D.B. Hi Ike, how are you doing?

I.I. Good, thank you.

D.B.  Several times in March and also in April, you stated that you expected the rally to last until the end of June,  which turned out to be case. Over the past eight weeks, it has moved sideways without giving up much in terms of price gains. In your opinion, does the action of the last eight weeks, represent a bullish consolidation, or, does it represent  a topping process?

I.I. Before I give you my opinion, I think I should elucidate first, on the process that I follow in order to formulate it. I believe it will make it much easier for you, and our audience to understand where I come from.

I believe that most aspects of the  financial markets are dynamic, not static. They constantly change, some changes  take place rapidly, others take place slowly. Some aspects lose importance, some gain more importance, some disappear altogether, and some new ones enter the scene.  Consequently, even the most sophisticated indicator -at some point, or another- will fail to account for what is going on the market, simply because the aspect that it is designed to measure, may have temporarily, or, permanently become irrelevant, thus, it no longer has the same impact on the market it used to have. Therefore, I strongly believe that "hanging your hat" on one, or, two indicators that "have always worked" is an approach which at some point can turn out to be a recipe for disaster. My approach is to examine  a variety of indicators covering  many aspects of the market, seeking to determine not only the message of each indicator, but more importantly, the degree of unanimity. One, or, two, or, even three indicators can be wrong at one time, but ten, or, twelve covering different areas of the markets, is highly unlikely to be ALL wrong at the same time.  In other words, if I am looking at 10 indicators, and 8 of them are telling me the same thing, then more likely, the message can be trusted. So, my "opinion" is based on the aggregate message given by the indicators that I follow. The higher the number of indicators giving the same message, the stronger my conviction about the validity of that message, and vice versa. 

In all the years that I have been in the business, I have never witnessed a period -with the exception of 1998- during which, not only a high number of different indicators -which normally confirm each other-  contradict each other by a wide margin, but also, even the message of a single indicator can have exactly opposite interpretations. 

The number of multiple and conflicting messages being sent by the market,  constitutes in itself a very important message, and I'll cover that at the conclusion of our interview.  For now, I'll give three examples, just to illustrate my point. The first example is of an indicator with a message that can interpreted equally bearish, or bullish. The other two, are of two different indicators, one with a strong bullish message, the other, with a strong bearish message.

The first one is the venerable McClellan Oscillator. In my view, it is one of the best short term overbought/oversold  oscillators available ever developed. In the past eight weeks the Oscillator has visited the -240 zone four times, yet in terms of price the NYSE is just 213 points below its June low, which is a negligible 3.7%. Even during the hey days of the bull market, one such  negative reading was usually  associated with declines in excess of 10%, we got four of them in eight weeks, and yet the NYSE is down only 3.7%. So, those who have a bullish bias can point out to that, and argue that this is a very strong market, exhibiting the characteristics of young bull markets which they tend to correct internally, but retain most of their price gains. On the other hand, the very same situation can be used by the bears to support a highly bearish argument. Thru out the years of the bull market, readings in the Oscillator below -200, had been followed by multi-month rallies, moreover, it took only one visit to that zone to produce a powerful rally. In the past 8 weeks, the Oscillator has been in the -200 zone four times, and no rally. So, those with a bearish bias can point out to that, and make an equally strong bearish argument. The only other time in recent memory that the Oscillator behaved similarly was in the Summer of 1998.

The market moved sideways for eleven weeks, while the Oscillator kept falling registering three highly oversold readings, below -150, while the Dow only gave up 404 points. The bulls were ecstatic pointing out how well  price had held, and they were expecting another rally and another 2000 point move. As we all know, we got the rally  but the 2000 point move was on the downside!  Am I saying that the market will follow the same script? If I  looked only  at this indicator, given the similarities in the action, I must at least consider the possibility. However, the real lesson to be learned from the last time the Oscillator behaved that way, was that many investors among those  who took positions only on the short side, or, on the long  side during those eleven weeks of consolidation betting on a rally, or, on a decline, lost money. The shorts were forced to cover at a loss when the market falsely broke out to the the upside, and many of the longs -unless they had very tight stops- also sold at a loss when the market fell below its June 22 low, which was the low during the consolidation period.  My point is,  when a time tested and reliable indicator deviates from price in a manner that is  uncommon, contradictory, and extreme in terms of the magnitude of the deviation, the real  message that the indicator is sending, is that market risk (volatility) can be expected to rise substantially and rapidly. Moreover, during times of extreme volatility both bears and bulls can lose money. Only fools the likes of those who appear regularly on BubbleVision can be arrogant, and ignorant enough to believe that they have figured Mr. Market out. In my view, based on  my  observations as  a student of the market for the past 14 years, the message  from the recent action of  this indicator,  ought to be, that this not the time to be supremely confident, this is the time to be scared, whether you are a bull, or, bear! 

D.B. What's the second example?

I.I. The second example is of an indicator with a very bullish message. The much talked about "RYDEX ratios."  The chart below is courtesy of my good friend Carl Swenlin, at www.decisionpoint.com. It shows the SP versus the URSA/NOVA fund ratio. The chart doesn't lie, the ratio is at the same level that in the past two years has marked major bottoms, and the start of 20% plus rallies. If one looked at this indicator only, would have a very good reason to be a raging bull! Moreover, anyone who is bearish/short, looking at this chart ought to be really scared! 

D.B. I see your point, what's the third example?

I.I. The third example is of an indicator with a very bearish message. It is the ratio of the NDX versus the VXN, which is my preferred way of looking at the VXN. Again, the chart doesn't lie, the ratio is at the same level that in the past two years has marked major tops, and the start of 20% plus declines!. If one looked at this indicator only, would have a very good reason to be a raging bear! Moreover, anyone who is bullish/long, looking at this chart ought to be really scared! 

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