BI-WEEKLY MARKET RECAP and TECHNICAL PERSPECTIVE

By: Larry Katz

November 26, 2001

Capsule

Short-term indicators have turned negative and a correction looks close to getting underway over the near-term. The medium-term out look is still OK but a number of key indicators are deteriorating and are closer to going negative. Long-term we do not believe that the bear market is over and expect to see the September lows violated prior to any important low. The bonds could bounce over the very near-term but the odds of a very serious top being seen in early November is quite high. The XAU may also be close to a bounce but the short and medium-term remain negative and lower prices are expected.   

Elliott Wave and Fibonacci

Since early 1999 we have been of the opinion that the post 1998 rally was wave 5 from 1987, which in turn we were counting as intermediate wave 3 of primary wave 3 from 1982. This remains our preferred count on both the DJIA and the S&P at this time with the current decline a large degree fourth wave correcting a 13-year run from the 1987 low. The DJIA made its peak in January of 2000 and while the actual high in the S&P was March of 2000, we are counting the orthodox peak of wave 3 as ending in September of 2000. While the DJIA showed a very acceptable five-wave pattern from October (September) of 2000 the S&P in our view traced out a rising wedge or diagonal triangle and that is how we had been approaching this average since early 1999.  These remain our preferred counts and as such we do expect to see a couple of 4’s and 5’s unwind over the coming years to complete a large five wave pattern from 1974. This should trace out a pattern similar to what we saw in the late 60’s early 70’s to complete a secular top. Keep in mind that based on our preferred wave counts we do no not see the potential for the kind of bull market we have just witnessed with excessive and prolonged gains. No, those kinds of gains are usually seen in wave 3 and that has long passed. The best we envision is a large trading range again like what we saw between 1966-1972 as we complete the last stages of a secular topping process. There are, however, a number of alternate counts that support the possibility that what we saw in 2000 was a more important top.  In fact we can, based on wave counts, make the case that last year completed the entire post 1974 advance and we are now in the first phase of the secular bear market similar to 1973-1974. However, back in early 1999 we wrote a research report on the S&P forecasting a price top for wave 3 in the area of 1550. This was based on a number of Fibonacci price relationships both within the 1987 advance and also with the 1982-1987 advance (this report is available on the web site). The fact that the March 2000 peak hit the price target almost perfectly and the September peak was only slightly off tends to support our view that the peak of 2000 was only part of the pattern and not the end of the pattern. Another part of that forecast was that once we hit those price targets the biggest decline in percentage terms since 1987 should occur. At the September 21 low the S&P had, on a print basis declined 586 points or 38.3% while the DJIA from January 2000 had dropped 3688 points or 31.38% both the biggest percentage decline since 1987. For the record, the S&P eclipsed the percentage drop of 1987, which was 35.9%. The September 21 low on the S&P took this average to within 21 points of the 1998 low, which is in the area of the fourth wave of previous degree. The DJIA came within 500 points of its 1998 low but that is less than 7%. We are counting the post September 2000 decline on the S&P as a double three with the March-May rally as an X wave. It is indeed possible that what we saw in September could have very well completed the post 2000 wave 4 decline However, Fibonacci price relationships on the S&P do not support that outcome based on our preferred count. As the decline from May to September exceeded a .618 relationship with the first three (September-March). As such we are counting the May-September Decline as only wave “a” of that second three and the post May rally as a “b” wave. There are two separate calculations pointing to important price targets in the 860-870 area. First this represents the 50% retracement of the rally from the 1987 low to the September 2000 top. Secondly, this is also the area where the post May decline would be equal in length to the September- March decline or where the second three would be equal to the first three. Thus there is a compelling Fibonacci argument supporting another move down once this rally runs its course. The DJIA is not as clean a pattern as the S&P from its January 2000 peak leaving open a number of very viable ways to count the pattern. However, it did come within 160 points of a perfect .383 retracement of the post 1987 advance. However, like the S&P we see the strong likelihood that the current rally is a corrective one and likely either a “b” or X wave, which should allow for a move below the September 21 low before wave 4 is complete. The weekly chart from September 21 is showing a three-wave pattern on both averages and as long as the weekly chart is corrective this will remain our preferred count. A five on the weekly chart confirmed by the daily chart would turn the picture more positive and allow for the strong possibility that intermediate wave 5 was underway. Until that occurs we are approaching the current rally as a corrective one.  It is our view that the NASDAQ completed a major top in March of 2000, one that will not be challenged for several years and perhaps decades. This is not based on Elliott alone and in fact since the NASDAQ has only been around for 30 years it is difficult to get a real good long-term count on this average. No we are basing that view on the historic performance of markets following the bursting of a huge bubble. The most recent example of a blown bubble is the Japanese market. It made its peak on December of 1989, nearly 12 years ago and is still nearly 75% below its all time high. A few other examples of bubbles include gold, which peaked in 1980 and has been mired in a bear market for 21 years and the DJIA in 1929 which took 25 years to get back to its 1929 peak. That said the monthly chart did show a five-wave decline from March 2000 into the September low but the sub divisions on both the weekly and daily charts makes it next to impossible to count the decline from May to September as impulsive and that makers it next to impossible to count the decline as a fifth wave. This leaves us with a couple of options. The first is that the decline was a “b” wave of an irregular from April and the latter is that the May decline is wave “a” of a larger pattern and once this rally runs its course a move back below the September low is likely. The latter fits in much better in our view and that is our preferred count at this time. As is the case with the DJIA and the S&P, the weekly chart from September shows a clean three-wave pattern. If we see a five we will have to respect it and allow that a more important low was seen in September. The rally on Friday took the DJIA and the S&P right back to their highs but not through them. This leaves open the possibility that the rally is a deep “b” or second wave. However, a move above last weeks high of 1152.45 for the S&P and 9976 for the DJIA would leave open the strong likelihood that the decline last week was a “c” wave of an irregular from November 14 and allow for a more serious challenge of important resistance sooner rather than later. Meanwhile, both averages are still within the confines of a potential diagonal triangle from the November 1 low and this rally may still be viewed as a “c” wave from September 21. The NDX also rallied but did not come close to its peak of last week stopping right near a .618 retracement of its five wave decline from last Tuesday. This five as discussed late last week is either a “c” wave of an irregular or the first wave of a larger pattern. We should know the answer by today. Support: S&P; 1128-1130, 1115-1117, 1090-1094, DJIA: 9717-9723 9600-9612, 9382-9404, NDX; 1500-1504, 1430-1437. Resistance: 1156-1158,1175-1180, DJIA; 10,100-10,125, 10291, NDX, 1582-1587, 1614-1620,1695-1710. Trend changes for the next two weeks are as follows: November 30*, December 4-5*. *denotes potentially important.

Bonds

The rally into early November on some bond charts took out the 1998 peak but on others it failed by a very small amount. That leaves us with two possibilities in regards to the long-term wave count. The first is that the rally from January 2000 is a very deep second wave from October 1998. The one thing that supports this count more than anything is the fact that the decline from October 1998 to January 2000 is best counted as a five. The other count is that the rally from January 2000 into November was the final fling of the corrective rally from the 1980 low. The rally from January no matter how you slice is corrective so either of these counts is possible and both point to the potential that a very important top has been seen in bonds as we enter the first wave down or the beginning of wave 3. Supporting this view is the fact that the decline from November 1 has unfolded in what is a clean, at least so far, five-wave pattern on the daily charts. This does allow for a rally ands a rally would indeed deal in the five as a stand alone wave but the fact that we have such a clean five argues for both lower prices and as mentioned supports the idea that a very important top has been seen. The decline from the November 1 high has also retraced a good portion of the rally from September 20 and more than .618 the rally from May adding more fuel to a more bearish outlook. The daily range oscillators are close to oversold but are not quite there yet. The daily trend oscillators are negative and still accelerating and short-term momentum is still negative. The weekly range oscillators have turned down from weak overbought levels and also locked in negative divergences. The weekly trend oscillators have turned down and weekly momentum is clearly negative. Short-term sentiment has improved but remains on the negative side of the equation with the latest reading from Market Vane at 63% bulls, which is negative while Consensus Inc is at a more neutral 41%. Support: 100 11/32-100 21/32, 97- 98. Resistance: 106-106 8/32, 108- 108 20/32. Sentiment remains on the negative side of the equation but is improving. Short-term momentum is getting oversold but is not quite there while medium-term momentum has turned decidedly negative. Given the five-wave drop we see the potential for the market to rally over the very near-term but given the indicators we are inclined to stay with our negative short-term rating. We are officially neutral on the medium-term and we will wait for a bounce to move to negative. Please  note that all price projections are based on a constant bond chart and not any one particular futures contract. Currently the constant chart is running 3/32 ahead of the March 2002 futures contract.

XAU

From an Elliott perspective the XAU is tough. We have a clear three-wave pattern up from the October 2000- May 2001 rally. The decline from that high is also best counted as a co9rretive pattern but it has exceeded the .618 retracement of the rally. We think it possible that the pattern is unfolding either as a triangle or the post May decline is the “e” wave of a large diagonal triangle from 1996 or perhaps further. This could ultimately lead to a move below the October 2000 low but could also complete a multi year bear market We had been expecting the XAU to move below the July 2 low and that was accomplished a couple of weeks ago. Some measures of sentiment have improved such as the assets in the Rydex precious metals fund, which is close to levels seen at good trading lows. However, both Market Vane and Consensus Inc.’s survey of gold futures traders are still showing far too much optimism as both are close to the 50% bull level. Short-term momentum remains down but is close to oversold so we could bounce at any time. Medium-term momentum remains negative and is not near oversold levels. Support: 45-45.25, 42,42-24. Resistance: 52, 53.80-54.10. Short-term we may be getting closer to a rally but the indicators are still negative and we remain on the sell signal. Medium-term we also remain negative. Long-term we still believe that we are in the process of completing a long-term bottom. That process may involve one more lower low. We remain neutral.

Indicator review

With one week left in November it looks very likely the DJIA and the S&P will record back to back monthly gains for the first time since April-May.  In fact November has been quite strong with the DJIA up over 880 points or 91.4% and the S&P up by 91 points or 8.59%. Both averages though are now in the vicinity of some important chart and Fibonacci resistance and are also within 3% or so of their declining 200 day moving averages. Since the 200-day moving average is declining a modest break above it would not, in our opinion be a bullish development. In fact, there were many times during the old bull market when the averages broke below their rising 200-day moving averages for several days but that tended to come towards the end of the decline not the beginning of it. This occurred for example in August of 1998 and lasted for a couple of months. However, the moving averages continued to rise and that turned out to be a bottom not the end of the advance. A lot depends on the slope and the slope now is quite negative. Price/volume relationships have begun to seriously weaken with volume on rally days in particular beginning to fade. Breadth has been strong or at least kept pace with the averages and remains a mild positive. The high/low statistics are getting interesting. The peak number of daily new highs occurred on October 30. It was tested on November 15 but not exceeded and the new highs have now been diverging for nearly two months. The new lows have been expanding a bit on declines but not running away and that has left our high/low indicators in a neutral to slightly weak position. The weekly statistics are not showing much of a difference. Small cap averages have done OK but are lagging during November. The Russell 2000 is ahead by about 30 points or 7%. Short-term is it getting stretched and is a bit overbought. Moreover, it is also approaching important resistance. We remain neutral on this average for the short-term and see it getting into a position to correct. The medium-term is neutral but with a positive but weakening bias. The Value-line is ahead by 88 points or 8%in November and it too is lagging the listed averages. This index is in the same position as the Russell 2000. We are neutral short-term but see a correction coming soon. The medium-term is neutral but also beginning to weaken. The NASDAQ composite and the NASDAQ 100 have also had a good month so far and until the last week or so had been strongly outperforming the big cap averages. That relative strength edge has begun to slip the past week. Even so, the composite is still ahead by 213 points or 12.6% and the 100 is up by 1213 points or 15.6%. Our short-term indicators have turned negative and we remain bearish on the short-term. The medium-term is neutral but does still have a positive bias. The DJTA has been a stellar performer in November as it has gained 340 points or 15.5%. The short-term is very overbought and due for a correction. We remain neutral. The medium-term has turned neutral but with a more positive bias. The DJUA and UTY are showing mixed but nearly flat results for November with the former lower by about 3 points and the latter up by about 3 points. However, they are both close to their late September low and well below their early October high. They have clearly been one of the weak sectors since the September 21 low. We are neutral short-term but very close to turning negative. The medium and long-term remain bearish.

Momentum

The breadth and volume oscillators are overbought and diverging giving off negative signals. The 3-day oscillator is also overbought and diverging. However, it did move back above the +600 level Friday and that is positive for the very short-term. The McClellan oscillator is also overbought and it too is diverging. The 100day and open 10-day Arms are neutral. The 5-day Arms is slightly on the negative side. The 21-day Arms is slightly oversold but not far from neutral. The new 10-day Arms is overbought at .79 and close to issuing another sell signal which will be completed on a move above .80. The daily range oscillators are close to overbought. The daily trend oscillators are neutral and weakening. The weekly breadth oscillators are neutral. The weekly range oscillators are neutral. The weekly trend oscillators are positive. The technical barometer did improve a bit last week but is also issued a sell signal the past three-weeks. More importantly, it never reversed its major sell signal from late April.

Sentiment

The sentiment model moved back to bearish last week coming in at –7. Investors Intelligence showed another rise in bulls and drop in bears with the current bull/bear ratio the worst since mid August with the bearish percentage dropping to its lowest level since early August. Market Vane has been over 50% bulls for two straight weeks. The 4-week moving average is not yet bearish but is higher than it was at the May high and close to its peak seen in early February. Consensus Inc. has been over 50% bulls for three straight weeks. The 4-week moving average has moved to a modestly negative level. It is close to its June peak ands not far from levels that have marked important peaks over the past two years. The American Association of Individual Investors reported net bulls at +33. This indicator is not as negative as it was in May but is negative. The member buy/sell ratio has been flip flopping between net buyers and net sellers the past several weeks but the overall reading from this indicator is negative. The insider sell/buy ratio has improved and moved back to positive this past week basis the 8-week moving average. The commitment of traders report was not available for the most recent week but the latest figure still showed a very high net short-position on the part of commercial hedgers and a high net long position on the part of the small speculator. This is negative. The CBOE put to call ratio basis the 10-day moving average is very close to the high end of negative and close to its level seen at the mid October low. The OEX ratio is neutral but just coming off bullish readings. The Rydex ratios have weakened enough to be viewed as slightly negative for the short-term but are not yet where they were at the peak of late May. The Volatility indexes have moved down sharply. The VIX for example is below 25 and not too far from levels seen near important tops. The VXN below 51 is lower than it was at the May 22 peak and not far from levels seen at important tops during the post May decline. They could go lower but are low enough now to be viewed as a negative.

Summary and conclusion

Technical analysis is the study of past performance extrapolated to predict future results. For example, certain chart patterns in individual stocks or market averages have a strong probability of similar results. This is also true of technical indicators and sentiment measures. One study we have done shows that historically price lows rarely if ever occur commensurate with momentum lows. This study was based on an initial decline of 15% or greater on the S&P going back to 1970. There were ten such instances from 1970 not including the current decline. And not one of those lows occurred commensurate with the momentum low. We did come close in 1987 but in December of 1987 the S&P did close below its October low. It was by less than a point but it satisfied the study. We have recently looked back beyond 1970 and found several other occurrences and on each of those occasions the final price low occurred after the momentum low. Those dates include, 1966; price low October, momentum low May, 1962; price low June, momentum low May; 1960, price low October, momentum low September, 1957; price low October, momentum low May of 1956, 1949; price low June, momentum low July 1948, 1942 is interesting as that was the culmination of a 5 year bear market. We made the price low in May of 1942. There was a momentum low in May of 1940 and also a momentum low in 1938. 1932; price low July, momentum low May 1930. The momentum indicator used for all dates is the McClellan oscillator. We have now presented another 8b occurrences and not one of the important price lows was seen commensurate with a momentum low. On September 21 of this year the McClellan oscillator made its lowest low yet confirming price. Most every other measure of momentum we follow confirmed as well. Historically we have a strong precedence that would argue strongly that we have not yet seen an important price low. This is evidence enough in our view to remain bearish on the long-term but there is more. Another important ingredient of important market lows is psychology or as we technicians put it, sentiment. Most important bar market lows have one thing in common and that is an almost universal hate for equities. Go back to 1982 and remember how the public and professional sentiment was at that low. No one ever wanted to buy stocks again. 1974 was most likely the same as was 1942, 1949 and probably 1932 as well. Currently, most investment strategists are still as bullish as ever at least in their allocation of equities in their portfolio mix if not in their out right price targets. The public although quite burned by technology stocks has not given up hope of getting back to even and even professionals are still quite complacent. Our proprietary sentiment model which is a combination of 12 key indicators never moved to bullish levels such as it did in 1998 or more so at the 1994 low and just this past week has moved back to negative. The percentage of bears from Investors Intelligence did improve in early October to levels seen in late April but that was not close to where it was at important lows such as 1998, 1994, 1990 or 1987. And just the past couple of weeks it has fallen sharply and is much closer to levels seen near peaks once again indicating a high level of complacency rather than the skepticism needed to imply an important low. At or near important market lows the up to down volume ratio tends to show at least one but more likely two or more sessions of 9 to 1 on the downside. That was not seen in September although we did come close. This is one measure of capitulation. Moreover, either just before or right after an important low we tend to get one and perhaps more than one day of at least a 9 to 1 up to down volume ratio day. We saw that coming off almost every important market low including 1998. The best we have seen following the September low was a 5.48 to 1 reading on September 24 and that did not come close to the 6.85 to 1 reading seen on April 5. Last but certainly not least, the outside position of technical barometer never reversed the –10 sell signal from late April as the best it got to was +2 and +4 is the minimum needed to issue a buy signal. And just the past few weeks the outside score gave three straight –6 readings. Reinforcing the –10 sell signal and remaining bearish. While there is always a possibility that this time it is different the odds are quite strong that September 21 did not witness a major price low for the averages are a lower low is ahead. Short-term we are faced with a number of negative divergences from an array of indicators while short-term sentiment indicators have weakened to the point of being slightly to modestly negative. There are two courses that the market can take from here. The first and the one we are favoring today is that the short-term sell signal takes hold and we correct now. That would in all likelihood allow the medium-term picture to remain with a positive bias for a while longer. The other possibility is that the market ignores the short-term warnings and pushes higher now. That would in all likelihood move the medium-term indicators to a more much more negative position and could turn the medium-term picture negative sooner rather than a bit later. We moved to bearish on the short-term last week and given the indicators we believe that is the place to be. Medium-term we remain neutral officially but with a still positive but weakening bias. Long-term we remain bearish.

QQQ traders are holding a 100% short position at an average price of 39.17. They closed at 39.28. Keep your stop at 40.54. Lower the stop to break even on any move below 38.20. Rydex switchers are holding a 5% Ursa position. Sell only if the S&P is above 1185 with an hour to go.         

The sentiment model shown above never got to levels consistent with important lows such as 1998 or more so 1994. Note also that at the September low it did not even get back to levels seen at the March-April low and just last week it has moved back to negative levels.

The outside score of the technical barometer (below) only moved up to mid neutral levels seen at short-term lows in September but never came close to bullish levels seen in 1998 and 1996 let alone very bullish levels seen in 1994. note the very bearish reading in late April below the February 1998 reading and the most recent series of –6 readings.

The percentage of bears from Investors Intelligence never got close to levels seen at important lows. It did not give great readings in 1998 either but that rally was almost fully retraced, however, it was better than what we saw in April or even October. Note how quickly this indicator has dropped as it is now where it was in mid August.  

The VIX and VXN have moved down sharply and are not too far from where they were at other important tops., In fact while the VXN has a bit more to go before reaching extreme levels as seen in July it is already below where it was at the May top.