D.B. Hi Ike, how are you doing?

I.I. Very well, thank you.

D.B. In concluding our last interview on 1-18-03 you said:

 "...The markets are at the same point they were in January of 2001. The indices have rallied sharply on hope that the economy is getting better while all evidence points to the opposite direction. In addition, the technicals have failed to confirm the rally. Given the negative divergences that have been going on for the last 8 weeks, and the deterioration in the fundamentals, the most logical expectation is one of lower prices." 

The SP was at 901 at the time, and subsequently it fell to 806, before recovering the past few days, have we seen a bottom of any importance? 

I.I. The fundamentals suggest NO, but the technicals suggest that the current rally may have more to go on the upside. I would like to spend most of this  interviews on the technicals because  they do paint a very interesting picture. However, before I do so, I'd like to comment on the fundamentals a bit. Since the bear market started Wall Street has blamed it on everything else but the real reason, and that is the imbalances that were created in the real economy due to the gross and negligent misallocation of capital induced by the loose monetary policies pursued by an incompetent and reckless FED. Right now the blame goes on the "uncertainty over Iraq." However, the imbalances -although somewhat reduced- they have not been completely purged form the economy. I read a great commentary by Comstock Partners (http://comstockfunds.com) which in my opinion says it all:

" Aesop's Fables:
Ever since the current bear market started in early 2000, strategists, economists, and general investors have blamed the market and economic woes on everything except the real cause—the massive structural imbalances and excessive valuations built up during the unsustainable late 1990s boom. Although the current mantra now says it’s all the fault of the Iraqi situation, this is only the latest in a series of excuses that have kept investors in the market in the face of the second worst market decline of the past century. The following is a chronology paraphrasing the various excuses put forward at different times over the past three years. 

February 2000—“This is a new era. Growth will soar, recessions are obsolete and the Dow is worth 36,000. The dot-com companies are the place to be. Forget price-earnings multiples. That’s for your grandfather. These are bargains at any price.” 

July 2000—“Well, we always suspected those dot-com companies, but the rest of the economy is in great shape. The better-quality technology companies will grow forever. Just wait until those portfolio managers get back from summer vacation. The market will take off after Labor Day.” 

October 2000—“We know the technology companies have hit the skids, but it won’t spread to the rest of the economy. This is strictly a tech-oriented phenomenon.” 

December 2000—"The market would have taken off by now if not for this stupid election dispute. You better load up on stocks right now. They’ll really take off once the election dispute is settled.” 

January 2001—“Now that the Fed has cut rates a market rise is a sure thing. We’ve got this study that shows that every time the Fed has begun a round of rate reductions the market has been up substantially over the following year—well, not every time—1929 was an exception, but that’s not going to happen again." 

September 2001—“Every statistic was showing we were recovering until the terrorist attack. If not for that we would be in strong recovery now. But soon everyone is going to go out and spend, and by the first half of 2002 the economy will be soaring—and we’re overdue for a new round of technology spending too.” 

February 2002—"Well, we’re definitely in a recovery mode, although we concede it’s a bit slow. We’re looking for a gangbuster second half.” 

October 2002—“ We would certainly have been in strong recovery by now but those Enron, WorldCom, accounting and general corporate governance problems have damaged investor and consumer confidence. The authorities are now taking corrective measures, and by the first half of 2003 these problems will be behind us. After that the economy will soar as both consumers and corporations will spend.” 

February 2003—"It’s all Iraq. People are focused on that and it's hurting the market and the economy. Even Greenspan says so. As soon as we resolve the Iraq situation the market and economy will really take off.”

(Http://comstockfunds.com, 2-12-02)

The message is rather clear, after the "uncertainty over Iraq" is resolved, we will still have to deal with the same old reasons that impede the economy's recovery, and the recovery in corporate profits, and those reasons are far from being eliminated. We have no evidence to conclude upon that the fundamentals support a sustainable multi month advance.  However, we also know that at times there is a disconnect between fundamentals and technicals which result in the two going in opposite direction for the short term. Such case may be the current one. 

D.B. Why ?

I.I. Several of our indicators are at the zero line which is the demarcation line between an up-trend a nd a down trend. In fact the trend as measured by our trend indicators is now characterized as neutral. We got the 10 day trend indicator pointing, up while the 20 day trend indicator pointing down, thus, rendering the short-term as neutral.

In addition, the Quantifiers -which are a composite indicator of  MACD, Stochastics, Aroon, 10 day SIs, 20 day SIs, 50 day SIs, SI25s, 10 day BSEs, 10/20 day TIs, SMIs, TOs, McClellan Oscillators and Summation Indexes-  are right at the zero line, which suggests that the indices can go either way from here in the short term.

D.B. Are any indicators that give us a hint as to the ultimate direction of the resolution?

I.I. No clearly!. Sentiment suggests that the resolution should be on the upside, given that bearishness has risen to rather high levels lately. However, two of the most important short term indicators in our arsenal, the Thrust Oscillators, and the Buy/Sell Equilibrium indexes suggest that the rally is almost out of fuel, and it should be a aborted within the next 1.5%-2%.

We had similar set-ups on 3/11/02, 4/16/02, and 5/14/02, and all three instances were followed by sizable declines. Thus, the important thing to keep in mind is that, if the markets fail to advance beyond 1.5%-2% over the next 3 days, and they turn down, along with the indicators, then in all likelihood we should expect a decline in excess of 10%.

D.B. Can you assign any odds to that?

I.I. With half of the technical indicators positive, and the other half negative, I would say the odds are almost 50/50. 

D.B. How about the bearish sentiment, shouldn't that provide support for the market?

I.I. Yes, it should, however, I am afraid is more talk and no action.

D.B. What do you mean by that?

I.I. There is one thing people being bearish and shorting the market, and another being bearish and covering their shorts! The chart below from http://fallstreet.com shows very clearly that although bearish sentiment has risen, short interest has decreased, so, all this bearish talk may not mean a whole a lot, if it is not accompanied, and confirmed by equally bearish action.

D.B. How about the Volatility Indexes, are they giving us any clue?

I.I. To get a better relative picture of where they are at a given point, I divide the index they track by the volatility index itself, the charts below illustrate the exercise rather clearly.

By this measure the VXN, is near the middle of its most recent range, and thus it supports a move in either direction. The VIX is near the bottom of its most recent range, and thus it supports a move on the upside. Therefore, between the two, we are back to square one! 

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