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[TTHQ Staff]

The breadth and volume related momentum indicators peaked in late May and early June. The breadth related indicators hit record or near record levels. This includes the McClellan oscillator, our breadth oscillator and even the short-term 3-day oscillator Volume related indicators did get overbought bit not one moved close4 to record levels. This includes the McClellan volume oscillator, our volume oscillator and both of our short-term volume oscillators. These indicators have since corrected back to neutral and turned back up.


At the same time, the averages have given back nothing and in fact from the June 1 the S&P is actually showing a modest gain of 1.5%. As we discussed in the last issue, one of the characteristics of a breadth is thrust is that "price usually continues to move higher well after the peak in momentum and if it did not move higher it corrected very little. Moreover, the initial reaction in the indicators was to correct to a less overbought condition or to neutral but they never moved back to oversold levels on the first correction off the peak. However, this is not as important as the reaction in price." To this end that is so far exactly what has occurred. From this angle we do have some support for the idea that what we saw was indeed a bona fide breadth thrust. These are rare as we have had only 12 prior occurrences in the past 22 years. Well actually 11 as the August 2002 signal failed miserably. The remaining 11 have been seen at the beginning of at a minimum a medium-term advance with prices moving higher several months out. In some such as 1982 and 1998 the initiation of a strong long-term advance (for all the previous dates see the June 1 issue). There were a couple of exceptions to this such as January 1992 that was followed by a sideways market for 8 months. Following The early October 2001 momentum peak market did move higher into November but from that point it traded in a fairly tight range of about 10% into March 2003. For the most part, however, prices did move up for several months at a minimum. Again, from this angle it seems likely that the momentum surge seen in May is suggesting that the market has several months of higher prices or perhaps several months before a more serious decline ensues.


However, in our view the single most important ingredient of a confirmed momentum thrust is missing. And that ingredient is price. As we pointed out last time, the average gain in in the S&P during the previous 12 occurrences was 14.4% with the smallest being 9.4%. This is measured from the price low following the momentum trough to the momentum peak. In most of the past 12 cases the momentum trough occurred well before the price low setting off bullish divergences. The August 2002 failure did not have a divergence. Neither did the September 2001 signal. As discussed above this was one of the weaker performances price wise as the S&P essentially made its price peak about two months after the low. The November 1991 to early January1992 signal also came with no divergence. As mentioned above, this was followed by nearly 9 months of a sideways to down market. In fact, the S&P was down nearly 6% from its level seen at the momentum peak.


The rally from the May low in spite of the gains since the momentum peak on June 1 is a mediocre 5.4% on the S&P . This is about 40% of the average and nearly half as much as the lowest previous gain. Moreover at the May low there was no divergence to speak of at all. The latter as we have seen has lead to a mediocre performance in the past. The former is something we have not seen previously but certainly is not consistent with previous bona fide initiation signals. Thus we have seen some characteristics that support a momentum thrust while a number of others that do not or that have historically been followed by a mediocre performances such as 1992.


The semi conductor index or SOX clearly leads the NASDAQ. The SOX for example peaked in early January and had already begin to turn down well in advance of the NASDAQ's peak in late January. The SOX made its low on May 3 and the NASDAQ made its low some two weeks later after the SOX had turned up. Not every peak and trough are accompanied by a divergence in SOX but when the divergences do occur they tend to resolve in the direction of the SOX. The SOX made its post May peak on May 28 close to two weeks prior to the NASDAQ's June 8 peak. It has since retraced nearly 3/4 of its rally and is at its lowest level since May 17, the day of the low in the NASDAQ. The Broker Dealer index has the same relationship for the S&P as the SOX does with the NASDAQ. In late April the XBD moved below its March low and that was followed by a move below the March low in the S&P and DJIA. The XBD made its intra day low on May 10 two days before the S&P. This is not much of a divergence but it is a divergence. The XBD made its peak in February and did not confirm the March 5 high in the S&P. Like the SOX it does not diverge often but when it does the resolution is almost always in favor of the XBD. The rally off the May low has seen the S&P retrace nearly 75% of its decline from March. At the same time the XBD retraced a mere 35% of its decline. It did peak at the same time as the S&P which so far leaves no divergence. However, while the S&P is just over 1/2% below its June low, the XBD has retraced over 80% of its May rally and is at its lowest level since May 17. Moreover, it is nearly 56% below its June rally. More importantly than all this is the fact that it has broken down out of a very negative bear flag formation. This is a continuation pattern and strongly suggests a move below the May low is likely. This alone would be a strong argument that the S&P has a date with its March low. This in turn could lead to the completion of a fairly large head and shoulders top formation.


The jury is still out as to whether the momentum surge in early June is the real thing or not. The market has displayed some of the characteristics of a true momentum thrust while there are a number of other indications that it is not. We are presently of the view that the rally is not the beginning of a new medium-term advance but a very strong counter trend rally related to the decline from March on the S&P. Our expectation is for a move back below the March low once this rally is behind us. At the same time both the wave structure and the strong momentum suggests that the rally is not over and that the move back below the March low is not ready to unfold. We are going to remain neutral on the short-term. Medium and long-term we remain bearish.


Larry Katz
email me at: LK1618@mta.org
website link: www.marketsummaryandforecast.com