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[TTHQ Staff]

One of the functions of a correction is to alleviate the over zealous sentiment that develops during a rally. To this end the decline failed miserably as we are only one week into a rally and we already have a chorus of calls that the correction is over and its up and away again. Granted, the rally was in some respects strong but to see the shift so dramatically over a one week rally does give one pause to be concerned. What became of that proverbial "Wall of Worry" that would set the stage for a strong and prolonged move. During the 1990's bull market corrections would do exactly that, set up enough fear to produce the degree of skepticism necessary to allow for the kind of strength and persistency we saw at that time. It was not until the latter stages of the 1990's that we began to see the kind of euphoria that set in to produce a trop of the magnitude that we saw in late 1999/early 2000. It seems to us that the pre 2000 investor psyche and expectations have not been quashed. To the contrary, they are alive and well. It is obvious that the biggest bear market in 70 years in the S&P failed miserably to eliminate the mentality that prevailed during the latter part of the 1990's. Two weeks ago for example, the American Association of Individual Investors (AAII) reported 31% bulls and 44% bears. The first week since early April that there were more bears than bulls. This was a step in the right direction. However, one week later we had 55% bulls and 22% bears, the worst bull/bear ratio since the week of March 5. Coming off the early April low it took three-weeks before this survey reached levels as it did last week only one week off the low. We are seeing similar, although not nearly as negative readings from the put to call ratios. Here at least the 10-day averages are only neutral but the last week has seen a sharp drop in both the CBOE and equity ratios on a daily basis with most sessions at or near bearish levels. The sharp drop on both Thursday and Friday last week does indicate that the big spike on Wednesday was likely due to last minute end of quarter activity ands not a change in investors attitude. The sentiment composite meanwhile showed no improvement during the decline and at +6 is quite bearish. Insiders continue to sell and at a very hefty pace. While the 8-week moving average has eased slightly from 33 year highs it is still near the top end of that level. We heard the argument last summer that this is just pent up demand from options that were underwater no longer. That may have been a partial answer back then but the selling has continued unabated for months on end. Moreover, the selling is not concentrated in one or two sectors such as technology, a sector that does have a considerable amount of options. No it is broad based across the board selling that has been going on for close to 10 months. The 8-week moving average has been above 5 .00 since early October or nearly six months. The other function of a correction is to relieve an overbought condition. To this end the decline was successful to a large degree and in fact produced a deeply oversold condition. This has been completely or nearly completely reversed the past week as most all of our short-term and primary momentum indicators have moved to overbought. And herein lies the problem as that overbought condition is not a strong overbought reading that would indicate a momentum thrust. Instead what we have so far is only a modest or even weak overbought condition. Today does have very low takeaway numbers that can push both the breadth and volume oscillators to thrust type readings. Whether that will occur in the McClellan oscillator and McClellan volume oscillator we cannot know until Monday's close. However, our experience in these signals has been that the truly strong thrust signals occur with both sets of indicators confirming. A failure by both of the McClellan indicators to follow suit would suggests that the signal was more a function of math rather than a function of a true initiation signal. At the same time, this does not mean to ignore the signal as it would need to be respected. Meanwhile, the short-term volume oscillators and the 3-day oscillator have turned down the past two to three says in spite of the rally and have moved to sell alert signals. Volume did expand a bit on Thursday and Friday as the rally progressed. This broke a string of negative price/volume patterns that was in place for the better part of the post March 24 rally. Expanding volume on a rally is usually viewed as a plus as it represents increased demand. However, volume can and often is a difficult beast to analyze. When a rally begins on low volume and then volume expands later it can just as often mark a reversal as it can a confirmation as it can also indicate an increase in selling as well as increased demand. Moreover in the beginning of a true initiation move volume tens to be very high the first couple of days of the rally. The reversal days of both July 24 and October 10 of 2002 occurred on big volume and we also had decent volume coming off the March 2003 low. However, in that regard volume was not that great. It did increase at the March 21 short-term top. The current volume is decent but not at thrust type levels nor at blow off type levels either. That said we see the key to late last week's volume as to what we see early this coming week. As impressive as the rally has been we do not see much if any evidence that it is much more than a counter trend rally related to the post March 5 decline for the S&P. The oversold condition is not only corrected but in most cases reversed and sentiment has moved from bearish/ neutral to bearish. There are of course some exceptions but that is always the case as it is rare if not impossible to have all the indicators lined up in the same direction. The favorable seasonal period is nearly behind us but could allow for some modest gains early this week. That said it appears that the counter trend rally is likely in its final stages and that the post March 5 decline is ready to reassert itself. Of course that could change with a very strong surge early this week. However, given the current position of the indicators and wave structure we are moving back to bearish short-term with a stop of 1155 on the S&P. Medium and long-term we remain bearish.