However, this is occurring within the confines of a deteriorating medium-term picture that is close to going negative. The NASDAQ Composite lost over 6% in July and for the first three days of August it is up modestly. The NASDAQ 100 lost close to 8% in July and like the rest of the averages has started out August in a slightly positive fashion. We are neutral short-term in both averages. The medium-term is also neutral but showing a number of signs of weakening and frankly is not too far from a sell signal. The DJTA was the standout performer fro July bucking the trend and gaining over 2%. It is only slightly higher for August. The short-term is neutral but weak. And any weakness in the days ahead could turn it negative. The medium-term is neutral but deteriorating. The DJUA and UTY moved to deeply oversold levels and have subsequently bounced. On a short-term basis we think the rally can carry on a bit more and we remain neutral. The medium and especially the long-term remain negative.

Momentum

The breadth and volume oscillators are neutral and have not generated much in the way of positive momentum. The 3-day oscillator reached mediocre overbought levels but also did not generate any real positive momentum as it failed to get above the +600 level. The McClellan oscillator is above aero and that in turn has turned the summation index higher. However, it is only neutral and mediocre neutral at that not having reached a level suggestive of any real strength, at least not yet. The 10-day and open 10-day Arms are neutral but still closer to oversold and somewhat positive. The 5-day Arms is neutral while the 21-day Arms is oversold but the latter is beginning to ease. The new 10-day Arms developed by Peter Eliades has moved below .80 registering the first part of a two part sell signal. The signal is completed by moving above .80, which it has not done. The daily range oscillators have broken out but are also now closer to overbought. The daily trend oscillators are slightly on the positive side. The weekly breadth oscillators turned up but only from neutral levels. The weekly range oscillators are neutral and weakening. The weekly trend oscillators are negative on the DJIA and the NYSE Composite and close to turning negative on the S&P. The technical barometer is neutral but keep in mind we have not come close to reversing the –10 reading in mid April and the overall position remains negative.

Sentiment

The sentiment model eased last week to +6 and is negative. Investors Intelligence reported a modest drop in bulls and a nice rise in bears. However, the bull/bear ratio is still quite bearish and while the percentage of bears did rise it is still only 27.8% and has just come off a 3+ year low. Market Vane and Consensus Inc moved up a bit for the latest reporting period. They are neutral but closer to bullish as are the 4-week moving averages. The American Association of Individual Investors are at a near dead heat between bulls and bears. The indicator is OK for the short-term but weak and still very negative long-term.  NYSE Members remain firmly on the buy side and that is bullish. However, the commitment of traders report for the S&P futures shows that commercials are still very heavily net short while the small speculator remains heavily net long. In addition, the insider sell/buy ratio on an 8-week moving average is still extremely high and very negative. The CBOE put to call ratio basis the 10-day moving average has moved back to negative levels but is not yet excessive. The OEX ratio is back to slightly bullish levels. The Rydex statistics are close to neutral but high neutral and not that far from bearish. The Volatility indexes are negative. They are not quite where they were in early to mid July but are not far away either. However, both the VIX and VXN are below where they were in May and June. So, while they are not extreme, they are on the negative side of the equation and are sending out big warning signals.

Summary and Conclusion  

At the July 24 low there were a number of bullish momentum divergences going all the way back to June 15. The breadth and volume oscillators had made two higher lows versus the S&P on July 11 and July 24 while the McClellan oscillator showed a bullish divergence on July 24 versus its June 15 low. This lead to a rally that in turn confirmed those divergences as real. However, the rally, at least so far anyway has failed to generate any real upside momentum. The breadth and volume oscillators have moved up but at a mediocre rate and are only at neutral levels. The McClellan oscillator also failed to generate any real upside momentum although by moving above the zero line it was able to turn the summation index up again. In addition to the momentum divergences we also had a price divergence with the DJIA holding above its mid July low failing to confirm the new lows in the S&P and the NYSE Composite.  At this point, however, we look at the markets inability to do very much with what was a very bullish configuration as a longer-term negative adding further support to our view that the bear market that began back in 2000 is far from over. We did at the July 24. The rally from an Elliott perspective from July 24 was a corrective one adding further to our longer-term view that a bear market is still in force. In a bull market environment the bullish set up from the indicators would have produced more than what we have seen so far and would have done so with a far more bullish price structure. That this weak rally has occurred with the 10-day and open 10-day Arms remaining at or near oversold levels is just another strong argument that the bear is still very much alive and kicking. In fact and in retrospect we are still somewhat surprised by the extent of the May-July decline given how oversold these indicators were during nearly the entire decline. Even in bear markets in the past deeply oversold Arms readings have led to a rally or if not a rally then at least to a slowing of the decline. However, the averages did no such thing this time around. We was asked in a recent interview about breadth and our view about how relatively strong it has been throughout thee year even as the averages have been weak. Historically this has proved to be a bullish long-term development, and in fact it may eventually turn out to be so in the end once the bear runs its course. However, when looking at the bigger picture back from the A/D lines 1998 top what we have seen is only a minor recovery of a huge loss. There always is a hook something to keep the masses and the analysts believing that the bull is right around the corner and the recent strength may just be that hook. Remember, the A/D line peaked in April of 1998 and the major averages did not peak until nearly 2 years later.  Speaking of the analysts, there remains far too much bullishness from the strategists on Wall Street. The average stock allocation or the SSI indicator is now at record highs of nearly 70%. One very influential strategist is still calling for 1550 on the S&P for this year. That would from current levels take a rally of some 336 S&P points or a roughly 27% gain. Remember the three phases of a bear market (not to be confused with Elliott waves). The first phase is disbelief, the second is recognition or acceptance and the third is capitulation or the final purging. It is quite obvious that we remain in the first phase and are not yet even beginning the second phase. The third phase should be real fun. While we could certainly make a case that what we saw last week was it as far as the rally from July 24 we do not think that this is the case and that a move above last weeks high is expected before the rally runs its course. However, the indicators are in most cases weakening, especially the medium-term ones and that expected rally will in all likelihood turn the medium-term picture to negative. We already have a preliminary sell signal from the weekly trend oscillators. The investors Intelligence survey, while improving a bit this past week is still coming off a three+ years low in bears and corporate insiders basis their 8-week moving average are selling at their highest pace in over 8-years. We still have OK readings on Market Vane and Consensus Inc as well as the American Association of Individual Investors that can support another leg up from July 24. The CBOE put to call ratio and has moved below its May 30 and July 2 levels both of which were near important tops. The Rydex ratio is not bullish but also not bearish or excessively so but the volatility indexes are not good at all. The VXN, which is based on options directly on the NDX is not yet at levels seen in early July but is below levels seen in May and June. The VIX is in a similar position and both are in danger zones. Low readings on these indicators tells us that people are willing to pay a lot more for calls relative to puts while high readings imply that people are willing to pay a much higher price for puts relative to calls. Obviously very low readings imply a high degree of complacency while high levels imply fear. The bottom line is that while we do see the potential for a move back above the August 2 peak once this correction runs its course this should set the stage for a more serious sell signal. Most of the sentiment indicators will likely get to extreme levels while there is also a good chance that the momentum indicators could reach overbought levels. This combination combined with the already weak medium-term momentum picture will likely trigger a fairly important sell signal just in time fro the September-October period, which is historically the weakest period of the year. Our expectations are that the post July 24 rally has not run its course and a move back above the August 2 peak is expected we also see this as most likely a precursor to a more important top. Risk is far too high and while it is tempting to try to take advantage of this rally the position of the indicators suggest otherwise. As such we are going to remain neutral on the short- and medium-term with a negative bias medium-term. Long-term we remain firmly in the bearish camp.

QQQ and SPY traders are flat. We do not expect to get a signal but make sure to call the early morning hotline just in case. Rydex switchers are holding a 20% position in Precious metals. This is a long-term position so the bearish switch medium-term does not affect it. The morning hotline will be on at 7:15 AM Pacific.              

Notice that in spite of the fact that the NDX is well below its May and June peaks, the VXN, is below its corresponding level. It is not as extreme as it was in early July but it is clearly negative.

The chart below shows both the 5-day and 10-day moving averages of the CBOE put to call ratios. They are both at or very near levels seen in late May and early July just as the market was entering a decline. They are also not too far from their extreme levels seen in late April.

The breadth oscillator had a very bullish divergence at the July 24 low. So far the rally off of that low has been the least bit impressive. We had a similar pattern unfold last October-December. We did ultimately get a decent rally at that time but there are two important differences. The first is that the time between the divergence was longer and secondly the oscillator started from a deeper oversold condition.

Another big difference can be seen on the chart below. In December of last year the weekly trend composite was flattening out from below zero and beginning to turn up. Currently, it is headed lower from above zero and that is negative. The market can rally a bit with the indicator headed lower, but the end results are usually quite negative.