AEGEANCAPITAL

WEEKLY COMMENTARY Q4-2002

(12-27-02) The SP was unable to overcome resistance at the 912-915 zone and it ended up closing at 875 for the week, disappointing and surprising those who were counting on the "traditional year end rally." For several weeks we have pointed out that the U.S. equities markets will NOT be able to withstand a simultaneous decline in the dollar and a rise in oil prices. Look at the charts displayed on the left, they illustrate the point crystal clear. It is important to keep in mind that the reasons behind the dollar's decline and oil's rise are not going to go away any time soon. Thus, for the intermediate term the environment continues to be negative for U.S. stocks. This is also confirmed by the fact that ALL of our indicators have fallen below zero. Moreover, although our indicators are negative, they are still not at levels from where we

(12-20-02) As we had expected we got the lower prices early in the week, with a recovery rally starting late on Thursday that carried into the close on Friday. In the mean time all the intermediate term indicators have turned down. Moreover, the markets the last two weeks have acted the same way they did during the 9th and 10th week, following the bottom in April of 2001. In the November newsletter, we pointed out the similarities between the rally from the October lows, and the previous two rallies, from the April lows of 2001, and the September lows of 2001. So, far this rally has followed more closely the pattern of the rally from the April 2001 lows. In addition, we see the junk that lead the current rally -such as JDSU, SUNW, etc- already having broken down severely, just like they did in June of 2001. Thus, the evidence suggests that the rally is more likely over. We may get a short-term pop due to the "positive seasonality" but a) we would not bet the farm on it, and b) we would use such rally to lighten up on long positions, and/or, to add to shorts. For short positions, we would target stocks that have broken down, and after rallying into resistance they turn down again. Going into next week, we would watch closely the 912 level in the SP. If the SP can close above 912, then we should see more rally into the 925-933 zone. Judging from historical patterns, if the much anticipated "year end rally" is going to take place, then Monday could be a down day, with the upside action starting on Tuesday and continuing Thursday into the following week. In any case, keep in mind that as long as the SP remains unable to close above 912, then it can fall to 855-870.

(12-13-02) In November's newsletter we said:

"If the rally is going to end in the next few days, then two things will take place inevitably, a) the SP will close below 885, and then when it attempts to rally, it will make a lower high, at the same time, our Quantifiers, Trend Indicators, and BSEs will turn negative.

On the other hand, if it is going to rally, then then we should see one more pullback, but the SP will not close below 895, while at the same time, our Quantifiers, Trend Indicators, and BSEs will remain positive, and the Thrust Oscillator will have a positive cross over. At that point we'll open a 30% long position with a stop at 892."

This past week the SP ended at 889, just 4 points above the 885 threshold, however, ALL of our indicators have turned decisively negative, which means the internals have deteriorated enough to warrant a change in the intermediate trend. Thus, we see any rally that develops out of the current decline as a superb opportunity to go short. Going into next week, the odds favor lower prices early in the week but a reversal later on as the short term indicators -10, 20 day SIs, McClellan Oscillators- get into oversold territory. One thing to keep in mind is that despite that the McClellan Volume Oscillator for NASDAQ exceeded its October lows, NASDAQ was unable to mount any sort of a rally this past week, which is indicative of a weak market that can easily run into more trouble. In our view, people should be prepared for the possibility that surprises may come on the downside, instead of the upside.

(12-6-02) On 10-26-02 the SP was at 897, it had advanced 130 points from its lows two weeks earlier, while none of our indicators had confirmed the advance. At that time, we said that given the divergences that had taken place, it would be statistically improbable to get additional gains in excess of 6%-6.5% without a significant correction first. The SP managed to go to 954, which was 6.46% above the 897 level. Our research has shown that once those gains -which were built in sand/divergences- are achieved, 100% of the time they are immediately given up in their entirety. That is why as the SP appeared to be closing in on the 955 level, we made last week the comment that "... we are very close to a 4%-7% correction and perhaps even more than that..." The SP fell from a high of 954 on Monday, to a low of 894 on Friday, thus giving up all of the gains that were built on divergences. The question is what happens now. Our research has shown that in the last 15 years for which we have complete data available for input in our models, 72% of the time the initial decline was halted at 7%. The lows of 894 on Friday represent a 6% decline, thus there might be one more percentage point down risk from the Friday lows. Assuming, Friday was the low, we should rally for about 3-5 trading days. Sixty two percent of the time the bounce is between 3% to 4.5%, which means we should expect the SP to rally to the 924-935 zone. (30% of the time the bounce has ranged between 4.5% and 7%)

Twenty five percent of the time, the initial decline ranged between 7% and 9%, which means 1:3 odds that Friday was not the low, and we can see an additional decline to 870, before we get a bounce. Clearly the odds 1:3 favor a bounce without further decline, thus we have to go with the odds, of course keeping in mind that favorable odds, does not mean 100% certainty.

The real important thing to keep in mind is that after this bounce -whether it comes from the Friday lows, or, even lower- is that it will be followed by a much more substantial decline. Thus, we can play the long side with 30%-40% for now, but we should be ready to move to 100% short, once this bounce is over, which is what we also said in discussing trading strategy in our latest newsletter. Notice that:

1) momentum has topped.

2) the 21 day EMA of the put/call ratio is in the vicinity that has marked important intermediate term tops, which have been followed by substantial declines, and finally

3) the market came under pressure, not because of "healthy profit taking" as the morons were proclaiming on Bubble TV. The markets came under pressure due to a simultaneous hit by higher oil prices, and a lower dollar. We have said several times, that the U.S. equity markets will decline when oil prices rise and the dollar falls. As long as, this combined trend stays in place, the markets will be under pressure. We expect this trend to stay in place, as long as, war with Iraq is a real possibility, and the U.S. keeps running huge current account deficits, while the economy is deteriorating.

So, for next week we will go with the idea that the odds favor a further advance to the 924-935 level, and maybe even back to the 955 level. We know that there are 1:3 odds that maybe Friday we did not have a short term low and further decline is possible. If on Monday the SP rallies in the morning but it is unable to get thru the 918-924 zone and it turns back down, then it will be a good idea to exit long positions, because the short term low may come below Friday's lows. On the other hand, if the SP falls early in the morning and rallies above the 918-924 zone later in the day, then the odds will increase that Friday was a short term low and we should see higher prices for the next 3-5 days. In that case stick with the long positions and exit on Thursday, or, Friday.

On another note, in an interview that Mr. Iossif gave on 11-16-02, he mentioned that going forward he was planning to build intermediate term positions in gold, defense and oil stocks over the coming weeks. Our gold position is nearly complete with the purchase of AU on Tuesday, we will be adding AEM and GG in any pullbacks. With our purchase of CVX, OXY and SII, our oil position is half built, we will be adding COP, UPL, and RD, in any pullback. We will begin building our position in defense stocks shortly starting with NOC and ATK. Notice that gold stocks broke above resistance, oil service and integrated oil stocks are completing bases and about to break out, while defense stocks are about 2 weeks away from completing bases. (See your emails, and your message box under the "USER" tab in the upper right corner)

(11-29-02)Once again we have mixed signals from a short week which tends to be notoriously unreliable with regards to the validity of the signals. Judging from the divergences that have continued unabated, our opinion is that we are very close to a 4%-7% correction and perhaps even more than that. Notice that all the short-term indicators have turned down, while the intermediate term ones, are still pointing up. That means we should see price weakness near term, followed by another advance. Going into next week, we are looking for a "split" action. Either an advance Monday and Tuesday, followed by lower prices into Friday, or, a pullback Monday thru Wednesday, followed by higher prices into Friday. Our belief is that the second scenario is the most likely to occur.

(11-15-02) After four weeks of wild intra-day gyrations the Dow is up 3%, the SP is up 2.9%, and the NDX which sports a p/e of 48 with very little prospects of earnings growth, is up 9.8%. At the same time every single indicator we use to gauge the market's health has diverged rather negatively, while the TIs and the Quantifiers have stayed positive. What does all that imply: In our view it implies the following: a) since the TIs and the Quantifiers are positive, the markets can still move higher in the tune of 6%, b) given the steep divergences that are in place, the upside potential is not only limited (6%) but also the return-to-risk ratio on the long side is un-appealing.

The last time we had a similar combination of developments, was during the rally off the lows of March '01, which ended with the spectacular decline in September of that year. Notice the similarities between NASDAQ's recent rally and the rally from the lows of March '01. Notice the similarity in the divergences in the BSE between now and then, the action is almost identical. (Click here to read our comments back then) We have a rally led by technology alone, unconfirmed by both technicals and fundamentals, going into a period of increased geopolitical tension ( Iraq has until December 8th to reveal its WMD arsenal, and it is already saying that it has none, when the Administration states otherwise)

It became rather fashionable in the 90s for the average investor not to want to be bothered by the facts. We hope that our subscribers are not average, or typical, and they are concerned with the facts when making decisions. Let us share something with you, which you will be able to see first hand as soon as we resolve the technical problems between our platform and Schwab's, so the portfolio page will again go live. As you know, our favorite strategy is to go both short and long, in order to profit from the difference in relative strength between shorts and longs, while assuming a neutral market position. In the past four weeks, we have gotten stopped out of our long positions -due to the wild intra day gyrations- a lot more often, than we have out of our short positions. In fact, it has been much costlier to be long the SPY, or, the DIA, than to be outright short! Why? Because the intra-day volatility has exceeded the entire net gains made by the indices for the last four weeks. Is that what one would expect in the middle of a "cyclical bull move" as some of our colleagues believe? In all respect, we do not think so. The last time we had a similar situation was in May of '01, and the "new bull market" ended in flames just three months later. Let us be clear: the markets can move higher, but the return-to-risk ratio is not one associated with bull moves, thus, investors need to keep this important little fact in mind when making decisions.

(11-8-02) The markets tried to move higher, but they were unable to do so. They reversed and finished the week right at support. In our view, either the markets are in the process of consolidating their recent gains, before they move higher, OR, the rally from the October lows is OVER. If the markets hold at current support, or, they even hold at a bit lower (DJIA:8198, SP:867, NASDAQ:1278) while our indicators stay positive, that should be a sign that the rally is of intermediate term, and we should expect another leg up, equaling, or, even exceeding the gains of the first leg. At this point we do not have any factual evidence -yet- to conclude that the rally is over, or, it is just consolidating. HOWEVER, what we do know with certainty, is that the fate of the rally lies in the dollar and oil prices. We do not see how investors can expect another leg on the upside, if oil prices begin to move higher, while the dollar moves simultaneously lower. It could be that the dollar finds support at 103.5, and oil breaks down, both such developments would be very positive for equities, our fear is that neither will happen. (Mr. Iossif will explain tomorrow in a lengthy interview why we suspect, neither will happen) Thus, investors need to pay attention a) the price of oil, b) the dollar and c) the following support and resistance levels:

(11-1-02) As we explained thru-out this report, both the charts and the indicators we follow are telling us the same thing: the markets are at an important juncture. They can have a blow-off type of a move that will mark the termination of the rally -as has happened with every other short term bear market rally, OR, they can consolidate within a 5%-7% range and then mount another leg up which should carry them higher until the end of the year. This coming week we should get a good indication whether we should mortgage our overvalued house and go long stocks for the next 8-12 weeks, or, we should short the heck out of the market.Given that we have elections and the FOMC meeting, this coming week has the potential to be very volatile. We highly advise not to make major moves until after Wednesday, when we can see how the dollar is reacting to whatever election results and FOMC decision have taken place.

(10-18-02)As you recall, in our weekly report for week ending 10-4-02 we said: " However, given that most of them are near the bottom of their range, we should also expect a tradeable bounce. If the indices make contact with the downside targets listed in the table, we should get at least a 10%-15% bounce... In any case, a tradeable bounce will come from lower levels than the ones the markets closed at on Friday." As it turnd out, the markets did make a lower low by Thursday of the following week, and since then they have rallied nearly 15%, pressing upon us the big question: "is this an intermediate term rally?" Our intermediate term model says not yet! Let's examine why. Our intermediate term model is designed to compare current reading with similar ones over the past 15 years, and by assigning higher weight to the most recent outcomes -since outcomes of a year ago are more relevant to outcomes of 10 years ago- it determines a probability for both a bullish and a bearish case going forward. It's the ratio between these two probabilities that determine the risk to return ratio in either being short, or, long. (If you are new subscriber you may want to check out these tutorials about timing the market on a return to risk ratio basis: http://aegeancapital.com/freeservices/tutorials/timing1/pg1.htm

http://aegeancapital.com/freeservices/tutorials/mt1.asx )

Remarkably, although our short-term model indicated a 10%-15% rally, our intermediate term model has yet to even turn neutral! Some of you may wonder why. Here are the reasons why, and intermediate term investors will be served well to pay attention to:

Notice the similarities -so far- between not only the pattern of the current rally, and the pattern of the rally from the March lows, but also, the similarities between the pattern of the decline that led to the March low, and the pattern of the decline that led to the October low! Of course the similarity in patterns does not automatically mean this rally will fail as well. First of all, now the market is lot lower than it was back in March. Second, the October-April period is "seasonally favorable" while the March-October period is seasonally unfavorable. Third, the much anticipated 4 year cycle low is supposed to arrive in October. All the above are positives, however, they are negated by the following: First, liquidity is a lot less now than it was back in March. Mutual funds entered the month of September with an all time low ratio of cash to assets, and then lost another 12 billion during that month. In fact, mutual funds continued to experience net outflows even as the rally roared ahead last week. So, there is no real liquidity to push the market significantly higher. Notice that volume decreased in NASDAQ, NYSE, SPY and QQQ as the markets advanced. If investors are really buying, why is volume shrinking? Second, the market rallied, while fundamentals are getting worse. There is no sign that the recent slowdown is abating. Every piece of data that has come in confirms that the slowdown both in the economy and in corporate earnings is accelerating. The market does bottom before earnings and the economy begin to accelerate on the upside. However,

it has never bottomed while they are accelerating on the downside! The ECRI weekly leading index (WLI) is down this past week to
the lowest level since last November and its six-month trend is down
which suggests a decline in economic activity ahead. The semiconductor book-to-bill ratio showed a decline greater than any prior two-month period over the past 7 years, yet the SOX index was among the best performing this past week. Third, neither the dollar, nor, credit spreads improved in a manner commensurate with the advance in the equities markets. Fourth, the geopolitical situation is much worse now than it was back in March. we are 2-3 months away from war, and terrorist activity is peaking up. Fifth, the markets continued to go lower from October of 2000 to April of 2001, despite the favorable seasonality that supposedly exists between October and March. All in all, our intermediate term model weights the positives with the negatives and the seem to cancel each other out, which leaves us with the chart pattern that happens to be almost identical to the one back in March, which turned out to be a 15% bear market rally and nothing more than that. Thus at this point, the market -on an intermediate term basis- is guilty until proven innocent! Also, those who have been subscribers prior to March 2002, certainly recall that back in March, everyone and their mother was again screaming "bottom!" We were among the very few who suggested that investors should wait for confirmation before they jump in, a suggestion that served them well. Based upon our intermediate term model, we are simply saying the same thing now. If the market pulls back and holds at support, then we will have something to be bullish about for several weeks, and we should be long. It amazes us, that despite the huge losses investors have endured over the past 2 1/2 years, they are ready to "kiss and make up" with the market after 6 days of a rally that has no confirmation from either the technicals, or, the fundamentals. Speaking about fundamentals, investors got all excited about the "good earnings" from IBM, and Citigroup. For next week our indicators are suggesting that we should be looking for a pullback, which for us will clear -at least the technical picture. If the market pulls back and it holds at support, then we will have technical confirmation that the rally will last more than six days, and it will exceed the 10%-15% range that our short-term model predicted back on 10-4-02. Obviously, in such case we should go long with stops below support. Ideally, we would like to see one more higher close on Monday, and then a decline Tuesday thru Thursday.

(10-11-02) The markets did head straight down early in the week, and then bounced strongly. Obviously it was a tradeable bounce which may have another 5% left in it. The big question is whether on Thursday of last week we saw an intermediate term bottom. We do not think so. Between Thursday and Friday we received 17 emails/calls from colleagues who had turned staunchly bullish, proclaiming a bottom of significance. It has been our observation over the years that bottoms of significance do not take place when every one and their mother is screaming "bottom, bottom!" If this turns out to be an intermediate term bottom, it will be the most anticipated, and immediately accepted bottom in the history of market bottoms!. Our indicators suggest that we may see a couple of more consecutive days of higher prices, followed by a sell off. How steep that sell-ff turns out to be will tell us whether Thursday's bottom was an intermediate term one or not. Keep in mind that the markets are still in an intermediate term down trend as long as NASDAQ remains below 1260, the SP remains below 870, and the Dow remains below 8400. For next week, we can expect the markets to rally either rally early on -Monday and Tuesday- towards these levels and then turn violently down, OR, pull back on Monday and Tuesday and then rally towards these levels going into Friday. We would like to show you a couple of intra-day charts going back 90 days. The 100 hour upper volatility bands always present a formidable obstacle to any rally. At best the markets consolidate right around the upper 100 hour volatility band for 10-15 hours before moving higher, or, the rally runs out of steam completely. The 100 hour upper volatility band comes for the SP at 860-862, and for NASDAQ at 1240-1245. If the markets rally straight up to these levels by Tuesday, they should be shorted. On the other hand, if we have the pullback early in the week, then they should rally towards these levels by the end of the week. In such case, entry points will be between 1160 and 1170 for NASDAQ, and between 800 and 820 for the SP500.

(10-4-02) We got the short bounce we were expecting in the form of another one day wonder rally, which gave way to lower prices as the indicators were implying. Looking forward to next week, we must conclude that since all of our indicators are still pointing down, we should get lower prices. However, given that most of them are near the bottom of their range, we should also expect a tradeable bounce. If the indices make contact with the downside targets listed in the table, we should get at least a 10%-15% bounce. In our opinion we got two possible scenarios for next week, either the markets head straight down to our downside targets and then we get a rally, or, they have another feeble bounce early in the week, and then they turn down by Wednesday closing near our downside by Friday.