D.B. Hi Ike, how are you doing?

I.I. 

Good, thank you.

D.B. In our last interview on 3-22-03, I asked you what we should expect going forward. You replied:

"...The 10 and 20 day TIs have turned up, which means the trend is up, however, the Thrust Oscillators are topping, which means the initial thrust of the up-move has been exhausted, thus, we should see a pullback, and then another push higher."

Following your reply, I said:

"Short-term you are obviously positive on the market, what will change your mind?"

and you replied back:

"I would get rather bearish if the SP goes sideways in the next two weeks moving in a tight 20-30 point range, while bullish sentiment moves up near the top of its range." 

The SP on 3-21-03 -the day before our previous interview-  had closed at 895.9, it then fell to 843.68  on 3-31-03, and subsequently it has continued to push higher, closing at 893.58 on 4-17-03. So, your expectation of a pull-back followed by another push higher, has been fulfilled. At the same time, one can argue that over the past 4 weeks the market has not gone anywhere, it is back where it was 4 weeks ago, but bullish sentiment -as measured by the put/call ratio, AAII, I.I., and the Volatility indexes- is much higher now than it was four weeks ago, with no net gain in the market, so, have you turned "rather bearish" now?

I.I. Not yet! All but 5 out of the 25 indicators that I look at regularly -as we will see in part II of our interview- have formed negative divergences. Normally, both in a bull and in a bear market, such action would indicate some short of a top coming within 5-15 trading days. Such top would be of  an intermediate term nature  in a bear market, and of short term nature in a bull market, cyclical, or, secular. The indicators that have not formed negative divergences are the Price/Volume oscillators. These indicators examine the performance of volume versus up, or, down days.

Notice that the P/V Oscillators for both  the SP and NASDAQ, made higher highs on 4-17-03, than the highs on 3-21-03. That is confirmation, and evidence, that up volume during up days, as a percentage of total volume during the last 40 days, has been consistently higher than down volume as a percentage of total volume during down days. To put it simply, these indicators show that there have been more buyers than sellers, and unless that changes, we can not expect the market to have a substantial decline. In a bear market such change takes place suddenly and with no forewarning, but in a bull market such change does not take place at all, or, when it does, it takes place slowly and it lasts shortly. Such was the action at the end of the first quarter of 1995. Many indicators -especially those that are momentum based- topped out in late March of 1995, causing many to think that the market had reached another top, yet, thanks to positive money flows, the market went straight up for nine months! I am not suggesting that the market right now is at the same point it was in the beginning of the second quarter of 1995, the main reason being that back then overall volume was expanding, while now it is contracting. However, what I am saying, is this: we can't expect the market to plunge into oblivion, while these indicators are moving up. Assuming we are still in a bear market, it can happen suddenly, but it has not yet, that is the point. Having said all that there is one more point that I wish to make. Take a look at the 30 day Buy/Sell Equilibrium indexes.

The Buy/Sell Equilibrium indexes are rising, confirming the message of the Price/Volume Oscillators that demand is higher than supply. However, these indicators measure absolute levels opposed to ROCs, notice the negative divergence. The meaning of this is that although up volume as percentage of overall volume exceeds down volume as percentage of overall volume during down days, overall volume -in absolute terms- has been declining over the past 10 and 30 days, that is a sign that liquidity is drying up, a characteristic of bear markets. In bull market  liquidity expands, it doesn't contract. It is for that reason that relatively  positive inflows -illustrated by the P/V oscillators- suddenly reverse up during bear markets, there is no more money available to commit to stocks.. 

D.B. How about the Volatility Indexes, some pundits are saying that they should come down as the war premium disappears and a new bull market has started. Others see the recent decline in the Volatility indexes as a sure proof that the market is at a top. What do you believe?

I.I. Lately there have been plenty of "Volatilitologists" expressing "profound" views on TV, radio, message boards, etc. I do not have the "knowledge" "experience" and "understanding" all these "experts" claim to have, but I'll tell you what I do have under  my belt, and based upon that, I'll comment on the Volatility Indexes.

I used to trade options. I have held positions both as an options trader, and as Head of options trading for Aegean Capital Mgt. In fact in an effort to showcase our options trading programs for the SP futures to U.S. institutional investors, we entered the "Methodology Showdown" contest that was conducted   by the "Traders Catalog Resource and Guide" magazine in 1995. Our account statements were audited and verified by Auditrac, which in turn forwarded the audited results to Traders Catalog for publication. According to the November 1995 issue, in 11 months I turned a starting capital of $50,000 to $470,356.61, by trading options on the SP futures contract. (Traders Catalog Resource and Guide, Vol. III, No1, page 21, November 1995) See table below:

So, although I "lack" the "knowledge" of all those "Volatilitologists" who probably have never traded an options contract in their life time, having under my belt a verifiable ROR of 920.46% in 11 months trading options, I feel that  I am somewhat qualified to have an opinion on the subject. 

The markets always convey a message. Our job is two fold: a) we must interpret the message correctly, and b) we must then decide whether the message of the market is correct, and  go with the market, or, whether the message of the market is incorrect, and thus go against it. Last week the action in the options markets conveyed -in my view- the message that investors saw no need to obtain downside risk insurance for their portfolios, instead, they were pre-occupied with positioning their portfolios for an upside impending move. It could be that the message is correct, and the real risk is on the upside. However, for the very short term, the odds favor the opposite.  Let's take a look at a couple of charts. The first one is the ratio of the NDX/VXN with 200 day volatility bands. We can see that even during the bull market of the 1990s, every time  the 200 day upper volatility band was briefly violated, almost immediately a decline ensued. In one occasion it marked the major top prior to the 1998 decline, in another, it marked another major top in August of 2000, and in between, it has marked several short term peaks.

Moreover, for the first time since August of 2000, I found on Wednesday and Thursday of last week, several  June SP puts, trading at a 25% to 35% discount. 

D.B. How about the implied volatility being below the actual volatility? (see chart by ivolatility.com)

I.I. By itself such a cross-over is not important, and it is NOT indicative of an immediate top. We had such a development on 11-4-02, the market did not top out until 12-2-02. However, when such action is combined with a piercing of the 200 day upper volatility band, then its significance is higher. In sum, my conclusion based on the action in the options markets is that the odds favor that we could see another 2.5% advance from current levels, and from there we should be looking either for a short term top, and perhaps a major one. If it is a major one, this chart below from our  friends at ewavecharts.com illustrates what may be in store.

Now let's move on to part B, so we talk about the rest of our technical indicators.