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Market Summary and Forecast 5/18/4


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#1 TTHQ Staff

TTHQ Staff

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Posted 18 May 2004 - 09:46 AM

The talk of when not if the FED will begin to raise interest rates is dominating the investment community. The talk we have heard most of is how well the market does after the initial interest rate hike. We have heard that the market on average rallies close to 10% once the initial rate hike is in place. It seems to us that this could be a case of sell on anticipation and buy on the news. Wait a minute lest take a trop back in time. There was also talk, albeit several years back of how, on an historical basis the market fares after the second interest rate cut. We do not recall the exact number but we do recall that the market is higher by at least 10% six months after the initial cut and in 18 months by more than 20%. The second interest rate cut took place in mid February of 2001. The exact date eludes us but in even using the low of that month, which occurred on the last day of the month there comes to light an interesting discovery. Not only did the S&P show losses for the first 6 months one year and 18 months following the second interest rate hike it is still below that level by nearly 10%. That one surely did not follow conventional wisdom. We do not bring this up as an argument that after the first interest rate hike the market will not rally but what we do see in regards to this talk is a high degree of complacency as it relates to the interest rate picture. And, as we all know., the market rarely if ever accommodates the crowd Others may want to know why this did not work in 2001. We as technical analysts do not concern ourselves with the why factor only the what factor. That is reasons why something should or something did or did not occur are of no interest to us. Frankly, we see the why as purely speculation and guess work. We are always amused to see reporters telling us why stocks went up or down on a particular day. There may be some educated guess work or even some logical or what seems like a logical answer to this but the truth is it is still guess work. Unless one talks to every person who bought or sold shares that day one is only guessing as to why they did what they did. The only thing important to us is what the market did. In digging deeper into this side of the market what is truly important is when the market does the unexpected. For example when it rallies day after day on bad news or when it does not rally on good news or goes lower on good news. These are especially important after a prolonged decline or rally. For a prime example of the former we need only to go back to last March. The news on a daily basis was bad and yet the market ignored the bad news and rallied. It would open lower on the bad news and then rally and did so day after day. This for a while seemed to defy the logic of the talking heads and to be honest it was something that we did not recognize very well either. Spring forward about six months and we see the economy starting to expand like gangbusters and earnings begin to explode. Whatever the market saw in March of 2003 was not obvious to the majority at that time but again we see why they say that the market looks ahead six to nine months and is reacting not to today's news but to future developments. An old friend coined the phrase " smart money moves in advance of known events. This brings us to the current situation. The economic news is mostly better than expected surprising most economists and forecasts (given their long-term track record this should not be much of a surprise). Earnings are coming well far better than forecast and yet the market is moving lower not higher. There are some cases of stronger than expected earnings moving an individual stock but this is basically an isolated case or three. What we are not seeing is big surprises in earnings from a key stock having an effect on the overall market or if so it is fleeting. This is contrary what was common placed last summer and fall. So far the averages have held up fairly well but looking beneath the surface this is not the case. We touched on this last time in looking at some indicators based on the S&P not the overall NYSE. We saw the same deterioration here as we saw in the same indicators on the overall NYSE. These indicators included the S&P A/D line and the percent of S&P stocks above their 200 day moving average. These have continued to decline and remain bearish and have confirmed the move below the March 24 low as they had forecasted would occur only a couple of weeks ago. Speaking of confirmation, nearly every one of our important momentum indicators confirmed the lows last week. The one exception is the McClellan volume oscillator. This one did hold above its March 24 low. As we have pointed out repeatedly in the daily reports, it is rare to see a price low occur commensurate with a low in momentum. This is especially true when momentum indicators reach the type of readings we saw last week. Those type of readings in fact are extremely rare and are always followed by lower lows. Those lower lows can occur in a few weeks, a few days or as long as several months but they always occur. A case in point is the McClellan oscillator. Last week it moved well below -300. The only other cases of a sub -300 reading was seen in September 2001 and July 2002. The reading last week was actually below the July 2002 low. We did rally directly off the September 2001 low without a divergence but that rally in reality peaked in two months spent four months making a top and then by July of 2002 the S&P was 18% below its September 2001 low. The July low saw another sub -300 reading leading to a rally but failed one and by October the S&P has moved back below the July low setting up a a bullish divergence. The other indicators followed a similar course. The point of all this is again to point out that the depth of the recent oversold readings are not bottom type readings but indications of strong down side momentum which historically have lead to lower prices. While these indicators are either oversold or coming off deep oversold readings the 10-day and open 10 Arms are neutral and in fact closer to overbought. The 10-day Arms is in fact not far from its level seen at the April 5 counter trend rally peak. This is not bullish. In fact looking at the momentum picture we cannot find anything that is bullish. Both the daily and weekly trend oscillators are still negative with the latter still accelerating down. Moreover, the weekly breadth indicators have generated a strong downside momentum surge. They are deeply oversold and that can set the stage for a rally soon but they like the daily counter parts are at levels that argue for lower prices and this is on a medium-term basis not short-term. In fact, the weekly McClellan oscillator using weekly data is at its lowest level in its history or we should say our history from 1970 and the weekly breadth oscillator is close. We have also had a confirmed sell signal from the second of our high low indicators as it moved below 70% from above. This occurred last Monday and was the first sell signal from this indicator since January 2003 and prior to that June of 2002. This is just one more indicator in a series of indicators issuing a medium-term sell signal and confirming that a top of some importance has been seen. Sentiment has improved over the past few weeks but other than the put to call ratio the sentiment indicators are nowhere close to levels that could support a low of any importance. In fact while they have improved most remain at or near bearish levels although they are clearly not at the overly excessive levels seen late last year and early this year. They have a log way to go to get to bullish levels with an exception or two they are not even back to neutral. The rally of the past week has relieved a good deal of the oversold condition but some indicators such as our breadth and volume measures can support a bit more of a rally. On the other hand the McClellan oscillator is right back to where it corrected to on April 22 and May 4. In addition the short-term volume oscillators and the 3-day oscillator have completely relieved their oversold condition seen early last week while both the 10-day and open 10 Arms are closer to overbought. The former is at its lowest level since April 5, the peak of the counter trend rally from March 24. The one area that is bullish is the put to call ratios. Short-term we can make a fairly strong case for a resumption of the decline right now. At the same time we see enough evidence to support some further rally now. It is also our view that a move below last weeks low early this week would be a better set up for a more exploitable short-term rally while a continuation of the rally from here would set up for a more serous move lower. Short-term we are going to remain neutral. While we do see the potential set up for a rally and it could be a good one if indeed we see lower lows now we do not see that rally as anything more than a strong counter trend move and not the beginning of a new medium-term move to the upside. We remain bearish on the medium and long-term.