BI-WEEKLY MARKET RECAP and TECHNICAL PERSPECTIVE

By: Larry Katz

September 24, 2001

Capsule

Over the near-term a rally could unfold at any time. Medium-term indicators are improving but have uniformly confirmed price and have reached levels that have always been followed by lower prices. We would expect that any initial rally will fail and that lower prices once that rally runs its course is expected. In a word the medium-term remains negative. Long-term a couple of indicators have improved but the majority remain negative and have a long way to go before they could even remotely turn positive. The bear market remains in force. The bonds have turned negative on the short and medium-term and lower prices are expected. Sentiment on both gold and the XAU has turned from bad to worse. Short-term momentum is overbought and medium-term momentum remain negative. Lower prices are expected.   

Elliott Wave and Fibonacci

Since our report and forecast in early 1999 with a 1550 price objective on the S&P (this is available on the web site) we have been operating with the idea that the S&P was in a larger degree fourth wave from 1982. We are still of that view currently but at the same time we are approaching some critical levels that need to function for this count to be correct. Fourth eaves usually retrace from between .383 to 50% of the preceding third wave. Our count has the rally from October (December) of 1987 to September (orthodox top) of 2000 as all of intermediate wave 3 from 1982. That in itself is significant in our view as wave 3 traveled an almost perfect 13 Fibonacci years and was quite extended. The 1030 area on the S&P was a very important level as that not only represented a .383 reteracement of the post 1987 rally but was also the level where the May 22 decline would have been .618 the length of the decline from September 2000 (orthodox top) to March of this year. We do not think it was a coincidence that the S&P stopped right in that zone on Monday and mostly held it on Tuesday. The break of that level last Wednesday was in our view significant. That now brings us to that important support level of 865-875. This is the area of both the 50% retracement of wave 3 (1987-2000) but also the area where the decline from May 22 will be equal to the September 2000-March 2001 decline. A marginal break of this level would be acceptable but a break by say more than 3% would in our view eliminate our preferred count and argue that a top of more significance than we suspect at this time has been seen.  Last week the S&P came within 20 points of the 1998 low. Thai is the fourth wave of previous degree and an area of natural support so again our preferred count is being put to the test. As for detailed wave counts we are approaching the post May 22 decline in one of three ways. First, we will digress a bit in that we are counting the decline from September 2000 to March of 2001 as a simple a-b-c three wave ‘a” wave and the rally from March to May as either a “b” or X wave. If it is a “b” wave then the decline from May is a “c” wave. If the May peak was an X wave we have two possibilities. The first is that the decline from May is all of a second three from September of last year. The latter is that this decline is only wave “a” of a larger a-b-c that is getting close to complete. The latter would allow for a fairly significant rally for wave “b” to carry on for several weeks to months before a devastating “c” wave unfolds to complete the pattern and wave 4. We are currently favoring the X wave only because “c” waves are always five-wave patterns. And while not entirely impossible to count the decline from May 22 as a still developing five it would have to be counted as a number of 1’s and 2’s going into the August 27 peak and that would leave a number of 4’s and 5’s on both the daily and weekly chart left to unwind following the completion of wave .3 of 3 from August 27. As it stands now we are counting August 27 as a “b” wave from May 22 and the post September 4 decline as wave 3 of “c” from August 27. Short-term it is indeed possible to count five-waves down from September 4 on the hourly chart at Friday’s low. This does allow for the possibility that wave 4 from August 27 has begun and a decent rally is underway. However, until this is confirmed by the daily chart we cannot rule out the possibility that wave 3 is still in force and a move below Friday’s low is still possible. A move above Friday’s high of 984.54 would turn the daily chart up and confirm that the post September 4 decline was complete.  The DJIA left no doubt that it is either in a “c” wave or a second three of its post January 2000 wave 4 decline. The DJIA has yet to move below its .383 retracement of its intermediate wave 3 rally from 1987 to January 2000 at 7900 but it did come close last week as it hit 8062. That is also not too far away from the fourth wave pf previous degree at the 1998 low near 7400 so we have a band of support in the 7400-7900 zone for the DJIA that is important to our longer-term counts. However, the DJIA still has room to move towards the 505 retracement of wave 3 without violating any rules for fourth waves. That level is 6760 and that is not too far from the October 1997 low, which is the next previous fourth wave. That latter level incidentally is not too far from where the decline from May 22 would be 1.618 the length of wave the decline from January 2000to March 2001. Since the DJIA has already exceeded equality by a fairly wide margin it is worth noting. For the record, the 1.383 multiple of the January 2000-March 2001 decline is 7700, which is right in the middle of that important 7400-7900 support zone. We are counting the post May decline in the DJIA in much the same way as the S&P. It is either a “c” wave or a second three from January of 2000. We are leaning in favor of the latter and are of the view that the post August 27 pattern is a “c” wave from May 22. Then September 4 decline is best counted as wave 3 from August 27. At Friday’s low it is possible to count wave 3 as complete but until confirmed by the daily chart we cannot rule out the possibility that wave 3 could extend further. A move above Friday’s high of 8235 would turn the daily chart up. The NDX moved well below the April 4 low and on the monthly chart it is possible to count the decline from May as a fifth wave from March 2000. the daily and weekly charts cannot yet be counted as a completed five from May and at this point best count as possibly near competing the middle third of the pattern leaving a few 4’s and 5’s left to complete a five. The five down monthly argues for lower prices and that could evolve in one of two ways. Once complete we could set up for a very large rally in terms of both time and price to complete a second or “b” wave to be followed by a large “c” or third wave. This would likely play out over a several year period. The other possibility is that the five down evolves as a seven and we get a short rally fo9llowed by another wave down. And then the entire post March 2000 decline is a corrective seven wave pattern, However, until we get a confirmed five down on the weekly chart from May we cannot count the post May decline as a fifth wave. Although the pattern is not great it is possible to count the post September 4 decline as a completed five on the hourly chart. However, like both the DJIA and the S&P we still need to see conformation from the daily chart that the post September 4 decline is in fact complete. A move above Friday’s high of 1160.24 would do the trick for Monday. Until that occurs we cannot rule out the possibility that the post September 4 decline can extend further. Support: S&P; 935-940, 893-900, DJIA; 8000-8030, 7750-7790, NDX; 1080-1084, 1046-1052. Resistance: S&P; 966.63, 1025-1030, 1050-1060, DJIA; 8437, 8875-8890, 9125-9140, NDX; 1160.24, 1245-1251, 1295-1305. Trend changes for the next two weeks are as follows, September 24*, September 27*, October 2*, October4-5**. *denotes potentially important.  

Bonds

The rally from the May low in bonds has come towards the Marc h high but not through it and more importantly has rallied in what is so far a clear corrective three-wave pattern. This rally is either part of the larger corrective pattern from the January 2000 low or is a completed deep second wave from the March 22 high. The former would allow for a modest penetration of the March 22 peak before wave 2 from October 1998 gets underway. The latter argues for a serious top now and a third or “c wave plunge to begin momentarily. In support of the latter is the fact that the bonds do show a five-wave decline on the daily chart from the September 11 peak. This could allow for a rally but if correct it should be viewed as the first wave of a larger pattern. The daily range oscillators have turned down from modest overbought levels and have also left negative divergences in place. The daily trend oscillators have turned down and short-term momentum is now clearly negative. The weekly range oscillators have turned down from near overbought levels and are showing modest negative divergences. The weekly trend oscillators are still positive but beginning to ease and medium-term momentum is neutral to weak. Market Vane came in at 65% bulls and Consensus Inc at 53%. They are negative but not excessive. The commitment of traders report showed some easing in the commercials net short position but they are still net short and this indicator is negative. Sentiment is negative but not overly excessive. Support: 101-101 6/32, 97-97 16/32. Resistance: 103 5/32-103 11/32, 104 08/32-104 14/32. Please note that all support resistance calculations are based on a constant bond chart and not any particular futures contracts. Currently the constant chart is running about 8/32 behind the December futures. For the past three years the bonds have moved in near 180% opposite direction of the stock market. Last week we saw a sudden change in character as bonds moved lower in spite of massive losses in equities. Sentiment is negative but not excessive. However, short-term momentum has turned down and mediumterm momentum is overbought and diverging. We remain bearish on both the short and medium-term.

XAU

The XAU has rallied right to a .618 retracement of the decline from May 18 to July 2 in what is best counted as a three-wave corrective advance. At the same time the rally while corrective has also appeared to confirm the decline from May 18 as a three-wave corrective pattern as well. As such we are now inclined to count the May 18-July 2 decline as wave a and the rally into the recent high all or most of a “b’ wave of a larger a-b-c that should carry the XAU back below the July 2 low. Where this pattern first in the bigger picture is not clear but we are still faced with a corrective three-wave rally from October 2000 to the May 18 high. Short-term momentum is neutral to slightly overbought but not excessive. Medium-term momentum is still negative. Sentiment has turned exceptionally negative. Market Vane was at 80% bulls and Consensus Inc. at 68%. The Commitment of Traders report still has the commercial hedger hugely net short while the small speculator is heavily net long. Last but not least. The asset level in the Rydex Precious Metals Fund is at record levels. Sentiment therefore is excessively negative. Support: 56.90-57.04, 54.70-54.90. Resistance: 61-61.30, 61.80-62.10. Short-term momentum is still OK but the combination of a still negative medium-term momentum picture coupled with extremes in sentiment is a big negative. We remain negative on the short- and medium-term and neutral on the long-term

Indicator review

September has a reputation of being the cruelest month of the year, and this year it has lived up to that reputation in spades. The DJIA had its worst weekly performance in over 60 years last week as it lost over 1300 points or 14.26%. The S&P fared a bit better as it lost 126 points or 11.65% while the broad based NYSE Composite lost 64 points or just over 11%. All three averages moved into the area of their 1998 lows with the S&P coming the closest missing that low by less than 20 points or a bit more than 2%. More importantly, all three averages have broken below important long-term trend lines drawn off of the 1982 and 1994 lows on log scale charts. The break is only minor but is a potentially big negative for the long-term trends. Volume moved to record levels last week on a couple of occasions and was consistently over 2 billion shares. Price/volume relationships were obviously negative but we are also beginning to see some signs from volume of a capitulation. Market breadth was terribly negative. The daily A/D line moved to near its April low and the weekly A/D line had its worst one-week ratio since March of 1994. We also saw huge expansion in the new lows both daily and weekly. The latter expanded on a daily basis and confirmed price all the way down while the weekly totals were the highest since December of 1999. The Russell 2000 lost over 14% last week and has moved to its lowest level since November 1998. The short-term is now very oversold and we are going to maintain our neutral rating as it could indeed rally at any time. The medium-term is improving but remains bearish. The Value-line was lower by 15.23% and as we can see the small cap averages, which had been one of the stronger areas of the last year were actually weaker than the S&P or the NYSE Composite. We are going to stay neutral on the short-term as the deep oversold condition could very well lead to a decent bounce at any time. The medium-term remains negative. The NASDAQ Composite lost 16% last week and the NASADAQ 100 lost 17.46%. They did hold up a bit better than the listed averages based on their historical volatility, however, both came within striking distance of their 1998 low. We remain neutral on the short-term and still bearish on the medium-term. The DJTA lost over 620 points or 23.23% last week and that was in spite of a minor bounce and slight positive close on Friday. The DJTA confirmed the DJIA by moving below its spring low and in turn confirmed a primary bear market under “The Dow Theory” to will be in force. We will remain neutral on the short-term and maintain our medium-term negative view. The DJUA and UTY closed the week lower as well but were not nearly as weak as the other averages. We remain neutral on the short-term and bearish on the medium and long-term.

Momentum 

The breadth oscillator joined the volume oscillator at record levels of oversold last week as it moved below its August 1998 low. The 3-day oscillator is deeply oversold but did not quite hit a record. The McClellan oscillator also moved to a record oversold reading and is pushing the –400 area. All key internal momentum indicators have confirmed price. The 10-day and open 10-day Arms are still oversold and bearish but at the same time moved lower last week. They are still positive but given the take-away figures early this coming week they could very well move to neutral. The 5-day Arms is already neutral while the 21-day Arms is still oversold and positive. The new 10-day Arms has moved up to very oversold levels and is on the positive side of the equation. That was something that was missing throughout most of the post May decline. The daily range oscillators are deeply oversold and at levels not seen since 1987. The daily trend oscillators are extremely negative and still accelerating. The weekly breadth oscillator have moved towards the oversold side of the ledger but still have a lot of room before reaching deeply oversold levels. The weekly range oscillators are deeply oversold with 13-week RSI lower than it was following the 1987 crash. The weekly trend oscillators are extremely negative and accelerating. The technical barometer has improved and the last 2-weeks has seen the inside score moved to a favorable +4. This could set the stage of a rally at any time. However, while the outside score has improved it is only a neutral +2 and that has not come close to reversing the –10 major negative signal seen in late April. 

Sentiment

The sentiment model has improved to a neutral +11 but is still not at levels that could support a medium-term bottom. Investors Intelligence reported bulls at 35.7% and bears at 37.6%. This is the first time in nearly 3 year that we have seen more bears than bulls. This is an improvement but the indicator is not even close to levels seen at important bottoms. Market Vane and Consensus Inc have improved and the 4-week moving averages have moved back to positive levels. However, they are not yet back to where they were in the late March-early April period but they are positive. The American Association of Individual Investors AAII) also showed some good improvement but is still only neutral. The NYSE members report has not been available the past two weeks but at least look it was negative. The corporate insiders have slowed their rate of selling and the 8-week moving average has improved to neutral but it is only low neutral and not far from negative. The commitment of traders report has shown some easing in the commercials net short position but the keyword is easing as they are still very net short while the small speculator is still slightly net long. Short-term sentiment has improved dramatically. The CBOE put to call ratio basis the 10-day moving average is now at very bullish levels. The VIX moved up towards 60 last week a level that was seen near the late 1998 low but sold off sharply from that level. The VXN also moved sharply higher moving over 90 a level seen at April and December 2000. The former produced a fairly strong medium-term rally while the latter produced a modest one-month rally. The Rydex ratios have also improved a good deal and are back to where they were at the April low. However, they are a far cry from level seen at the 1998 low but they are a plus.

Summary and Conclusion  

The tragic events of September 11, 2001 will live and completely change our lives. We have a number of friends that worked in the World Trade Center and the surrounding buildings. We personally are grateful that none of the people that we know were harmed and are doing fine.  However, our heart and thoughts go out to those families of individuals who did not make it or are not accounted for. A number of analysts are going to be blaming the tragic events of September 11 for the markets big drop. Make no mistake about it, we think that clearly it exaggerated the decline, however, at the same time it is our view that the market was going to go to these levels one way or the other and that the World Trade Center tragedy pushed it their a whole lot quicker. Or maybe, and there is now no way to tell, the market was going to do exactly as it did whether the September 11 tragedy took place or not. There has clearly been some strong improvement in a number of medium and long-term indicators. Some of the indicators we had said in past letters that needed to get to certain levels have done so. The percent of NYSE stocks above their own 200 day moving average is now well below 30%. When we discussed this a couple of issues back it was closer to 60% and we stated that there has not ever been a bottom of importance seen without this key indicator moving below 30%. We have now hit the first phase of the signal as it moved below 30%, however, a buy signal is not rendered until the indicator moves back above 30%. Moreover, who’s to say that the indicator cannot move lower. In 1987 it moved to under 3%, in 1990 it was under 12% and in 1998 under 17%. Other indicators have improved but none have yet to reach levels that could support an important market low. For example, Investors Intelligence has reported more bears than bulls for the first time in 3-years. However, the absolute level of bears is not even where it was in April when it hit over 42% let alone near levels seen at important market bottoms such as 1998, 1994 or even 1990. Other longer-term indicators, such as the insider sell/buy ratio, are still closer to negative and not close to bullish signals. The technical barometer has improved and the inside score at +4 the past two weeks is suggesting that we could be getting close to a decent rally. However, the outside score, which is the longer-term component is only neutral and at +2 is not close. In addition, the sentiment composite has only just now moved to neutral and it is low neutral at +11. At the March-April low the sentiment composite moved up to +13. However, at the 1998 low it moved to as high as +15 on two separate occasions and in 1994 it moved up to +18. From a momentum perspective we are seeing things that we have never witnessed before. Breadth and volume related measures have just reached record levels of oversold. The McClellan oscillator whose previous record in August of 1998 at –290 has been blown away and is close to –400. Our breadth and volume oscillators are also at record levels of oversold. The Arms indexes remain oversold but they are starting to move towards neutral. In fact, they could very well move to neutral or even worse given the take-away numbers the first part of this week. What is curious and also interesting is that throughout the bulk of the post May decline we were getting extremely high readings from this indicator while also seeing relatively strong breadth. The 10-day and open 10-day Arms hit record or near record levels of oversold prompting a string of highly bullish comments as to how rare and positive an event this was. It was as well advertised as an interest rate cut and a number of people who had never heard of the Arms was beginning to refer to it. The past week on contrast we have seen relatively low numbers accompanied by extremely negative breadth. In fact the 10-day and open 10 are not too far from where they were on August 27, a day that marked the beginning of this acceleration to the downside. What it all means for the market is not clear but what is clear is that we are seeing things occur that we have never seen before and before it is all done we moist likely will see more of this. The market is very stretched and deeply oversold. Short-term sentiment indicators like the 10-day moving average of the CBOE put to call ratio are at bullish levels and we do have a rally signal from the inside position of our technical barometer. The wave structure has not yet confirmed but decent strength early this week could do the trick and a rally of short-term degree could very well be close at hand. We expect that any rally from here could be quite sharp due to the oversold condition, however, it is also our view that it will end nearly as quickly as it started as initial rallies from this deep of an oversold level almost always fail. In fact the depth of the oversold condition almost guarantees it. In fact, our research has shown that when we get this oversold price never bottoms commensurate with a peak in downside momentum. And as we stated during the past week we have not yet confirmed that we have seen a peak in downside momentum. So, while we the potential for a rally over the short-term we do not see it as anything more than a short-term affair and one that could be over quickly. We are going to maintain our neutral view on the short-term with a positive rally bias. However, a move below Friday’s low could allow for the post September 4 decline to extend further with possible targets of 893 on the S&P. The medium-term picture is improving nicely and some areas have turned positive. However, the overall picture remains bearish and lower prices are still expected. How we get to those lower prices will be important and how the indicators look when we get there will be more important. As it stands now we are going to maintain our bearish medium-term rating with the idea that we could be in the latter stages of the post May 22 decline. On a long-term basis most of what we need to see for an important low has not been met. We are beginning to see some signs of capitulation especially from volume and a couple of the shorter-term sentiment gauges such as the put to call ratio. However, most of what we need to see is not in place and a lot of these indicators have more than just a little way to go. It is tempting given the deep decline and oversold condition to ease up a bit on our negative long-term view and we would actually like to be in that position. However, given what we see the market leaves us no choice but to remain bearish as we just do not see the ingredients in place to support an important market low at this time.

We are holding a 50% position in the SPY bought on Friday per the morning hotline at 96.45. They closed at 97.28. Place your stop at 92.90 and make sure to call the early morning hotline for any changes. Rydex switchers sold ½ of their 10% Ursa position for a gain of  22.41%. We are holding a 5% position in Ursa. Make sure to call the Noon Pacific hotline for any changes. The early morning hotline will be on at 7:15 AM Pacific.   

The S&P has broken and closed below a long-term trend line drawn off of the 1982-1994 lows. The DJIA and the NYSE Composite have broken below their respective trend lines as well. The sentiment model has improved from bearish levels of a few weeks back but so far it is not even back to where it was prior to the March-April low let alone where it was at other important bottoms of the past 7 years.

The open 10-day Arms has moved lower all week last week in spite of the sharp drop in price and is not too far from levels seen at the late August top that set the stage for the latest decline.

The percentage of bears from Investors Intelligence has improved in recent weeks but is not yet even back to where it was at the April low. More importantly it is not close to levels seen at important market bottoms such as we saw in 1998,1994, 1990 and 1987-88. Note how following the 1990 low it remained high for months on end setting up the kind of skepticism needed to support a multi year bull move such as we had in the 1990’s.