BI-WEEKLY MARKET RECAP and TECHNICAL PERSPECTIVE

By: Larry Katz

December 24, 2001

Capsule

The short-term is mixed and can support a move in either direction, however, the seasonal factor do favor a positive bias into early January. If this plays out it could very well lead to a more important top and a medium-term top. The long-term remains bearish. There are several factors leading us to expect a move below the September 21 low before the bear market is complete. The bonds look higher over the short-term and could rally strongly. However, that rally if it does transpire would be within the confines of a negative medium-term and possibly long-term out look. The XAU is at an important juncture for both the short and medium-term. Further strength could turn the picture more positive but a failure near current levels could set the stage for a move back below the November low

Elliott Wave and Fibonacci

The December 5 peak on the S&P stopped right at important Fibonacci resistance in the area of a .618 retracement of the May-September decline. The rally on the daily chart in our view cannot be counted as impulsive for a couple of reasons. First the hourly charts within each wave on the daily chart are corrective. Secondly, what can be counted as wave 3 on the weekly chart (October 30-Nmovember 27) is also corrective on the daily charts, complete with overlaps. Lastly, the rally from November 30 to December 5 is a three. The only bullish case we can make from September 21 in regards to the S&P is that this averages has traced out a couple of 1’s and 2’s with the second waves both being irregular patterns. If this is the case an acceleration to the upside as a third of a third unfolds should be close at hand.  This is a possibility but in our view a rare one. We are still of the view that the rally from September 21 is a “b”’ wave. Our preferred count is that it is a “b” wave related to the May-September decline. The fact that we have stopped right at a .618 retracement of wave “a” in what is a corrective pattern leaves open the possibility that December 5 did in fact complete wave “b”. The fact that the December 5-December 14 decline can also be counted, and very easily we might add, as a five on the hourly chart also supports the idea that December 5 did indeed mark the peak of wave “b”. This five could also be part of that second wave irregular from November 27.  However, a move above the December 5 peak would not eliminate the “b” wave count nor confirm that the S&P was entering a third of a third. Keep in mind that “b” waves can and very often do move well past a .618 retracement of the “a” wave they are correcting.  In fact “b” waves can retrace most all of an “a” wave and in some cases actually exceed the peak of wave “a”. This is how we get irregular corrections. What will be important if we do move above the December 5 peak is how we do it. Third waves have specific characteristics such as acceleration of the advance, the best breadth and volume and as importantly momentum. If the latter fails to take out the early October peaks it would argue strongly that this was not a third of a third. Of course, the structure of the rally will also be very important. The DJIA is in a similar pattern as the S&P. However, we can count the November 1-November 27 rally as a five on the daily chart with an extended first wave and an irregular in the wave 4 position.   However, the same problem pops up in regards to the November 29-December 5 rally, which is best counted as a three. Moreover, the rally from November 29-November 30 was a five on the hourly chart adding to the three-wave pattern into December 5. It is, like the S&P possible to count this rally as a “b” wave of an irregular from November 27. We can count a very clean five from December 5-December 14 on the hourly chart just like the S&P. But unlike the S&P, which did move below the November 27 low on December 14, the DJIA did not. Unless wave “c” ended in a failure the December 5-December 14 decline cannot be counted as a “c” wave of an irregular. If it did end on a failure that would be very bullish as failures show that the prevailing trend is very, very bullish. For the record, irregular patterns are also signs that the prevailing trend, and in this count that would be up, is very strong indeed. At this point our preferred count is that the post September 21 rally is a “b” wave in the DJIA as well. Whether it is a “b” wave related to the post May 22 decline or as far back as January 2000 is not clear at this point. The short-term patterns are getting interesting. As mentioned, the decline from December 5 to December 14 can very well be counted as five-wave patterns on both the DJIA and the S&P.  The rally into the December 19 peak can be counted as a five but is better counted as a simple a-b-c, at least so far. (see charts on the website). The “a” and “c” waves are almost perfectly equal in length and the S&P stopped right at a .618 retracement of the December 5-December 14 decline. The action from Wednesday is so far inconclusive. As it stands now both averages are in no mans land as far as the wave structure is concerned. The one thing that favors a push above last Wednesday’s high is the fact that the decline from Wednesday does not look to be impulsive but that could change on a strong down move. We also see the possibility of a nearly completed triangle from December 19. The short-term should tip its hand soon but for now we need to wait for the market. The rally from September 21 in the NDX is so far a three wave affair basis both daily and weekly charts. The weekly charts show the rally from October 30 to be a new wave. The daily pattern from October 30 is clearly corrective as is the September 21 to October 26. The decline from December 6 is also corrective, at least so far. There are a couple of possibilities in regards to this decline and as it relates to the rally from September 21. The first is that it is a “b” wave related to the entire post September 21 rally and in that case we are most likely on the early to middle stages of the corrective pattern. The other possibility is that the decline is an X wave as was the October 26-October 30 decline and we are about to embark on another three to trace out a triple three from September 21. We can count five-waves down from December 18 if the second high on December 18 was the orthodox top of the rally from December 14. However, this would involve a small failure. If the actual price high was in fact the orthodox top then we need one modest new low below Thursday’s low to complete a five. We would count this five as a “c” wave from December 6, with wave “a” taking the form of a double three. The alternate count is that we are in the early stages of a third of a third from December 6. However, what would be counted as wave 1 of 3 is best counted as corrective on the hourly chart making this a difficult count at best. Support S&P; 1138-1139, 1128-1130, 1092-1095, DJIA; 9955-9961, 9870-9882, 9640-9650, NDX; 1520-1526, 1475-1483. Resistance: 1147-1149, 1152-1154, 1175-1180, DJIA; 10,045.10,057, 10,100-10,120, 10,275, NDX; 1598-1602, 1624-1630.  Trend changes for the next two weeks are as follows:  December 27-28*, January 2, January 4*. * denotes important

Bonds

We are quite satisfied with the 5-wave decline from November 1 to November 27. However, the action from the December 4 peak is not, at least at this point, not impulsive. That leaves us a number of possibilities The first is that the decline from December 4 is a “b” wave of an irregular from November 27. This would allow for a rally back above the December 4 peak to complete a large irregular. It is also possible that the decline from December 13 to December 17 is an irregular from December 13. This would allow for a rally back above the December 13 high. It is also possible that the bonds are tracing out a number of 1’s and 2’s with a third of a third to the downside directly ahead. However, in our view this would require an almost immediate acceleration to the downside now. The last possibility is that the decline from November 1 is not an impulsive move but corrective. We are favoring one of the two irregular counts at this point. How far we rally will be the key. The daily range oscillators have turned up from oversold levels and locked in some minor bullish divergences. The daily trend oscillators are positive and short-term momentum is positive. The weekly range oscillators are not close to oversold and remain negative. The weekly trend oscillators are negative and medium-term momentum is also negative.  Market Vane and Consensus Inc are in the mid 30% area on bulls and the commitment of traders report shows that commercial hedgers are still slightly net long. Support: 97-97 20/32, 94 24/32-95 10/32. Resistance: 102 29/32 +/- 10/32, 105 18/32 +/- 12/32. Please note that all price levels are based on a constant bond chart and not any particular futures contract. Currently the constant chart is running around 7/32 below the March 2002 contract. Short-term momentum is positive and sentiment is constructive. A continuation of the rally towards resistance is the most likely course and we remain bullish on the short-term. The medium-term picture is another story and we remain bearish.

XAU

The rally on the XAU from the November 19 low has traced out so far at least a very clean 3-wave pattern on both the daily and weekly charts. The two waves were almost perfectly equal in length supporting the possibility that we have just completed a classic zig-zag. We say zig-zag because the first wave up from November 19 to December 7 was a clean five on the daily chart. The rally did slightly exceed initial resistance levels related to the post September 21decline. However it moved back below almost immediately. The XAU is now at an interesting point. A move above last weeks high would confirm the move above resistance as real but more importantly could give the pattern a 5-wave look on both daily and weekly charts. A failure here could argue that a “b” wave was complete and a move below the November 17 low was underway. Short-term momentum is OK but getting overbought. Further weakness would turn it negative. Medium-term momentum is negative but improving and strength could turn it positive. Sentiment is on the negative side. The Rydex numbers are on the negative side, not excessively so but negative nonetheless. Market Vane on gold futures was 62% bulls and that is negative. Consensus Inc. was neutral at 39%. The commitment of traders report shows a shift in commercial hedgers from net long to net short but it is not yet excessive. Support: 54, 50-51, 44-45. Resistance: 57, 61-62. The indicators and price structure are at an important juncture. Further weakness could turn the short-term indicators negative and at the same time keep the medium-term indicators from turning positive. Conversely, any decent strength next week could turn the medium-term indicators positive. We are going to remain neutral on the short and medium-term awaiting next week’s action. Long-term we remain neutral.

Indicator review

December started out strong across the board with all of the averages up strongly in the first week. However, from that point the results have been mixed as has the month. The averages are still up but the DJIA is swell ahead of the S&P up about 1.86% while the S&P is up only about .50%. Even the broad based NYSE Composite is lagging as it is up only about 1%. We did get the short-term top early in the month as the averages peaked in the first week of the month. Most of the disparity in the averages has occurred since that peak with the S&P losing nearly 3 times that of the DJIA. Both averages have broken below rising trend lines drawn off of the September 21, November 1 and November 27 low. The DJIA mid week did snap back to that broken line while the S&P has lagged and has not come close. The last two days of last week, both averages traced out consecutive inside days lower high, higher low). Inside days tend to be followed by big moves and back to back inside days suggest the potential for a very big move. Price/volume relationships have weakened and are bordering on negative. The last rally leading into the December 5 top was on weaker volume than the rally from October 30 into late November, which in turn was weaker than the initial rally from September 21. Breadth has held up quite well with the daily and weekly A/D lines doing OK. The high/low statistics are mixed. We did get conformation from the new highs on December 5, as they finally moved above their early October peak. However, the high/low indicators have eased and are slightly on the negative side. The Russell 2000 is having a very decent December as it is up over 4.5%. The short-term is close to going negative but seasonal factors are positive and we are going to remain neutral.  The medium-term is also neutral. The Value-line is also having a strong December as it is ahead by nearly 3.3%. This average is in the same position as the Russell 2000. After soaring into early December and showing strong relative strength since late September the NASDAQ averages have taken a backseat to the rest of the market. The NASDAQ Composite is still ahead for the month by 15 points or .77%. The NDX by contrast, is down 18 points or 1.1%. And since their peak on December 6 the Composite has lost 109 points or 5.1% and the NDX is down over 140 points or 8.1%. They are slightly oversold and could bounce but the short-term remains negative. The medium-term is neutral but also weakening. The DJTA is up about 4% fro December continuing its decent relative performance. The short-term is neutral but also showing signs of weakening. The medium-term remains slightly bullish. The DJUA and UTY look to have stabilized and are showing very modest gains. We moved to bullish on the short-term and will remain there but it is a fragile signal and it is important that the rally continue. We are neutral medium-term and we remain bearish on the long-term.

Momentum    

The breadth and volume oscillators are neutral but the volume oscillator did reach the low end of oversold last week. The 3-day oscillator is neutral. the McClellan oscillator is also neutral and right back to the zero line. The 10-day and open 10-day Arms are neutral but the open 10 is closer to oversold. The 5-day Arms is slightly overbought. The 21 day Arms is slightly oversold. The new 10-Arms is neutral but did get close to oversold. The daily range oscillators are neutral but weak, The daily trend oscillators are negative but close to going neutral. The weekly range oscillators are neutral. The weekly trend oscillators are positive. The weekly breadth indicators are neutral but weak and look to be setting up negative divergences.

Sentiment

The sentiment composite remains negative at +6. Investors Intelligence reported a rise in bulls to  46% and a small drop in bears to 28%. The bull/bear ratio is not excessive but is negative. The 4-week moving average of both Market Vane and Consensus Inc are on the negative side with both near levels of important market tops of the past two years. The American Association of Individual Investors (AAII) did show a drop in net bulls last week, but the overall level is still negative. Moreover this measure of public sentiment just one week prior reported the lowest number of bears since early February. NYSE members were net sellers. This indicator is neutral. Corporate insiders picked up their pace of selling last week to its worst weekly reading since mid August. The 8-week moving average is only neutral but moving up sharply. The Commitment of Traders report is still quite negative with commercial hedgers still heavily net short while the small trader is heavily net long. The CBOE put to call ratio basis the 10-day moving average is neutral but there could be definite distortions due to triple witching. The OEX ratio is neutral but closer to negative. The Rydex ratios are neutral to slightly negative. These also tend to show some distortions around options expiration. The Volatility indexes are negative. The VXN is not at new lows but is also not far away. The VIX is actually below where it was at the December 5 peak while the S&P is not close to its respective high.

Summary and Conclusion 

December is a difficult month to analyze and more so to trade. It gets more so as the month progresses due to a number of factors not least of which is triple witching along with end of year portfolio adjustments and tax considerations. Often times these considerations cause a lot of distortions in the indicators. Seasonally the last few days of a month and especially the first few days of a new month tend to have a positive bias. This is especially true of the beginning of a new month, which occurred on time into early December, December 5 to be exact. The question is will we get the so called “Santa Claus rally” that most seem to be expecting or will it be a bust? The day before Christmas, which is today tends to be positive as does most days prior to a holiday. The indicators are mixed at this point and most are at neutral levels. They have corrected the negative pattern leading up into the December 5 top with all the divergences discussed two weeks ago. However, our experience is that after the second negative divergence the correction is far deeper then the previous ones and most of the indicators move oversold not just neutral. This was accomplished on some but not all and the level of oversold in those cases was only borderline. The question is, was this enough to satisfy the pattern and allow for a move back towards the early December high? At this point we honestly are not sure. As mentioned most of the momentum indicators are neutral. However, none of them really did give a good buy signal at the most recent low. A couple of the sentiment indicators did improve. This was mostly seen in the CBOE put to call ratio but in spite of it all the 10-day moving average is still only at neutral levels and not close to oversold or bullish. The Rydex ratios also improved a little but both of these can and often times are distorted by options expiration week. On the other side of the coin are the volatility indexes. The VXN on the NDX is not at its most negative level but it is not bullish and is much closer to where it stood in early December. Moreover, it is still below where it stood at the May 22 top. It did move lower in July while the NDX did not move to new highs. At its recent low it was not that far from where it had stood in September of 2000, which marked a very important top. The VIX late last week moved below its December 5 low. This is right where it was at both the May and August peaks, and not too far from where it was in July. The VIX also moved below its December 5 low while the S&P has held well below its December 5 peak. We saw the same pattern near the same levels in May-June as the S&P was peaking. There is still some room for these indicators to move lower but they are already well into the danger zone and are extremely negative. Investors Intelligence is still negative although the percentage of bears has improved a bit. However, it hit its lowest reading since July and only two weeks ago at its levels seen at the more important tops of the last several years. Market Vane basis its 4-week moving average is the most negative in nearly two years while Consensus Inc is as well. The latter is also a levels seen at most of the important tops of the last several years. Last but not least, the American Association of Individual Investors (AAII) just last week reported the lowest number of bears since early February just as the February-March decline was unfolding. And just 4 weeks ago we had the highest number of bulls since January 2000 as the DJIA was making its all time high.

What does this all mean for the market? Short-term, we moved to a sell signal on December 10. That signal has not been reversed as yet, but we are entering a strong period seasonally. From both a price structure perspective and from the indicators we believe that we are at an important point for the short-term. The momentum picture can support a rally although the fact that we have not gotten sufficiently oversold suggests that it will not be long lasting or sustainable. The seasonal pattern also supports a rally. However, there have been some occasions where the rally into late December did not move to new rally highs such as 1997 and others when it was quite strong. We think the real limiting factor is the sentiment backdrop as most of the indicators are negative. Of course they could get more negative and reach excessive levels and we would expect to see that on any further gains into early 2002. That is why we see them as limiting. The short-term is tricky given all the cross-currents and mixed indicators. It is difficult to remain bearish going into what is normally a strong seasonal period. However, as mentioned the sell signal has not been reversed but we see enough to move the signal back to neutral. At the same time, further strength unless it is an acceleration to the upside will put the sentiment indicators into a much more negative position than they already are and will also set off even more negative divergences than we already have in place now. This would lead to a more important top and would turn the medium-term negative. As it stands now we remain neutral on the medium-term but with a more cautious outlook. Long-term we remain bearish. There are three key factors behind our long-term bearish view. The first is one we have discussed over the last several months and that is  the fact that the September 21 low was confirmed by every measure of momentum we follow and not once when the averages have declined by 15% or greater have we had a price low commensurate with a momentum low  going back to 1930 (the study is available on the web site). Secondly, while we do not put much faith in short-term cycles we do put a lot of faith in the 4-year cycle. It has been extremely consistent for decades. The only time in the last 30 or more years that we had a 4 year cycle bottom early was in 1990, 3 years after the 1987 low. However, if indeed 1997 not 1986 was the 4-year cycle it was one that extended and bottomed 5-years after the previous one in 1982. The 4-year cycle bottomed in October 1998 and is due sometime in 2002. We fully expect it to be on schedule. Lastly, we did not see nearly enough pessimism or give up at the September low to mark an important low, especially following a decline of the magnitude that transpired. In fact, we still see a lot of complacency on a long-term basis and a lot of very bullish expectations. This is not consistent with important market bottoms and all of this in our view implies that the market is still very much at risk and a breach of the September 21 low is expected to occur sometime late Spring to mid summer of 2002.

SPY traders are short from 115. They closed at 114.95. Keep your stop at 118.75 but lower it to 116 on any move below 113.56. Rydex switchers are holding a 5% Ursa position. Sell only if the S&P has been above 1192 at anytime.

We want to take this time to wish all of our readers a wonderful holiday season and a happy, safe and prosperous 2002.

The decline from November 1 to November 27 in the bonds is a clean five-wave pattern. The action from that low is inconclusive. The December 4 high is either a second wave or as the alternate count shows a possible a wave of a large irregular pattern.  

The chart below shows the VIX and the S&P. Note the similar pattern now as we saw in May-June Note also that the VIX is at levels seen near important tops

The DJIA broke below the rising trend line drawn off of the September, late October and late November lows. The rally on Wednesday took the DJIA to the backside of the broken line. The S&P not shown also broke its respective line but the rally has not carried back to the lone as it has on the DJIA

The high/low index below  gives a sell signal when it moves above 70% and back below 70%. This indicator is a confirming one and does lag at times. On occasion it will move below and then back above to make a lower high as it in early to mid August. However, the move above 70% this time was very weak.