The last two weeks since our last report the market has not done very much or given us very much to write about and discuss. About the only thing we see from the bullish side is that the dreaded month of September has hot produced a major hit to the averages in spite of its history of doing just that. Of course the month is only half over so we are not out of the woods but it is interesting. In fact the past two years saw a flat to slightly higher September leading to a year end rally. However. both of those year end rallies lead to tops early in the new year. This is also fascinating but to think that this year will work out like the past two years based on what we do in September would be pushing the strong a bit. While the market has so far anyway broken with historic precedence and rallied so far in September, the quality of this rally has left a lot to be desired. what we have seen so far, is what we have seen over the past two plus years, and that is a continued weakening in the underlying quality of a rally both in terms of momentum and in terms of participation.
We have discussed ad nauseam the long-term deterioration in a number of momentum indicators and a number of indicators that measure participation. The former include such indicators as the McClellan oscillator and the latter such measures as the new highs. With the risk of sounding like a broken record (this is due partially to the fact that over the past two weeks nothing much that could be viewed as noteworthy has developed) what we are seeing from late 2003 early is a classic pattern of deterioration that is now at the stage typical of the last gasp in an aging bull run. The only area that has not yet classic late cycle behavior has been breadth. And this has also been the major argument set forth by the bulls as to why this market has a lot of life left in it. When looking at the market and making an analysis of the market we have to look at the weight of the evidence and when the weight of the evidence point in one direction it would be foolhardy to let one or maybe two indictors out of a multiple of such indicators take sway. As persuasive historically as the breadth argument is, the fact that it is fast becoming the single most looked at indicator to support the bullish case needs to raise a caution flag as to how important it may be this time around, especially in light of the massive deterioration in the majority of the indicators.
We still see the breadth figures as being overly distorted by a number of combinations such as the proliferation of closed end funds, interest rate sensitive vehicles and such that are traded on the NYSE but are not traditional equities such as common stock in a particular company. We can see the lack of participation over the last few months really take form in any number of indicators. One that is a real eye opener is the A/D line of the DJIA. It peaked in December of last year failing to make new highs in March with the DJIA. The deterioration has continued throughout the post March experience with the A/D lie failing miserably leading into the early August peak, having recorded its post April peak in late May. It is not like the DJIA is setting the world on fire the last several months. In fact it has continued to lag the S&P since their joint high in March falling far short of its March high in August but even so the deterioration on the A/D line has continued. What we see here is not only a pack of participation from the one average that was so widely expected to be the strength coming into this year but also a clear lack of participation within the index.
A lagging DJIA may not seem that and may in fact seem a bit positive as historically a lot of bull markets have ended with the DJIA leading the last hurrah while the rest of the list struggled. However, the 2004 medium-term top saw the NASDAQ peak in January, the DJIA in February, the S&P in March and the Russell 2000 in April. Granted that was not a major top but it does show a period when the DJIA was not the last man standing. However, and even more important divergence between the DJIA and the S&P occurred in the not too distant past, 2000. The DJIA made its bull market high in January while the S&P and NASDAQ peaked in March. Those waiting for the classic last leg up lead by the DJIA in 2000 got left holding more than the proverbial bag, a lot more. The DJIA and S&P made joint highs in March with the DJIA failing to match its March peak in August and confirm the S&P At this time, the DJIA is nearly 275 points (2.57%) below its March high This does not seem like a big deal but at its March 2000 high it was only 2.85% below its January high which is not much different then where we sit today. Of course there is always the possibility that the DJIA will come on and play catch up and give us that traditional last gasp rally and confirm but as of now we are facing a potentially very serious divergence, a divergence that has not yet been confirmed but one that does add another element to the weakening technical picture.
The latest rally has also served to reignite the bulls even though the S&P has not yet made new post August high. Some of the sentiment indicators have remained constructive but these are mostly shorter-term indicators such as the CBOE put to call ratio and the Rydex data. The long-term measures are not quite so healthy. Yes it is true that Investors Intelligence is not as excessive as it was in early August but that followed a multi week and multi month rally. Here wee have rallied for a little over two weeks and we are running well over 2 to 1 bulls. In addition, the August decline did not produce one week of under 50% bulls although to be fair we did get a rise in bears over the time span but only to a less bearish level. Market Vane has been in the mid to high 60% level for weeks and weeks and weeks and another poll has hit its highest level since the week ending August 5. These levels of bullishness are not where they stood in late 2004 or late 2003 but for the most part they have remained bearish from an excessively long period of time. This is a reflection of excessively high expectations and a very negative long-term development, In addition, the speed in which these indicators reflect increased bullishness early into a rally is a sign of fear. Not good fear but fear of missing the next big rally. The proverbial "wall of worry" is hard to find if it exists at all.
We still see the most likely outcome of a new high in the S&P above its August high and still see this new high as the last wave up from 2003 and as part of a topping process that has been carrying on since early this year. Whether that new high is coming now or after a minor decline back below last weeks low is another story. The indicators and the wave structure support both possibilities. The rally late last week has carried the S&P to near important short-term resistance and how the market responds early this week will be the key to whether we get that run now or from moderately lower prices. Until this is resolved we deem it best to remain neutral on the short-term.
Hope all is well,
Larry
