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McMillan Market Commentary 10/21/5


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#1 TTHQ Staff

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Posted 21 October 2005 - 09:38 AM

Stock Market

The market has certainly awakened from its non-volatile slumber. October, as it has done many times in the past, has issued in both volatility and bearishness. It appeared that the market was out of the woods with Wednesday's rally, but Thursday's decline was a real counter-punch by the bears. As a result, the outlook is still negative and there is danger of a more massive breakdown lurking. This market not only remains bearish, but it is quite oversold, which accounts for the volatility. As we've stated before, oversold markets are very dangerous and are the most difficult to trade, as both bulls and bears are shaken out of their positions by large upswings and downdrafts.

The major averages have established a support area, which is 1170, basis $SPX. That is a double bottom and is the bulls' best hope right now. If that area is violated, expect a quick downdraft to the 1140 level. However, Wednesday's rally has proven that support and resistance levels are general guidelines at best, in this market -- for it appeared that once $SPX had rallied above a line of multiple tops in the 1190-1192 area, it should find support there. That was not true, as the market sliced right back down. From a trend perspective, the major indices are in obvious downtrends, and no rally has even been able to rise to the 20-day moving average thus far. Usually, the first rally to that level is repelled, as the market sets up a retest of its lows. In one sense, someone might say that the retest has already occurred -- with the double bottom at 1170 -- but the lack of follow-through of Wednesday's rally puts that thesis in doubt.

The equity-only put-call ratios remain on sell signals. They have risen sharply this week and are now at fairly high levels on their charts. Hence, they can be considered "oversold." As long as they are rising, though, they are bearish. Only when they begin to roll over and head downward, will buy signals then occur.

As has been the case for well over a month now, breadth (advances minus declines) has been our most bearish indicator. That continues to be the case. As the decline unfolded throughout this month, declines have dominated advances by a large margin. Hence breadth indicators continue to be oversold.

Volatility ($VIX) was the most bullish indicator of the lot. About a week ago, when the bearish phase first began to pick up significant steam, $VIX rose above 17. That didn't last long and, by Wednesday's close this week, it had dropped all the way to 13.50. That much of a reversal is bullish. But just as the overall market reversed badly on Thursday, so did $VIX (see Figure 4). It was up over 2 full points to close back above 16 again. It's nearly impossible to discern a trend in $VIX with this wild action, but in a general sense, it's rising. I suppose we could say that only a multi-day close below 14 would signal a "buy" now.

So, from a short-term perspective, the market is still pretty oversold, and there is support at 1170. However, a lot of short-term buying power was wasted by Wednesday's rally, so it's hard to imagine another rally springing up again this soon. Meanwhile, from an intermediate-term perspective, we have no buy signals. This bearish phase probably won't end until the put-call ratios turn bullish. So for now, we remain bearish. Furthermore, if 1170 is violated on the downside, expect another swift leg downward. The only thing that will turn us bullish would be buy signals from our intermediate-term indicators.

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