BI-WEEKLY MARKET RECAP and TECHNICAL PERSPECTIVE

By: Larry Katz

October 8, 2001

Capsule

Short-term the market is overbought and a modest correction looks close at hand. It should be fairly well contained and once complete the rally should continue. The medium-term picture has improved to neutral and could turn positive depending on how we correct over the near-term. Long-term the weight of the evidence remains bearish and lower prices are expected. The short and medium-term indicators on bonds are giving off mixed signals. We remain neutral for now. The XAU is into important resistance and sentiment remains excessively negative. We look fro lower prices and a move below the July low.7

Elliott wave and Fibonacci

The S&P moved above the previous weeks high last week. This has eliminated any possibility of the rally from September 21 as being a fourth wave from August 27. in addition, the decline from august 27 has been confirmed as a corrective three-wave pattern as has the post May 22 decline. That leaves us with two possibilities in regards to the post May 22 decline. The first is that it was all of a second three from September of 2000. However, the fact that the last leg down from August 27 is a three makes this a very difficult count to justify. Also there is no real good Fibonacci relationship between the May 22 decline and the first three that took place from September of 2000 into the March 2001 low. As we discussed in the last report, the 1030 zone was both the .383 retracement of the post 1987 advance as well as the area in which the May 22 decline was .618 the length of the first three from September to March. The next level of multiple Fiboacci relationships is in the 860-875 zone, which is both the 50% retracement of intermediate wave 3 and also where the May decline would be equal to the first three. The only thing that could support the possibility that September 21 did in fact complete wave 4 from 1982 was the fact that the S&P stopped within 21 points of the October 1998 low and that is the fourth wave of previous degree. Under the wave principle that is a natural support level but a modest break of that level would not be a serious threat to the count. However, a break of the 850 level on the S&P would question the count and would in all likelihood indicate that a more serious decline than a large degree fourth wave was in progress. Given the wave structure and Fibonacci relationships it seems that the best count and the one we are going with at this time is that on September 21 wave “a” of a larger a-b-c pattern from May 22 was completed and that the S&P is currently in a large “b” wave correcting that decline. Once wave “b” is complete a “c” wave back below the September 21 low should unfold and carry the S&P below the September 21 low and towards important support to complete wave 4 from 1982. This would fit in well with the 4 year cycle low that is due to bottom sometime mid to late next year. As longer-term readers are aware, we do little if any work with cycles but we have found the 4-year cycle to be very consistent. We do not believe that the 4-year cycle bottomed early in September although it (the September low did have some characteristics of a 4-year low. In our studies of the 4-year cycle we have found only one instance where it did bottom after only three-years and that was in 1990 following the 1987 low. However, the 1987 low came five years after the 1982 low and was extended and the 1990 bottom only brought the 4-year cycle back to its normal rhythm. While, it is possible that the 4-yesar cycle did bottom early it is more likely not the case and we should expect to see it in its regular time in 2002. That would also fit in well with the decennial pattern combined with the presidential cycle that when both occur together produce an important low in the second year of a decade. There have only been four other occurrences in the twentieth century, 1980, 1960, 1940 and 1920 when the decennial and presidential cycle have come together. The only time we saw a low in the first years of the decade was in 1921. The other lows occurred in 1942, 1962 and 1982 so the odds favor a more important low sometime next year. Adding some support to the preferred count is the fact that the rally from September 21 has been confirmed by both the daily and hourly charts as a corrective pattern but we should be correcting the entire post May 22 decline so we expect to see higher prices before wave “b” is complete. The very short-term is a bit tricky. We should be correcting at last the rally from October 1. The low on Friday stopped right near a .618 retracement of that rally so it is possible to see a move above last weeks high before the rally from September 21 is complete. It is equally possible that what we saw late last week did in fact complete the initial phase of wave “b”. The late rally on Friday took the S&P right back to a .618 retracement of the decline from Thursday so what we see today will be important to the short-term.  Like the S&P, the weekly chart of the DJIA ahs eliminated the possibility that the rally from September 21 is a fourth wave from August 27 and has also confirmed that the post august 27 decline is a three wave pattern. The DJIA then is in the same position as the S&P from its January 2000 peak with the decline from May 22 best counted as an “a” wave of a second three from the May 22 high. The short-term patterns on the DJIA are following those of the S&P from the September 21 low. The rally from at least October 1 but more likely September 27 has been confirmed as corrective on both the daily and hourly chart. As such we have to approach the entire post September 21 rally as a corrective one and not the start of wave 5 from 1982. The DJIA did rally back to near a .618 retracement of the decline from Thursday’s high to Fridays low so what we do on Monday will be important. A move above Thursday’s high would indicate that the pattern from September 21 was extending. AS it stands now we are 50/50 from an Elliott perspective on the very near-term. We are counting the NDX as having completed a fifth wave from August 27 at the September 27 low. That low did not move below the September 21 low but did move below the orthodox low of wave 3 seen on September 19 and did move down in five-waves on the hourly chart. The post May 22 decline on the monthly chart of the NDX can be counted as a fifth wave from March 2000. However, the daily and weekly charts cannot yet be counted as five’s. Therefore, if that count is going to prove to be correct we need to see both the daily and more importantly the weekly charts unfold as five’s from May. The August 27 decline can be counted either wave .5 of 3 of iii and if so then we still need a couple of 4’s and 5’s to complete the pattern from May. However, the post August 27 decline was clearly extended and it is equally possible that the decline is only wave ..3 of .3 of 3 of iii and that would leave a number of 4’s and 5’s. In either case if indeed we are to get a five from the NDX from May we are not over and lower prices are needed. The key going forward is going to be the Monthly chart. As long as it remains down, the pattern will have a possibility of unfolding as a five. However, a move above the previous months high would confirm the decline as complete and if we do not have a five on the weekly and daily chart we will not have a five from March 2000. For October we need to focus on September’s peak of 1502. Of course, a move to that level would more than invalidate the count based on the daily and weekly charts as the rally would move well above normal retracements. The rally from the September 27 low has sub divided on the daily chart with each sub division on the hourly chart best counted as three wave patterns. Unless the NDX is tracing out a number of small 1’s and 2’s with all of those being irregulars the rally is best counted as corrective. The NDX has also moved into the window of important near term resistance related to the post August 27 decline so over the next few days our count is going to be put to the test. Support : S&P; 1048-1051, 1030-1032, DJIA; 8900-8915, 8750-8764, NDX; 1205-1210, 1180-1186. Resistance: S&P; 1095-100, 1120-1126, DJIA; 9355-9370, 9530-9550, NDX; 1347-1355, 1406-1417. Trend changes for the following two weeks are as follows: October 11*, October 19*. *denotes potentially important.

Bonds

The bonds have rallied sharply last two weeks and moved above the March high indicating that the corrective pattern from January 2000 is still in play. The rally from September 20 looks corrective not impulsive adding some support to the idea that the post January 2000 rally is still a big corrective wave from October 1998. However, we are beginning to push that count to its limit and we really need to see the market begin to decline in earnest if indeed that count is correct. Since we still have what is best counted as a five-wave drop from October 1998 to January 2000 and a corrective rally since we will continue to focus on our preferred count for the time being.  The daily range oscillators are close to overbought but are also showing negative divergences. The daily trend oscillators are positive but slipping. Short-term momentum is neutral and beginning to weaken. The weekly range oscillators are close to overbought and diverging. The weekly trend oscillators are positive but beginning to weaken. Medium-term momentum is neutral. Sentiment is mixed. The Rydex numbers are quite positive. The commitment of traders report has improved but still showing that commercial hedgers are net short while the small speculator is net long. Market Vane is excessively negative at 78% bulls while Consensus Inc. is modestly negative at 51% bulls. Support: 103 17/32 +/- 9/32, 101 17/32 +/- 16/32. Resistance: 107 16/32 +/- 10/32, 109 +/- 16/32. Please note that all price projections are based on a constant bond chart and not any one particular futures contract. Currently the constant bond is running 12/32 behind the nearby futures contract (December). In sum, both sentiment and momentum are giving off mixed signals. We are going to remain neutral on both the short and medium-term due to this and an unclear wave pattern.

XAU

First and most importantly, the rally from the July 2 low is clearly corrective in terms of Elliott wave and looks to be a “b” wave from May. Important resistance in the 61-61.50 zone has functioned and although there could be one more push up into that resistance it looks to us from a structural perspective that a move below the July 2 low is the likely outcome. Short-term momentum is beginning to roll over from modest overbought levels but has not yet gone negative. Medium-term momentum is on the negative side of the equation. Sentiment remains the biggest negative for the XAU. The Rydex precious metals fund continues to show excessive levels of assets while the commitment of traders report is showing huge net short positions by the commercial hedgers and very large net long positions by the small speculator. Support: 45-54.50, 50-50.70. Resistance; 61-61.30, 61.80-62.10 The bottom line is that while we may see one more attempt at resistance the weakening momentum backdrop coupled with excessive sentiment is a very lethal combination and a move below the July 2 low is expected. We remain negative on both the short ands medium-term and neutral on the long-term 

Indicator review

The market continued its post September 21 rally with the DJIA, S&P and NYSE Composite posting their second consecutive strong weekly gain. They are now anywhere from 2% for the S&P to about 5% for the DJIA below their September 10 closing level. The break of the 1982-1994 trend line shown and discussed in the September 24 report turned out to be only a temporary phenomena as all three averages moved back above those trend lines in short order. However, that long-term rising trend line is not too far below and bears watching.  In spite of the strong gains recorded in the last week of the month, September was still down sharply with the DJIA losing over 1100 points or 11%, the S&P losing 93 points or 8% and the NYSE Composite losing 46 points or 7.8%. All three are now back into the area of the March-April low and that could provide some stiff chart resistance. Price/volume relationships the past two weeks are mixed. We have seen the rally unfold on bigger volume than we had seen prior to the September 11 tragedy. However, volume has been running below the levels seen the week of the September 21 low and on in most instances volume has been easing as prices have moved higher. We would have to rate volume as neutral to slightly negative. Breadth has been quite positive with a number of very strong 2 to 1 days. The daily and weekly A/D lines have, like the averages recouped a good portion of their post September 11 losses. The new highs have begun to expand both on a daily and weekly basis confirming the rally on a short-term basis, However, while easing over the last week, the new lows have remained relatively high. The Market Summary and Forecast un-weighted price average has also recovered a lot of its post September 11 loss but on a relative strength basis has been lagging the listed averages by a wide  margin. The Russell 2000 has rallied along with the DJIA and the S&P, but up until late last week it was lagging badly. However it is now close on a percentage basis to where the big cap averages are in relation to their September 10 peak. We are neutral short-term. The medium-term is negative but also improving. The Value-line is in the same position technically as the Russell 2000 but lagging slightly. We are neutral on this average on the short-term. The medium-term is negative but also showing some minor signs of improving. The NASDAQ Composite and the NASDAQ 100 finally got it into gear late last week and began to play a little catch up with the DJIA and the S&P. They are now f 5.5% and 6.8% below their September 10 closing low. The short-term is neutral but with a positive bias. The medium-term remains bearish.  The DJTA hit its lowest level since July of 1996 on September 21. It has rallied sharply since then as it has gained over 150 points or 7.30% but is still 465 points or 21% below its September 10 level. We are moving to a slightly positive stance for the short-term. Medium-term we remain negative but this is beginning to improve. The DJUA and UTY have begun to stabilize and rally a bit. We are bullish on the short-term and look for further gains. The medium and long-term remain bearish.

Momentum

The breadth and volume oscillators are very overbought but have also hit thrust type readings, which are at least short-term positive. The 3-day oscillator is turning down from overbought and beginning to diverge. It is on a sell alert status for the short-term. The McClellan oscillator is overbought but only mildly as it has not come close to thrust readings. The 10-day and open 10-day Arms have eased. They are neutral but closer to overbought. The 5-day Arms is slightly overbought and negative. The 21-day Arms is oversold but beginning to ease. The new 10-day Arms has moved down sharply and is overbought at .61. However, it needs to move back above .80 to complete a sell signal. The daily range oscillators are neutral but closer to overbought. The daily trend oscillators are positive. The weekly breadth oscillators have moved back to near neutral from oversold. The weekly range oscillators have moved back to low neutral from deeply oversold levels. The weekly trend oscillators are negative. The technical barometer has slipped with the inside score at a negative –4. the outside score never did turn positive and has slipped back to a –2 reading (there is more on this tool on the web site).

Sentiment

The sentiment composite has remained at a neutral +10. Investors Intelligence was little changed last week with the bulls at 34.4% and the bear at 42.7%. This is the best bull/bear ratio since April but is not even close to levels seen at important market lows and is only neutral. Market Vane remains positive with the latest reading at 28% bulls. Consensus Inc at 34% is also in good shape and the 4-week moving averages are also bullish, but neither are at levels seen at the April low although Market Vane is close. The American Association of Individual Investors (AAII) have reported over 50% bulls for the past two weeks. This indicator is neutral but close to going negative. The NYSE members have remained deeply on the sell side and have been for the past six weeks. This key indicator of smart money has turned negative. Corporate insiders have remained firmly on the sell side with the 8-week moving average at bearish levels. The commitment of traders report has improved a little but commercial hedgers are still heavily net short while the small speculator is still net long. The CBOE put to call ratio basis the 10-day moving average hit its highest level in over 3 years a couple of weeks ago. It has since fallen sharply and is at the low end of neutral. The OEX ratio is neutral but never did reach bullish levels. The Rydex ratios are still in good shape for the short-term with Ursa still showing more assets than Nova. However, the absolute level of assets in Ursa never got to levels seen at the March-April low. The volatility indexes have dropped sharply from their bullish levels of September 21 but are still OK.

Summary and Conclusion    

On September 21 a number of key momentum indicators moved to record oversold levels. This includes our breadth and volume oscillators as well as the McClellan oscillator. Other momentum indicators such as 13-day RSI and even the weekly RSI moved to extreme levels of oversold as well. The 13-day RSI hit its lowest level since 1987 and the weekly its lowest level since 1974. In nearly every instance the low in RSI occurred prior to the final price low for the S&P.  A report we have made available on the web site shows all declines in the S&P from 1970 of 15% or greater. In not one of these instances did the price low occur commensurate with the momentum low as measured by the McClellan oscillator. Then final price low occurred as early as three-weeks after the momentum low as it did in March of 1980 and as long as 11 months between November 1973 and October 1974. From an historical perspective we should then expect to see lower lows in price sometime in the future on a higher momentum reading before we can begin to even think about the possibility that an important low is in place. However, to remain long-term bearish on this alone would be foolhardy to say the least. There has been some improvement in some of our longer-term indicators. The percentage of stocks above their 200-day moving average did drop below 30% in late September and has subsequently moved back above that level rendering a buy signal. This is one of the indicators we discussed a few issues back that needed to improve and it did. However, others are just not even close. For example, the insider sell buy ratio has moved to very bullish levels at both the 1994 and1998 lows while currently it is still in negative territory. Moreover, the NYSE members have moved heavily to the sell side in recent weeks ands this too is not consistent with important market lows. The latest numbers from the mutual fund industry for August show the cash to asset ratio at very bearish levels, which is also not consistent with important market lows. The percentage of bears from Investors Intelligence has improved and at 42.7% is close to levels seen at the April 2001 low. However, it is not yet close to levels seen at the 1998 low and is eons away from where it was at the important 1994 and 1990 lows. And given the fact that we have just seen the biggest decline percentage wise from both the DJIA and the S&P since 1987 we should expect to see a lot more from this area as well. Our technical barometer is composed of a short to medium-term component and a longer-term component. The short-term component, the inside score did render a buy signal two weeks ago as it moved to a 4 reading. For the record, this has been completely reversed as of last week as it reached a –4 reading. The outside score is a longer-term model. It moved to its most negative level that it can reach in late April at –10. It did improve to a +2 reading a few weeks back but that is only neutral and did not reverse the –10 sell signal. Plus 2 readings are good for rallies but a +4 is the minimum we expect to see for an important low. This was the reading in 1998 and we had a series of +6 readings throughout 1994. It has slipped this past week to a –2 reading and given the position of a couple of the key indicators it is not far from moving back to fully bearish levels (go to the home page on the web site fro more on the barometer).  In addition, the sentiment composite has not come close to reaching levels consistent with important long-term bottoms. It is currently neutral and did not yet even reach levels seen at the April low let alone what was seen in 1998 or 1994. And the fact that this decline has been a lot more steep in terms of both price and time we would expect to see much more bullish readings from these indicators at an important low. We did not see one day of better than 10 to 1 downside to upside volume during the post May decline that would indicate a real capitulation. We did see one in March prior to the March low and we also saw one in April of 2000. We saw two in August of 1998.  That was a real capitulation.  We did see both the simple breadth and volume oscillator reach thrust or kick off type readings late last week as they moved to extreme levels of overbought. These are often times seen at during the initial phase of important market rallies. In most cases they have at least medium-term bullish implications. On occasion they are seen following important market lows as an initiation phase to a new bull market. However, we had similar readings from the breadth oscillator in January of this year and that only produced a three-week rally followed by a severe decline. The volume oscillator did a similar number in late April and that too led a rally of a few weeks. The McClellan oscillator did not reach thrust type readings above the +200 level but only reached modest overbought readings such as was seen in late December and again in early May. Those led to short-term rallies and were followed by much more serious declines. What we would have to say is that the strong momentum readings are at least short-term positive and could have medium-term bullish implications but are not an indication of any sort of long-term reversal or initiation. We think that the odds are high that the market has already begun or is on the verge of a correction of the rally from September 21. This decline should only be related to the post September 21 rally and given the strong momentum readings in place it will most likely be fairly well contained. However, there is risk short-term and that will keep us in the neutral camp for the time being. While it is possible that the post September 21 rally is only a short-term phenomena it is looking more and more likely that it will turn out to be a medium-term affair and could last for several weeks or more. We moved to neutral from bearish last week on the medium-term. We will remain neutral for now but with the idea that we may indeed switch to bullish depending on the degree and nature of the short-term correction we are expecting. Long-term as discussed earlier the evidence remains quite negative and we remain bearish.

QQQ and SPY traders are flat. Stand aside for the morning. Rydex switchers are holding a 5% Ursa position. Make sure to call the Noon Pacific hotline for any changes. The early morning hotline will be on at 7:15 AM Pacific      

Due to some software problems we are not able to generate any charts for this issue. We apologize and should have this corrected by the next report.