D.B. Hi Ike, how are you doing?

I.I. Fine, thank you.

D.B. In concluding our last interview on 11-23-02 you said:

 "...Almost every indicator we use has acted nearly identically to the way it acted during the previous two bear market rallies, which leads us to believe that the current rally is also a bear market rally. If it was not, it would not share the same "technical signature"  with the other two  bear market rallies.  We find it rather  improbable that a rally which marks a new bull market will have identical technical characteristics with the two most recent bear market rallies of significance, we truly doubt that this is  some type of a "Trojan" bull market rally, we are not aware of such variation. Bull market rallies act like bull market rallies, and bear market rallies act like bear market rallies....At the moment, our indicators show that the rally is at a critical point. The rally from the March lows ended when it reached the same point, but the rally from the September lows consolidated and was able to move higher for another 16 weeks. Thus, we got to be prepared for either outcome. Right now, the markets are rather overbought, thus another pull-back, or, a consolidation should be expected. If the rally is to last for several more weeks, the TIs, BSEs and Quantifiers need to remain positive while  the SP  holds above 895 and  NASDAQ  holds above 1370 during any pull back that takes place in the next 3-5 trading days." 

As it turned out the market topped within 5 trading days and both the SP and NASDAQ subsequently closed below 895 and 1370 respectively while the indicators you follow turned down. That would have signaled that the rally from the October lows was over, and any new rally would fail to take out the highs of December 2nd. So far, that is how things have played out. So, are we to conclude that the markets are going much lower from here?

I.I. If all we had to consider was the technicals and the fundamentals, I would say yes. However, we also have to consider  geopolitical developments that may temporarily distort and exaggerate  the direction of the markets both on the upside and on the downside.

D.B. Can you elaborate?

I.I. If the situation with Iraq was to have a favorable outcome rather quickly, it would give the markets a psychological boost, which could lead to a substantial rally. However, in the intermediate term it won't probably change much, because the Iraq situation is not what caused the economy's woes. The economy's woes are due to overcapacity, excess debt burden, reckless policies by the FED, and lack of economic recovery in Japan and Germany, the world's two other biggest economies. By the same token, an unfavorable outcome will  exaggerate the negatives that are already present.

D.B. If we were to exclude Iraq, what is your assessment of the markets right now.

I.I. My "assessment" is based on the facts that are in front of me. The markets from a technical and fundamental point of view are where they were in January of 2002. They have rallied substantially from their lows on hope that the economy is about to turn around, despite that all the evidence points the other way.

Here are the facts with regards to the fundamentals -charts don't lie, do they?

1. Personal Bankruptcies are on the rise.

2. The Chicago PMI has been falling.

3. Consumer Confidence has been  falling.

4. Chain Store sales have been  falling.

5. The Current Account deficit is widening.

6. The Trade deficit is widening.

8. The Federal Budget is widening.

9. The ECRI WLI is topping.

10. Factory orders have been falling.

11. The Help Wanted Index is at a 40 year low.

12. Mass layoffs are on the rise.

13. Mortgage applications have topped out.

14. The Semis book-to-bill ratio is at a 4 month low.

15. A negative PPI number of -0.3% was reported  for December. According to the WSJ, core
wholesale prices were down -0.4% for the year, the first time in 28 years that the U.S. has ended a year with annual declines in core wholesale prices, indicating that deflation is a threat.

16. Similarly, the German C.P.I. continue to decline, indicating that Germany may be on the brink of deflation, as well.

In addition, the economy's deterioration is confirmed by the fact that major corporations such as GE, INTC, IBM, MSFT, etc., have guided lower.  There is not one piece of evidence other the economy, or, corporate revenues  have even stabilized, let alone turn around.  This is exactly the situation which was confronting the stock market last January.

D.B. How about the technicals?

I.I. Let's take a look at some of the technicals, and I'll cover all of the indicators that I follow in part II of our interview.

In our November newsletter which was posted on 11-23-02 we said: "The 10 and 30 day BSEs are illustrating that -up to now- the supply/demand characteristics of the  current rally are identical to the supply/demand characteristics from the previous two rallies. In the case of the March '01 rally, supply overwhelmed demand  totally within a few days, in the case of the September '01 rally, due to seasonal reasons, it took seven more weeks before demand was totally exhausted. Notice that the BSEs are declining while the market is advancing, that is a sign of distribution, which suggests that the bear market is still with us. You do not see distribution patterns during the early stages of brand new bull markets. " (1-18-03) The 10 day BSEs are already below zero, and the 30 day BSEs are just now turning lower, moreover, neither indicators is close to the oversold levels  from where we get reflex rallies, that means the current decline has more to go. The Momentum Summation Indexes diverged negatively for 8 weeks, and now they are also below zero.  In addition, notice they  have yet to reach the  levels  from where we get reflex rallies, that means the current decline has more to go.

 Moreover, on a long-term basis, the SP and NASDAQ are still below their necklines. The following chart which is courtesy of http://ewavecharts.com  "Technically speaking" what is it that I should be optimistic about, the negative divergences that have failed to confirm the rally for 8 consecutive weeks, or, the fact that the major indices have failed so far to break above resistance?

D.B. So, what should we expect from here?

I.I. Our intermediate term model is comprised of two variables, a "technical" one which carries a weight of 65% in the equation, and a "fundamental" variable which carries a 35% weight in the equation. In addition, more recent outcomes carry higher weight than more distant outcomes. Everyone, would understand that how markets acted 6 months ago based on the same data, is more relevant to how they acted 15 years ago, based on the same set of data. The "technical variable is comprised of a few "sub-variables" such as our 30 day Buy/Sell equilibrium Index, the 50 day Summation Indexes, the SI25s, the Quantifiers, the Aggregate Bullish Sentiment Indicator, and a 2-3 others that I do not wish to mention. The "fundamental" variable is comprised of the rate of change of few "sub-variables" as well, such us: ECRI's L.E.I., the "Help Wanted" index, the M.L. High- Yield Master II index, the I.S.M. Index, the Consumer Confidence index, and the Federal Funds futures. Based  on the current technical and fundamental conditions of the markets, this is what our model is forecasting:

The key thing in this forecast is the standard error. Notice that it stands at 20.5%. That is quite high, and makes the forecast suspect. The  forecast usually has a standard error of less than 5%. It basically means that developments in the geopolitical arena which can't be quantified, can and will affect the markets, in a way that can't be accurately anticipated. Having said that, it does give us a pretty accurate idea of what kind of returns investors should be expecting based upon the current technicals and fundamentals, ex -Iraq.  

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