The market this year has done what it does best and that is to do exactly what it has to do to make the majority wrong. Coming into the year most of the so called experts were looking for another strong year of gains. They did not expect to see a repeat of 2003 but the majority were bullish and expectations were indeed high. So what does the market do in its infinite wisdom but to spend the first 10 months aggressively going nowhere as the S&P has eked out a measly 1.6% gain. Since marking its post 2003 rally peak in early March, the S&P has traded within the confines of a 100 point range or less than 10%.
This nearly year long range has evoked a steady and over the past several weeks increasing comparison to the 1994 period, a year that saw the major averages hold to a fairly tight 10% or so range. The prime motivation and comparisons this time spring from the fact that both years are (or were) followed by the fifth year of the decode a year historically that has never been down according to the lore. If you recall, 1995 was a banner year as prices moved up sharply and ignited an unprecedented 5 year run of 20% or better returns for the S&P. While we have not heard a lot of forecasts suggesting the same type of gains lie ahead for 2005 we have been fed a steady diet of the extreme success of the decennial patterns fifth year. From that angle alone it is indeed hard to argue as it has been more than just a little impressive. Our bone, however, is not with the decennial pattern and the success of the fifth year but instead with the comparisons to 1994.
We think it fine to use the past to try to extrapolate future market trends. In fact that is what part of what technical analysis is all about, looking at the past and seeing how the market responded in similar situations in other periods. However, in our view it is also important to compare apples to apples. In this regard, making comparing 2004 to 1994 is way off the mark. The one thing this year does have with 1994 is the sideways trading range type pattern. The major differences that we see are numerous and in our view extremely important. Most of this comes from the psychological or sentiment area. In 1994 after 10 months of going nowhere a huge level of bearish psychology was in place. Investors Intelligence for example showed 45 consecutive weeks of more bulls than bears lasting well into the first quarter of 1995. From mid September of 1994 into early January of 1995 we saw 17 of 18 weeks of over 50% bears. Other polls were not as excessively lopsided but were similar in scope with the psychology at levels of bearish expectations rivaling that of 1982.
Fast forward 10 years and what do we see. Well only two weeks ago the Investors Intelligence report showed the largest number of bulls since early March and the lowest number of bears since late July. We have not seen one week this year of more bears than bulls and only one or two that came close. And by close that that was still nearly 9% more bulls than bears. At the end of 1994 the insider sell/buy ratio dipped below 1.00. In other words, insiders were buying more than they were selling, which is an extremely rare and very bullish development. Fast forward again 10 years and what do we see. One year ago the insider sell buy ratio saw its most bearish level in 33 years of data. Yes that has eased off a bit the past several months but last weeks reading of the 8-week moving average was, with the exccp0etion of last year, the higher than at any time post 1990. In other words insiders are selling and have continued to sell all year long at a more than 4 to 1 clip over insider buying. This is 180% opposite to what we saw during most of the 1994 period.
At the end of 1994 the percentage of NYSE stocks above their 200-day moving average had dropped below 30%, showing a fully oversold reading from one of the more important longer term indicators. The current reading is 67% and that is closer to the overbought threshold of 70%. To be fair, at the August low we did get down to 38% but that was far from the oversold threshold of 30%. The fifth year of a decade has had a near perfect record of higher prices and that type of success is hard to argue with. However, to compare 2004 to 1994 is in or view way off the mark as the technical backdrop between then and now are in a lot of cases 180% opposite. and to expect to see the same or similar type results would be a grave error.
The rally last week has carried the S&P back to important short-term Fibonacci resistance points. The very short-term indicators did generate some modest upside momentum early last week and that did produce a modest amount of upside as these indicators suggested. However, all of our important primary momentum indicators have so far down very little. The McClellan oscillator for example has done nothing more than to hit a weak neutral reading just slightly above zero. The rally has moved both the 10-day and open 10 Arms from deeply oversold to a level not from from the low end of overbought. So far the momentum picture suggests a weak not strong rally off last week low, which is more consistent with the mature phase of a rally rather than the beginning of a bigger move to the upside. to be fair, the rally is less than a week long and as such there is still time for these indicators to develop a momentum surge but what we se so far does not add up to that.
At the same time the rally last week has seen a sudden shift in acceptance of the rally from both the put to call ratio and to a lesser degree the Rydex ratios. At the early October top neither of these indicators were anywhere close to where they stood at the late June top. Over the last week the 10-day average of the CBOE put to call ratio has come down sharply and is at or very near the same levels it hit in late June. They are not at fully bearish levels but they are not far off either. The Rydex ratios are not as negative and do have some room before moving towards those same levels but they are certainly no longer bullish and are now closer to bearish. This does not mean that the rally is over but it does add strong support to the picture we are seeing from the majority of both our sentiment and momentum indicators as well as the wave structure.
That picture is that the rally from August is no stronger or better than what we saw coning off the May low. Secondly we are likely in the last and final phase of that rally. While we can make a case that what we saw last week was nothing more than a bounce related to the decline from early October we see enough from the indicators to give the rally the benefit of the doubt for now and approach it as the second and last leg of the post August advance. We do see the potential for a modest correction but view that as being a normal reaction to last weeks rally. We moved to bullish last week on the short-term and will remain so with a stop of 1102. Medium-term we are neutral and long-term we are bearish.
Regards,
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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