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[TTHQ Staff]

Over the past several weeks our major theme has been that the May lows would have to be broken before the market had a chance to set up for a sustainable rally. In fact we had said this so many times that we were getting tired of hearing it ourselves so we can just imagine how tired you, our readers were of hearing it. The break of the May low did finally occur on August 6 for the S&P and the DJIA joining the NASDAQ which had moved below its May low back in July. This has left us with some interesting readings from a number of indicators.

The move to new lows has, as we had suspected it would, lead to some solid improvement in some important sentiment indicators. The volatility indexes, the 10-day moving averages of both the CBOE and Equity put to call ratios and the Rydex data are at or near the same levels they had reached at both the March and May lows. These led to fairly good rallies. However, the key in both cases is that these rallies were only counter trend affairs and both were followed by moves to lower lows. The fact that they are only back to the levels seen at the March and May low while price is lower is also a bit of a concern as it suggests that although the averages are lower the amount of fear that the lower lows generated is not that deep. We are seeing similar readings from some of the longer-term indicators as well. The one survey that is showing bullish signs is Consensus Inc. The 4-week moving average is at its lowest and best readings since late March of last year. However, while we have seen improvement in the other sentiment polls such as Investors Intelligence and The American Association of Individual Investors neither have come close to to levels that could be construed as bullish. The AAII survey is neutral and we have seen mote bears than bulls the past few weeks. However, our key longer-term measure of this survey, the 10-week moving average of the bulls divided by bulls plus bears remains at bearish levels. This is also the case with the Investors intelligence survey. In spite of its recent improvement we still have nearly twice as many bulls as bears. Here too the 10-week moving average of bulls divided by bulls plus bears is overly negative and not far from its 17 year peak seen in March. Last but not least, the sentiment combo, which is a combination of the above mentioned polls plus market Vane is not yet back to where it stood in late May let alone close to bullish levels.

While sentiment is still not there we do have some interesting developments from the momentum side of the equation. All four of our primary momentum indicators are showing potential bullish divergences with their July 27 lows. This includes the breadth and volume oscillator and both of the McClellan oscillators. Although these divergences have been in place for over a week the market has not yet been able to take advantage of them. It looked like the rally last Tuesday had locked those divergences in as real but the markets failure to follow through and its subsequent reversal of Tuesday's gains late last week has put these divergences in a critical position. The divergences are still there but need to be confirmed They not only have to be confirmed by the indicators themselves but more importantly by the market.

This is in fact crucial. A failure for the market to rally and take advantage of such a bullish set up is about the single most bearish development that we can see. This would be akin to what we saw only in reverse last year. in fact this occurred several times last year beginning in early June and all through the fall and winter where we had a series of negative divergences coupled with extremely negative sentiment lead to what turned out to be nothing more than a minor hiccup. These negative divergences kept a lot of people, including us, off balance most of the year as the market continually failed to react and confirm the bearish divergences. The last time on the downside that we see a set up such as we are seeing now occurred in May/June of 2002 and in mid to late August of 2001. Those periods too saw bullish divergences in such indicators as the McClellan oscillator lead to nothing more than a bounce before failing and seeing prices fall dramatically.

The momentum divergences and the improved sentiment backdrop has put the market in its best position to rally since the May low. We do not see the necessary ingredients in place to support a move to new post March highs but we do see the potential set up to allow for the best rally of the year so far. Now it is up to the market to take advantage of the set up. A failure to do so would be a very bearish development. Perhaps not to the degree that we see in 2001 and 2002 or even last year in reverse but bearish nonetheless as in our view there is nothing more negative than a market that fails to react in a positive manor to a positive set up just as it is very bullish when a market fails to react negatively to a negative set up. We see this week as being important to the short-term. For now we are going to remain neutral on the short-term and see what unfolds early this week. Medium and long-term we remain bearish.


Best,
Larry Katz


Larry Katz
email me at: LK1618@mta.org
website link: www.marketsummaryandforecast.com

Larry Katz serves as both editor and research director of Market Summary and Forecast. Mr. Katz is a full member in the Market Technicians Association and is both one of the founders and the president of their Southern California Chapter. He also serves on the management committee chairing the membership committee. Mr. Katz is a regular contributor to Top advisors corner on America On Line. He is a regular guest on the Business Channel in Los Angeles with Richard Saxton. He has been a quest speaker of the Market Analysts of Southern California (MASC), the Omega users group of Thousand Oaks, Ca. and Orange County, the Market Technicians Association Atlanta Chapter as well as the Foundation for the Study of Cycles. He also ran a workshop at the Market Technicians Association 1999 Annual Seminar. He has been a regular commentator on the Reuters Financial network, both in the US as well as in Japan, as well as being published in the Market Watch section of Barrons Magazine on a number of occasions. He is currently ranked in the top five for intermediate term gold timing by Timer Digest.

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