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Market Internals vs. Price


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#1 Guru Dudette

Guru Dudette

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Posted 27 April 2004 - 09:06 AM

"Market Internals Vs Price "

Over the past few weeks we have had a rather peculiar development in the equity markets. All three major indices have moved sideways while remaining below resistance, but above support!. From a price only based point of view, the action has been consistent with the type of price behavior that we see during consolidation periods, which precede successful break-outs. However, during the same period, the internals have been more consistent with failed consolidations, which precede break-downs. Consequently, the end result has been a bifurcated, and choppy market characterized by lack of follow-thru in either direction.

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The reason for the lack of follow thru in either direction, is due to the tag of war between overall favorable price action by the major indices as a whole, and the unfavorable internals that characterize the very same indices. Obviously I can't list here every single component of the SP, and of NASDAQ, but I'll use just three, and a sub-sector to make my point (I encourage the readers to take a look on their own of all the stocks that make up the Dow, the SP, and the NDX) the price behavior of many leading stocks such as CSCO, AMAT, NVLS, AMGN, KLAC, INTC, in the case of NASDAQ for example, we can see that they have experienced a more severe deterioration. KLAC, INTC, and CSCO, are already at their March lows, while NASDAQ itself is roughly 5.2% higher. In addition, the all too important Semiconductor Index, didn't even manage to reach the 38.2% Fibonacci retracement level. It turned down as soon as it reached long term resistance (orange trend-line) and it has remained below it. If the price action of the Semiconductor stocks is a leading indicator, or, if it continues to deteriorate, then, one has to consider the possibility that NASDAQ will revisit its March lows.

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Next, I would like to examine the McClellan Volume Summation Indexes for the Dow, the NDX, and the SP500.

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The current pattern of the McClellan Volume Summation Indexes at point #3, looks very similar to the pattern at point#2, and at point#1. Point#1 marked the beginning of a horrendous decline, while point#2, marked the beginning of a spectacular rally. Even, if we didn't bother to do any further analysis, the very fact that the current pattern is almost identical to a pattern that in the past preceded both a substantial decline and a substantial advance, should be enough of a reason for rational investors to consider both outcomes, and devise their investment/trading strategy accordingly.

We can also take a look at the cumulative breadth, and volume for the Dow, the OEX, and the NDX.

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Notice how the cumulative volume has fared for all three indices over the past two months. In terms of units, we have had a bigger loss over the last two months, than we did between August '02, and October of '02, a period which included the waterfall decline following 9-11. Also, notice that cumulative volume reached its March lows, although price didn't, which indicates a much bigger exodus of money from the market, than what we are lead to believe, looking only at price. It doesn't take a genius to realize, that if money continues to leave the markets at the current rate, it would be nearly impossible to see higher prices. Moreover, during periods of consolidation that precede further market advances, what is really taking place, is accumulation. The steep decline in the cumulative volume over the past two months, more than likely, indicates the beginning of a distribution phase, which of course can last several weeks to months, and during the same period prices can even move higher.

More interestingly, cumulative volume under-performed the A/D line on the way down, but it has out-performed the A/D line since the March lows, despite an overall decline in total volume. How should we interpret this action? In my view, it means that investors were selling heavily across the board on the way to the March lows, and subsequently, investors have become rather discriminating buyers, favoring a narrow number of stocks. The out-performance by the cumulative volume signifies that most of the up volume has been going to a relatively few stocks, which is the reason why the A/D line has lagged on all indices. Narrow participation is a sign of a bull move in its late stage. However, keep in mind that "late stages" can last for quite some time. In fact during the glorious bull market of the '90s, it lasted from mid-1998, until mid to late 2000, when all indices finally broke down.

In addition, we have observed a rotation by institutional investors out of high beta stocks, and into low beta, more defensive issues such as health care, food, energy, and even pharmaceuticals. In other words, investors are no longer exhibiting a robust preference to take on risk, in fact quite the opposite, they have become more risk averse. A robust appetite for risk, is not only an essential element of every bull market, but also, a sudden shift in the level of risk tolerance, almost invariably results in above average market declines.

In other words -in my view- the equity markets at the moment are not "firing on all cylinders." The price action exhibited by the indices is positive, but it is due to positive price action by a small number of stocks, with high capitalization, which disproportionably affects the price of the index itself. Take a look at the percent of stocks above their 200 DMA for the NYSE, and the NDX


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It is quite obvious that a large number of stocks that are making up these two indices are not faring very well, yet, the indices themselves are near their most recent highs. The positive price action, is masking the weak internals. That doesn't mean the market has to decline, or, it will decline by 10:00 AM PACIFIC time, today! It means that the overall market environment is not as favorable as "financial comedians*" like Kudlow and Cramer shamelessly proclaim in their "not ready for prime-time market analysis."

Once again I want to emphasize, that the markets can move higher despite weak internals, but they can't do it for very long, and they are vulnerable to abrupt and sharp reversals. Last but not least, I would like to point out a couple of things, about the very near term expectations of the equity markets, and gold.

The two charts below, are the "Technical Quantifiers" for the SP500, and NASDAQ. The "Quantifiers" are a composite of our 12 core indicators. They move from +30 to -30. These are not overbought/oversold oscillators. A reading of +30 means that the market's technical condition is as positive as it can be, and vice versa. In addition, it is great tool for predicting turning points, and volatile moves. Those who follow our technical work know that when the Quantifiers have little, or, no change of two or more consecutive days, then within 1-3 trading days we get a move in the SP500 in excess of 1.5%, and a move in NASDAQ in excess of 2.0%. Notice that in the past five trading days, we have had very large moves in the Quantifiers, but relatively little movement in terms of price. What does this action mean? it means that the internal condition of the markets is rapidly approaching its "boiling point" and thus we should expect a dramatic rise in price volatility, within the next 5-10 trading days, if not sooner.

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The above charts are property of Aegean Capital Group, Inc. All Rights Reserved, Reproduction without written permission, is strictly prohibited.

And finally, a couple of thoughts on gold.

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Notice that a 61.8% re-tracement of the rally that started in April of 2003, will take gold to 364.39. A 38.2% re-tracement of the entire bull move that started in February of 2001, will also take gold to 364.55. In addition, the 364.55 level, represents "channel support." My point is, I believe that the 364-365 level represents very important support, and in all likelihood, it will be tested in the coming weeks, and I would expect gold to bounce sharply from that level.



*financial comedians: Many times in the past, I had wondered how to accurately describe the vocation of people like Kudlow and Cramer. Certainly, they can't be considered financial professionals because real financial professionals do not say the idiotic things that these two clowns regularly try to pass for qualified, and educated opinion. However, they are just as entertaining, as they are clueless! They have a certain comedic quality which makes them tolerable. Since they perform their brand of comedy in a financial setting, I came up with the conclusion that the term which best describes these two -and others like them- is "financial comedian."
"I'd rather be vaguely right than precisely wrong." J.M.Keynes