(9-17-04) The indices  pulled back on Wednesday, and finished with the customary  rally into options expiration. Both the Dow and the SP  came pretty close to breaking out of their 8 month range, prompting super-bullish calls from many quarters. From our point of view the most bullish aspect of the market, is the fact that investors still remain skeptical. The total assets in the RYDEX bear funds are well above the levels that in the past have marked market tops. Of course, a "break-out" will undoubtedly  change that rather quickly. For our risk tolerance, we see no reason to increase our long exposure more than the 15% that it now stands. The strength of any rally, is measured by the weakness of its pullbacks, we want to see how deep the first pullback is going to be -there hasn't been any to speak of, as of yet- before we determine that an increase in our long exposure is warranted. 

(9-10-04) we said: For the fourth time this year the markets rallied back up to the top of the channel  that has contained  price movement. Will the markets be able to break out this time?, and if they do, will it be for real, or, will it be a head fake?  Take a good look at the SPX/VIX ratio shown in the chart below. Once again the ratio is up to the 80 level, which has defined every top since the inception of this indicator, with only one exception in August of 2000. Notice, that back then the ratio had challenged the 78 level six times, before it finally broke thru, and when it did, it marked a major top, the indices have yet to return to the levels they were at, in August of 2000. The ratio in recent months has bumped against the 80 level six times, it has been our experience that when  resistance, or, support levels keep getting challenged, eventually they are penetrated. Consequently, don't be surprised if this time around the ratio manages to get above the 80 level, with the SP rallying up to the 1135-1150 zone. However, if the past can serve as a guide to the future, the break-out will turn out to be synonymous with another  important top. Usually there is a small pullback, and then comes the final push. So, the most probable scenario for next week, would be a 1-2 day pullback, and then another push to the upside going into options expiration on Friday.  Overall, the current rally could conceivably last another 1-3 weeks and carry the SP to 1050, and NASDAQ to 1960, but  we do not believe they could go higher than that. Why? Because the two charts on the bottom are telling us, so. The fuel that keeps markets going is UP Volume, when Up Volume is expanding  it implies that demand for stocks is increasing, which results in higher prices. When UP volume keeps contracting, it implies that demand for stocks is contracting, and eventually it dries up altogether, which results in lower prices. The two charts below show  a 10, and 21 day moving average of the daily UP volume for NASDAQ, and the NYSE. Notice, that UP volume has been contracting continuously since the January high. We have no way of knowing, whether something will spark interest among investors,  causing them to put money in the market and thus, changing the current dynamics. However, what we do know with certainty is this: if  UP volume keeps contracting at the same rate as it has thru-out this year, it is only a matter of time before the equity markets run out of fuel and collapse. In other words, under  the current conditions any break-out,  more than likely will turn out to be a fake-out. We monitor this indicator on a daily basis, thus, we will bring it to your attention if any changes take place, implying a change in market conditions. As it stands right now,  under current conditions we estimate that NASDAQ may  have enough fuel left  to rally up to 1960, with the SP re-challenging the 1050 level, and that will be the best case scenario. For next week, our preferred action would be a pullback on Monday and Tuesday, to be followed by a rally that will carry into options expiration on Friday. If the markets do not act that way, we will re-evaluate based upon the way they do act!

(8-27-04)  The popular indices concluded a second week of price gains. In fact,  they have rallied 8 out of the last 11 trading, during which the Dow gained 3.75%, the SP500 gained 4.4%, and NASDAQ gained 5.5%. In studying the  price/volume data of the past 11 days, we can make two very interesting observations:

a) The pattern of the advance has been a "V" type, and

b) Volume has been shrinking on a daily basis. 

The charts of the DIA, SPY, MDY, and QQQ provide an excellent visual example of the negative correlation that we have witnessed between price and volume  during the rally of the past eleven days. Notice that the higher the price, the lesser the volume that accompanied the move. To give you an even more clear idea of the relationship that has prevailed over the last 11 days, we have posted a table under the charts listing the daily price gain/loss, the daily volume, and the percent change in volume from one day to the next for the two most popular ETFs, the SPY, and the QQQ. Notice that the SPY gained -on average- 0.40% per day, while at the same time, the accompanying volume -on average- shrank  4% per day. In the case of the QQQ, it gained -on average- 0.53%  per day, while volume -on average- shrank  3% per day. NO RALLY CAN  CONTINUE MUCH LONGER  AT THE CURRENT RATE OF DECREASE IN VOLUME ON  A DAILY BASIS. AT THIS RATE, IN 4 WEEKS, VOLUME FOR THE SPY WOULD BE ZERO! Sharp "V" shape advances that are accompanied by a consistently diminishing volume, are the  dominant characteristics of short covering rallies.  Before we continue further with our analysis, we need to make an important point:  not EVERY "V" shape advance, accompanied by shrinking volume is a short covering rally, however, EVERY short covering rally is "V" shaped, and  it  is accompanied by shrinking volume.  Moreover, a rally being born out of short covering, is not necessarily bearish, most rallies do start due to short covering. If  real buyers   step in and continue to buy  with conviction -after short sellers are done covering- then the  rally becomes a legitimate one, and usually turns out to be one of intermediate duration.  

Given what we just described, there are three scenarios that in our view can take place going forward.  

A) Since the current advance is displaying the characteristics of  a short-covering rally,  more than likely, that is what it will turn out to be. If that is the case, real buyers who are committed to the long side need to step up to the plate and begin buying, otherwise, once the short-sellers are done covering, in the absence of new buying interest, the rally will be abruptly aborted.  Our Buy/Sell Equilibrium Indexes are indicating that given  the current rate of short-covering, short-sellers will be done sometime  this week. Consequently, the indices may get -in the coming week- a  boost of 1.5% to 2.0%, courtesy of short sellers covering the remaining of their short positions. However,  unless real buyers come into the market after the holiday weekend and push prices higher,   1.5%-2.0%   is all, that the current rally has left in it under the existing circumstances.  NO RALLY CAN  CONTINUE MUCH LONGER  AT THE CURRENT RATE OF DECREASE IN VOLUME ON  A DAILY BASIS.

B) How about if  we are not dealing with a short-covering rally,  how about if the bulk of the  buying that we have witnessed the last 11 days  is from  real buyers, does that change anything?, does the  picture turn bullish? Actually, NO! If the action of the past eleven days reflects real buying, instead of short-covering, then the markets could be in deep trouble rather shortly. Why? Because, there are only two explanations for such low participation, either  a large number of traders/investors  haven't  return from their vacations, yet, or, almost everybody is already fully invested  expecting the  much advertised  but elusive election year  rally, and thus, there are very few -if any-  left to buy. If that is the case, then  the markets can experience a rather  large decline unfolding over the next 3-5 weeks.  NO RALLY CAN  CONTINUE MUCH LONGER  AT THE CURRENT RATE OF DECREASE IN VOLUME ON  A DAILY BASIS.

C) The third possible scenario -and the most bullish of the three- is that many  institutional/individual investors are still on vacation, thus, although the markets may pull back to support this week, the week after, when all these willing, ready and able buyers come back, they will provide the demand necessary to carry the markets higher into the election, or, even into  the end of the year.

From a return-to-risk point of view, the most ideal situation would be if the markets rallied another 1.5%-2% and then they  reversed, in that case we would be willing to short the markets heavily. We would not be interested in the long side, unless we saw the indices rallying on increased volume, we would like to see daily volume exceeding by 10%-15%  its 45 day moving average, in order to  warm up to the long side.

We are still operating under the assumption that scenario#2, which we presented 3 weeks ago  is currently   playing   out (see chart at the bottom of this page)

(8-20-04)Last week   we mentioned that "... Never-the-less, given that the level of  total assets for the RYDEX bear funds, is where it is at, it is only prudent to contemplate the possibility of a sharp short covering rally, that can start at any time, for whatever silly reason, in which case you don't want to be caught with newly open short positions, because more than likely you'll be forced to cover them at a loss.  If you already have previously opened short positions, use tight stops in order to  lock in your profits."  We got a sharp bounce that accomplished two things a) brought the McClellan Oscillators to the top of their range, and b) it brought the Quantifiers to the zero line which is the demarcation point between dead cat bounces within a downtrend, and sustainable rallies.  At this point, the odds favor  a pullback. However,  a termination of the rally all together is still in the cards, as long as the Quantifiers can't penetrate the zero line decisively. The nature, and, the severity of any pullback, will give us the data needed to determine whether the current rally is for real, or, a dead cat bounce. We enter next week with a NEUTRAL bias.

(8-13-04) The technical indicators are back at the bottom of their range , as they  were on 7-23-04, while  the major indices are lower, in the tune of 1.4% for the  Dow,  1.5% for the SP500,  5.4% for NASDAQ%, 3.4% for the Mid-Caps, and 4.2% for the Russell 2000.  In other words, despite that "technically" the markets were at levels that in the previous 15 months had attracted buyers, the last time around that wasn't the case. From the  inflows/outflows comparison charts below, we can see that every bottom that took place the last few months, was accompanied by  increased  selling, by  higher level of outflows, which in the latest case, exceeded inflows by such margin, that neutralized almost immediately the anemic buying that came in, resulting   in a  failed 5 day rally, which took the indices between 2% to 3.2% higher, before they turned back down again. The obvious question now is, are we going to have a repeat of what happened two weeks ago, or, selling has been exhausted, and thus, buying pressure will be the primary force behind the markets' move,  resulting in a sustainable and successful rally?  Judging from the inflows/outflows comparison chart, we see no reason to believe that such a thing is about to happen. As we can see very clearly, selling has been expanding, and buying has been contracting as prices erode further. If  outflows had been contracting as price made lower lows, then we would have a a clear indication that selling is being exhausted, and thus, buyers would soon have the upper hand.  Currently, this is not the case, it doesn't mean it won't change in the coming days, or weeks, it simply means that it hasn't changed as of now, consequently, the odds are better than even that the indices will continue lower, or, if they stage another rally under the current circumstances, it will fail as well. If the markets were to continue lower from their closing levels on Friday, we wouldn't expect to see any signs of selling exhaustion until l they reached the second downside targets (see table below). On the other hand, if they did have another dead cat bounce  that starts between current support and the first downside targets, then we would look for  signs of failure around the 1845 level for NASDAQ, and 1088 for the SP500(see charts below) Both these levels represent  formidable double resistance, any  buying due to short covering alone, won't be enough to carry these two indices above  that resistance. So, if the indices continue lower to the second downside targets, we would look for reasons to be buyers, if they rebounded between current levels and the first downside targets, we would look  for the rebound to fail at the levels we mentioned, and at that point we would be selling short. We suspect, that any rebound which takes place between current levels and the first downside targets, not only can get ignited at  anytime, but also it can be pretty sharp and fast, even if it ultimately fails. The reasons for our suspicion, and trepidation can be found in the current levels of the RYDEX bear funds (see chart below) Notice that as of Friday the total assets in the RYDEX bear funds, reached an old-time high, and exceeded the levels seeing back at the March lows of 2003. Of course, if the market has indeed changed "character" from bullish to bearish, not only we can't expect another rally similar to what we got from the  March '03 lows, but also, it may take another 10%-15% increase in the level of total assets, before we even get a short covering rally. Never-the-less, given that the level of  total assets for the RYDEX bear funds, is where it is at, it is only prudent to contemplate the possibility of a sharp short covering rally, that can start at any time, for whatever silly reason, in which case you don't want to be caught with newly open short positions, because more than likely you'll be forced to cover them at a loss.  If you already have previously opened short positions, use tight stops in order to  lock in your profits. Last but not least, we would like to discuss our  thoughts about the state of the markets, beyond next week's action, which in the larger scheme of things may actually be totally insignificant. Our  approach towards trading/investing has never been guided by our desire not to "miss the next big move"  which we think  might be  coming. Instead, we have always been concerned about that  big move  which may come, and it may not miss us!  Along these lines of thinking, we want to point something out to you that is really bothering us, and if it was to materialize, we definitely want to make sure it misses us! As we pointed out to you in previous reports -courtesy of our good friend, Mr. Carl Swenlin, and http://decisionpoint.com - the equity markets appear that they had been  paying NO ATTENTION to the rise in the price of oil, until it  exceeded $35.00 per barrel. However, as the chart below illustrates  very clearly, since March of 2004 short-term tops in oil prices have coincided with short-term bottoms in the equity markets and vice versa. In fact the message from this chart is -in our view- that the equity markets find oil prices, irrelative  as long as they stay below $35.00 per barrel, but $35.00 per barrel is the current "line in the sand"  and if it is above it, then  oil  becomes very relative to the market, and much to its concern!  As of Friday, the  price of West Texas Intermediate  closed  at $46.58, and it is our  belief that it will reach at least $47.50. We don't think equities  will make much progress with oil at these levels. Moreover, there is the possibility that due to some exogenous event it will rally up to channel resistance  (see chart on page 2)which comes around $54-$55, and if that was to happen, then we can expect equities to take some additional heat, and perhaps a whole a lot of heat. Such an outcome, wouldn't come as surprise to us, or, to anybody else, because almost everyone now is expecting oil prices to go to the moon, and oil has been declared as public enemy#1. If you look at major declines that were followed by major rallies, you'll see that in most cases, the equity markets had been declining for some time, and then something exogenous took place that caused the final cathartic plunge, like what happened after September 11th. So, if oil prices suddenly spike up, and the equity markets take a dive, it may get ugly, but once it is over, the markets should rally strongly. What is bothering to us, is that we hear this scenario from many market participants, it seems to us that many investors have come to "expect" and even bet on such outcome. Unfortunately, the market is seldom accommodating. Therefore, what we are afraid that may happen, is that if oil prices  approach $50.00 per barrel,  the public's  outcry, for the government to "do  something"   combined with  the President's desire to get re-elected, will result in the the release of oil from the strategic oil reserves. Such move, will have NO impact what-so-ever in the intermediate term, but it will have great impact in the very short term. Last time something like that took place was during the Presidency of Bush Sr., and oil prices dropped $10.00 in one day! Given that oil is blamed for the economy's lackluster performance lately, and for the  malaise that has befallen the equity markets, a sudden drop in oil prices -even if it temporary- will  ignite a very powerful rally on Wall Street. If such event took place, it will be very painful for any investor/trader who finds himself/herself on the wrong side, because the markets will move with the speed of light, and there will be no time to get out of  wrong sided positions without substantial losses. So, the point we wish to make to you is this; yes, oil can spike up to $50-$55 per barrel, and that would cause the equity markets to sink further. However, in an election year, you should expect the government to try to show that it is doing something about the situation, and the only available tool the government has, is the oil strategic reserves. Any announcement that oil will be made available from the reserves, will sink the price of oil, and it will cause equities to temporarily skyrocket, and if we are short, we can lose mightily, and we definitely want something like that to miss us! So, in our opinion, if oil continued higher, the prudent think to do would be to scale down short positions, instead of adding up, betting on a crash. The odds for government intervention, are a lot higher than the odds for a market crash over the next 2-3 weeks. We have had 2 crashes in 75 years, we have had dozens of government interventions during the same time, so, what do you think is more probable?  The market has taught us to watch out for  the least-expected, most people  are expecting high oil prices to cause a substantial decline in equities, it COULD HAPPEN, we're not saying that it won't, but how about if the opposite happens? How are you going to be prepared? Hopefully, you'll find our thoughts on the subject  insightful, and helpful in developing  your game plan with regards to your investing/trading.

(8-6-04) Unfortunately for the bullish camp, higher oil prices, and weak economic data, drove prices lower, placing all indices squarely into negative territory for the year. In our view, going forward there are two developments that are worth paying attention to:

a) For the first time since March of 2003, the indices failed to respond to a positive divergence, and instead reacted to a negative divergence. In addition, the Quantifier turned down after making contact with the zero line (see charts below) This type of behavior is seen in bear markets. It is premature to conclude that the bear is back, but it is wise to consider the possibility, which means long positions taken on any rebound, ought to be limited in size. Moreover, it makes more sense to look for rallies to short, than for bottoms to buy.

b) The RYDEX bear asset level, is at the point from where in the past two years we got bounces, thus, another one may be in the offing this week.

When we put it all together, our assessment is that the markets will probably stage a rebound starting between current levels and the first downside targets. However, such rally ought to be used to lighten up on long positions, and/or, to  sell short. 

(7-30-04) All the major indices rallied and in terms of price they finished the  week very near the first resistance levels, while in terms of underlying strength, they are at a pivotal point, from  which either the move will accelerate, or, it will fizzle out. Look at the 4 charts below for NASDAQ -the same holds true for the SP, and the Dow- internally it is at the same point it was on 5-21-04. Back in May, within a couple of days after reaching this pivotal point, the indices accelerated to the upside and they continued to rally until 6-30-04. Consequently, if we get a similar acceleration and the indices close above the first upside targets, then in all likelihood the rally will continue for another 2-3 weeks. On the other hand, if they roll over here, then the odds are better than even that they will take out support and head towards the first downside targets. 

Therefore, for next week  we have three  scenarios to consider with regards to the  price action  that is most probable. (see NASDAQ, and SP charts below)

Scenario#1: The indices overcome resistance (see table below)  and accelerate to the upside  reaching the first upside targets by the end of the week.

Scenario#2. The indices are unable to overcome resistance, they roll over take out support, and reach the first downside targets by the end of the week.

Scenario#3 The indices make one failed attempt to overcome resistance, they turn back down but support holds, in that case they turn back up, and in their second attempt they are able to take out resistance and accelerate towards the first upside targets.

(7-23-04) The markets  tried to bounce twice last week, but both attempts lasted just one day, and the next day they were followed by downside reversals that took out the previous day's lows. In doing so, all the major indices have  come even closer to channel support (see charts on page 1), while technically we are seeing the same type of positive divergences that since the beginning of the year have preceded rallies back up to channel resistance. The obvious question is -once again- are the markets going to  take advantage of the positive divergences, and rally from channel support like they did in March, and in May?  The markets train people to expect the same, and once they become confident that history will repeat itself, the markets change direction!  Going forward then we  have three different possible outcomes:

a) The markets react as they did the previous two times  when we had a similar combination of channel support, and positive technical divergences. They  stage a fast rally from channel support, back up to channel resistance. In such case we would expect the major indices to mount a powerful reversal between Friday's closing prices and no lower than the second downside targets -with the exception of NASDAQ which needs to stay above 1780. If channel support holds, position traders can open a 25%-30% long position, and add to it,  in 25% to 30% increments as the indices overcome their first two resistance levels. 

b) The markets  bounce from channel support, but they are unable to rally back up to channel resistance, they fail at the .50, or, .618 Fibonacci re-tracement levels,  then  they turn back down and this time they take out channel support. In this case, things will start off as in the previous one, but the rally will fail. Consequently, if you are long, and the markets  have a tough time moving above the 0.50, or,  the  .618 Fibonacci re-tracement levels,  take profits in the long positions, or, place some very tight stops, and be ready to go short on the break down from channel support.

 c) The markets are completely unable to take advantage of the positive divergences, and they go right thru channel support. If that happens  and the move is for real and not a bear trap, it would imply that the glorious  bull market of 2003-2004, has come to an end.  If the markets break down from channel support (that's the second downside target for Dow and the SP, and current support for NASDAQ) do not go short. The markets are already quite oversold, and there is always a   chance the break-down is a bear trap, which means  as soon as you are committed to the short side, the markets  will  turn around, and you'll be forced to cover at a loss. If the markets break down, and the break is for real, that means over the next 2-3 weeks we'll have a bounce back up to the break-down point. When the indices fail to get back into the channel, THAT WOULD BE  THE TIME TO SHORT and position yourself to benefit from the resumption of the bear market.

(7-16-04) The technical weakness manifested itself, last week,  in yet lower prices, despite the  usual bullish bias during options expiration week. At this point, given that several indicators are near the bottom of their range, a bounce can take place at any time. However, the first rally will be -in our view- a dead cat bounce, and nothing more than that. In fact we are seeing the positive divergences that usually precede a turn around in price. However, sentiment remains exuberantly bullish in the face of poor price action, and unless we see some real fear in the market, we see no reason to be optimistic.

(7-10-04)  You probably recall that in the Weekly report for week ending 6-25-04, we gave you three possible scenarios with regards to what we thought could develop over the next 2 weeks. It turned out that scenario#1  took place, and as it stands right now, the SP is at support. From here we may see an additional decline with a magnitude of no more than 2.5%-3.0%, or, the SP -just like the rest of the indices, could turn back up again and try to re-test the previous resistance. Given that all indicators  are below zero, the odds favor  more the former than the latter. However, given that next week is options' expiration which tend to have a bullish bias, we wouldn't be surprised at all to see a choppy rally instead, even if the odds are  in favor of more price weakness. Use the support/resistance levels listed on the table below for your entry/exit points, but limit the size of your bets in order to  control  risk better in a choppy market.