It was our opinion in mid August when the rally got underway that it would be on par with the May-June rally perhaps a bit stronger but we did not see the ingredients in place both from momentum and more so sentiment to support a new medium-term advance to carry the averages past their winter highs. Last time we went into a more detailed explanation of why we see it this way so to avoid the process of repetition we will refer you back to that report. We will, however, say that in spite of the strong rally late last week the weight of the evidence from wave structure to momentum to sentiment continue to support that outlook
At the same time, there was a heck of a lot to like about last weeks late rally. In fact, from an internal perspective it had it all, good breadth expanding volume and a huge expansion in the new highs. The latter in fact hit its highest level since early April indicting a broad based participation even after adjusting for interest rate related issues and closed end funds. We have pointed out often that it is rare to see a peak in price commensurate with a peak in the new highs. This alone suggests that the rally from last week is not over and we should expect to see higher prices. However, like every indicators that on e can follow, this one too is not infallible and as recently as June 24 and April 2 we did see a peak in price at the same time as the new highs. Even so, historically a peak in new highs tends to occur in advance of a peak in price and as we saw from last year sometimes this can be well in advance. This does not man that the rally will last for months or even weeks as the new high data, from what we have seen, does nothing in forecasting duration or strength. But it does argue that there is more to for this rally nonetheless
As for breadth well what we saw last week was nothing new as breadth has been strong throughout most all of the rally from August so there is nothing new here. The volume expansion is another story. The big rally late last week occurred on a big surge in volume and this occurred as the S&P was moving above its mid September peak. There are two ways to view this increased volume/ The most obvious is that it is bullish as it represents a sharp[ increase in demand. Given the modest new high on Friday this does seem to fit. However, back in late August early September, we had discussed the low volume rally in detail. We had stated that low volume rallies can last far longer than one would expect, which was certainly the case. We also stated that low volume rallies were more a reflection of a lack of selling not a sign of investment demand and that low volume rallies often end badly. We had also pointed out that a big increase in volume following a low volume rally may not necessarily be bullish, may not reflect a big increase in demand but could in fact suggest that sellers are becoming more active. We saw something of this nature in late January early February as the market was beginning to complete its top and as the internals were peaking. The question is whether last weeks surge in volume was the beginning of this process or in fact is part of an initiation phase of a new leg or wave from August that may have more bullish implications medium-term.
At this time it is next to impossible to say but in either case at leas on a short-term basis we would have to rate it as bullish. What we do have to watch our for is blow off volume leading to a reverse capitulation. We are not there yet but a few more days of big volume could do the job. That is what we saw in late January. At the same time we would not want to see volume drop off to levels seen in August or September either as that would be a strong indication that the big volume last week could very well have been a function of end of quarter activity. As we said, for now we view the expansion in volume last week as at last short-term bullish.
The S&P was able to make new rally highs last week as it moved above its September 21 peak both on a print (barely) and closing basis. This new high in the S&P has left a number of potential negative divergences in place. The most obvious is the fact that the DJIA is well off its September 7 peak having been able to retrace slightly more than 50% of its September 7-September 28 decline. The divergence between the two averages may not seem that important but in fact when they do occur they tend to be just that whether short medium and long-term. We saw a similar divergence this year as the DJIA peaked in February and the S&P in March. We also saw a similar divergence in 2000 as the DJIA peaked in January and the S&P in March. In 1998 the S&P bottomed in October moving below its September low while the DJIA made a higher low. We also saw divergence in March 2002 as the S&P did not move above its January high while the DJIA did. The S&P peaked in October 1983 and the DJIA in January 1984, which was followed by an eight month 15% decline. In 1974 the S&P bottomed in October and the DJIA in December as it made a lower low. These are certainly not all of the divergences between the two averages only a sample but in all the above instances the divergences lead to a top or bottom of some degree.
Speaking of divergence's the new high in the S&P has left a slew of potential divergences in place from a number of important momentum measures. This includes the breadth and volume oscillators both of the McClellan oscillators and internal momentum indicators such as RSI. At the same time, the daily trend oscillators are still slightly negative although a strong day today would likely turn them up slightly. However, as it stands now we see a lot of similarities in the current position of the indicators as we saw in late June following a mid June correction. However, there are some differences too such as the Arms indexes, which were closer to overbought in June and are only neutral now. The biggest difference though comes from the sentiment arena. In June both the put to call ratios and the Rydex data were bearish while on Friday both remain bullish. The AAII survey is now neutral compared to a fully bearish reading in June. There are some negative from sentiment as well including the extremely low volatility indexes, the insider selling that has not abated much at all and the fact that the sentiment combo is at bearish levels. On balance, sentiment is negative but not anywhere close to what we saw in late June and this is reflected by the Sentiment model, which is currently neutral. It is also rising where as in late June it had begun to decline.
The problem with divergences is that until they are confirmed as real they need to be treated as only potential divergences. A continuation of the rally could very well eliminate a number of these divergences. Although to be honest it would take one heck of a really to do so. While these are a concern to us and a potential negative to the medium-term until they are confirmed they will remain as potential divergences. Short-term there was enough momentum generated last week to support higher prices and the still high put to call ratios along with the bullish Rydex numbers support this outlook. This does not preclude a minor correction that can begin as soon as today but the odds favor higher prices and as such we are going to move back to bullish short-term with as stop of 1116 on the S&P. However, it is imperative that any weakness be well contained as a failure to do so can lead to confirmation of the divergences and weaken the technical structure severely. Medium-term we are going to remain neutral but with a positive bias and long-term we are bearish.
Rydex switchers are holding a 25% position in Ursa and 15% position in the Precious Metals fund . Make sure to call the Noon Pacific hotline for any changes
Regards,
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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