Here we are, with nearly two thirds of the year gone and we still wait patiently for that big rally that was so widely talked about and so widely expected, you know, for the fifth year of a decade cannot miss rally. The S&P is up a bit for the year by an unimpressive 8 points or less than 1% and the Russell 2000 is up less than a point. But all of the other key averages including the DJIA, DJTA and both NASDAQ averages are showing losses for the year. Granted, the year is not over yet and the market can pull a rabbit out of its hat and rally strongly the last four months but that also flies in the face of the seasonal patterns as we are about to enter the two worst months historically for stocks. More importantly is the continued deterioration in the long-term technical condition of the market, a condition that is consistent historically with the late stages of an advance not the early to middle stages. Yes, there is room for some further rally and yes our preferred pattern is that we favor another rally to modest new highs on the S&P as we do not see the rally from April as complete. But no, we do not see this rally as the one that will fulfill the great expectations coming into the year but to complete those expectations.
In other words, we see that rally, if indeed we are correct that there is one last rally ahead of us, as the rally that puts the final touches on the post 2002 cyclical bull market and ushering in the next wave down in the post 2000 secular bear market. The rally the past three years has done everything expected with its most important function being that of brining back investors expectations to levels seen near or at the 2000 peak. This is evident in a number of the sentiment surveys, some of which during the rally hit record levels well in excess of where they stood in early 2000 and some such as the insider sell/buy ratio at a 33 year peak. We have heard that these surveys just do not matter any more. They are not tested, not scientific and archaic and last but not least they are not good timing tools. On the first three, we say go look at history and on the fourth we agree, they are not good timing tools. As we have pointed out painstakingly the past two years all we have to do is look at 2003 to see how well they functioned as timing tools.
However, in 2003 the market had entered the early stages of its advance generating strong and persistently positive momentum. here we are over two years later and we see quite the opposite in regards to momentum. to this end, we have had a series of lower momentum peaks with a series of higher prices with the latest rally from showing a lower peak in momentum than what we saw in November and the November peak lower than what we saw during the 2003 rally. In the last issue (August 8) we went into this in graphic detail so we will not do this again this time. We will, however, point out the decline of the past two weeks has solidified this argument. We are seeing these divergences from internal measures such as the new highs as well as from price and internal momentum measures. The former would include such indicators as rates of change and RSI, and the latter such indicators as the McClellan oscillator and summation index.
Some of our favorite indicators measure the internal strength of the S&P. These include the percentage of S&P stocks in positive trends both on a daily, weekly and monthly basis. The raw data comes from Masterdata (http://www.masterdata.com). Our interpretations is our own but what we see here is the same pattern as we see on all the other indicators, and that is a series of lower peaks accompanied by a series of higher peaks in price. This is clear on the S&P as it relates to the trend data as well as the percentage of stocks above their 200 day moving average and 30 week moving average. Both of these series have moved below 70% from above while also showing two lower peaks following the 2003 high.
As we progress in time we see more and more deterioration a pattern that is historically consistent with a market in the very late stages of an advance not the beginning or even middle of one. As we pointed out last time, we continue to hear a lot of talk about how bullish the confirmation by the A/D line is. And as we also pointed out last time, there is always a hook at a major market top and it is quite possible that the A/D line may well be the hook this time around. The best way to describe a hook is that it is the thing that keeps most investors bullish well past the time that they should be. Of course, we will not and cannot know if this is correct until after the fact so for now it is just conjecture but as Joe Granville once said "What everyone knows in the stock market is not worth knowing". And from what we have seen, everyone knows about the A/D line.
So what now you ask? We continue to favor and have been approaching the decline from August 3 as part of a still unfinished last wave up from the 2003 low. We see it as either related to the July 7 rally or a correction related to the post April 20 rally but at this time we do not see the top in August as the end of the rally but the beginning of the end. We do, however, recognize the distinct possibility that what we saw three-weeks ago could have very well been the top putting us in the very early stages of the next wave down from 2000. The majority of the indicators certainly do support this possibility. However, while not being able to put a finger on what exactly it is, there seems to be something missing. Maybe its the nature of the decline, which from an Elliott perspective looks corrective but whatever it is we think that the more likely course will be to have one last gasp rally that carries some of the averages to new highs prior to the big bang on the downside. The key price level for us is 1175 on the S&P (see the Elliott wave section above for more details).
About Larry Katz
