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Weekend Newsletter of May 4th, 2003


Summary of this newsletter

simply click on the section below, and you will automatically be taken to that section.


Part 1. Administrative comments, repost of market cycles, and US dollar

Part 2. Market Index, daily analysis, sectors

Part 3. Gold, US dollar, CRB


Part 1. Brief War Comments

1st. some administrative notes:

Keith aka stt on the Message board and chat room is out of town and will not be back until Monday night.

Also, I have placed a transcript of Friday, May 2nd's Chat room log onto the message board under general market discussion. Click Here, or go to the message board to see the log. For those of you who have not been to the chat room, this will give you a good idea of all the activity that goes on in the chat room during the day.

Also, I realize that the chat room is complicated to access, therefore we might look into purchasing chat room software for the site so members could access the chat room with a click of a button.

I am reposting this from my April 20th newsletter, with a few additions:

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"The stock market trades in cycles, short (also called cyclical) and long term (also called secular). Secular markets typically last 10 - 20 years, while cyclical markets last 1 - 3 years. To give you some examples, a secular bear market begin in 1929 and lasted until 1948. A secular bull market began in 1948 and lasted until 1966. A secular bull market began in 1982 and lasted until 2000. A secular bear market is thought to have begun in 2000 and will probably last at least until 2010 - 2015.

The last secular bear market was from 1966 - 1982 which spanned 16 years. The DOW in 1966 hit 1000, and hit a 800 in 1982 - 16 years later!!! Sort of makes you want to tell your broker to "go to hell" when he/she tell you hold stocks for the long run - I don't know about you, but 16 years is too long for me to have my money tied up only to go no where.

Of course, a Secular bull market began in 1982 that lasted until 2000, or 18 years. Thus it is now logical to assume that the stock market entered a secular bear market in 2000. As history shows, this current secular bear market will probably last at least another 10 years.

However, this IS NOT a reason to be a perma bear. Obviously, secular bear markets, while they last 10 - 20 years, keep in mind that every year is not a down year. There will typically be several small, or cyclical, bull markets inside the long term secular bear market.

One thing we need to do as traders is not be become overly biased either long or short to the point where we can't change our trading style. For example, I see far too many traders becoming 'perma bears' who just always assume that every rally is going to end quickly just as it has the past 3 years. However, you really need to note is that during the horrific 70's secular bear market, there were 4 bull markets that lasted from 1 - 3 years each, these were cyclical bull markets in a long term secular bear market. We are already 3 years into a long term secular bear market, sometime in the in future the market will probably enter a 1 - 2 year short term cyclical bull market. As traders, you need to be prepared for this, don't always blindly assume that every market rally is going to end quickly and be another big shorting opportunity. Because as history has show us, every secular bear market has several small bull markets interlaced inside it.

Please keep in mind that I'm not saying this current rally is the start of a cyclical bull market, it most likely is not and will probably soon end just like all the other recent bear market rallies over the past 3 years.

So why am I mentioning this, do I think this current rally is the start of one of those 1 - 2 year cyclical bull markets? To answer the question, no I'm not sure and I doubt it, however as history shows us, this current rally very well could be the start of a cyclical bull market that lasts 1- 2 years. On the other hand, this current rally could end shortly just like all others over the last couple of years. However, keep in mind that this secular bear market is due a 1 - 2 year bull market, it could start now, or it could start next year, but one is probably coming sometime in the next few years. I'm not saying I believe we are starting one of these cyclical bull markets now, I'm just saying that the possibility exists and you need to be prepared for it as traders and not allow yourselves to become overly biased to the bear side. As traders, you need to be able to turn on a dime, and take advantage of the current trend of the market."

Also of interest is the price of oil. The price of Oil ran up to high levels early this year, but took a nose dive around mid February and has been falling every since because of the war with Iraq. However, notice that Positive Divergence is now creeping into the oil chart. Therefore, I'd expect the price of oil to start rising again soon and possibly expect to be paying more at the gas pump soon. For those of you who have experience trading commodities, it might be worth picking up some crude oil futures, however futures are volatile, so do so at your own risk. For more on Positive Divergence, please visit the education section.

The US dollar

The US dollar broke major support this week by breaking $97 which was a support that went all the way back to 1999. Short term support was 97.5 which was formed from the low in March - see the chart below:

However, the longer term picture of dollar is more interesting: notice from the chart below the long term support of about 97 was broken. A weaker dollar can eventually help the trade deficit by making foreign goods more expensive in the U.S. while causing U.S. goods to be cheaper in other countries - thus fewer imports and more exports would theoretically result. This breach of support lays the ground work for further decline in the dollar in the future.

HOWEVER: Notice the Positive Divergence that is showing up in the dollar chart. This will probably cause some short term strength in the dollar that could last a few weeks. Note how this happened in July-Oct. of 2002, and is likely to happen again. I would expect the dollar to move slightly up to sideways soon, but it could still fall more in the short term.

This has implications to the stockmarket. If the dollar's fall were to stabilize here, it could cause the current market rally to continue for a while. This also goes along with the weak VIX, as discussed below, and the bullish charts in the NASDAQ, DOW, and sectors. However, this would also not bode well for gold stocks in the near term and could cause some weakness there.

Part 2. Market Index, daily analysis and conclusions

So what does the market look like from here? Let's look at some charts starting with the Indicators, VIX and BPCOMPQ:

The VIX or Volatility index is ratio of put options to call options. It is a useful indicator because it indirectly measures market psychology. The VIX is like a contrarian indicator, when it's low, it means that more people are buying call options, and thus are bullish on the market. Contrarian theory tells us that the majority of people are wrong about the stock market, therefore when the masses are overly bullish, the market is usually topped out and about to tank, and vice versa.

The VIX can be used in two ways:

1. Usually the VIX is used to indicate when the psychological levels of the market are overly bullish or bearish. Overly bullish levels are in the mid 20's and lower, while overly bearish levels are in the upper 40's and higher. Traders use these levels to indicate when the market is at extremes, such as oversold or overbought. The old saying applies, when the VIX is low it's time to go, when the VIX is high, it's time to buy.

2. The VIX can also be used to forcast the market direction because of it's inverse correlation to the market direction. For example, by using technical analysis, if you decide the VIX is going to fall in the short term, the market will usually rise, and vice versa. Normal pattern or technical analysis can be preformed on the VIX an attempt to decipher short term market direction.

A few weeks ago, the VIX broke support at about 26 and a half area, and fell hard. This support goes all the way back to last fall and is significant support.

A theorem of Technical Analysis is that when support is broken it becomes resistance, of which 26.5 now is. Also, many times when support is broken, it is retested at once. Notice how the VIX broke support and then basically retested it and is now turning down again? This sets the VIX up to possibly fall to the very low 20's and even retest 20. This would of course cause even more upside in the market because when the VIX falls, the market usually rises.


Below is an even longer term view of the VIX that shows the 20 support level. You can see how significant the 26.5 support for the VIX was, as it went all the way back to November. Also notice that an even longer term support exists at about 20.

And now, an even longer term view of the VIX, here you can see the 20 support area, but an even stronger support at 18 exists. Will it make it this far? Who knows, I doubt it at this point in time but we'll just have to see. However, it's possible if the dollar bounces here, as it would provide further strength to the markets.

Below is another chart I find very useful in predicting major market tops and bottoms. The BPCOMPQ very accurately predicts market tops when it is above about 49 and market bottoms when it is below about 30. One thing about this indicator is that it move very slowly, notice that while it is nearing or is at overbought levels.

Notice how the BPCOMPQ is now in the low 50's, this is indicating stocks are in over bought levels. However, this does not mean the market will drop like a rock, notice how in the past, the BPCOMPQ usually stayed in the low 50's for several months at a time and right now, it has only been in this area for just a few days. Also notice how the blue EMA has not yet made it to the 50's, thus I suspect there could be a little more upside in the market.

However, now it should be noted that when playing breakout stocks, traders should take profits more quickly rather then letting the positions ride as holding long positions become riskier.

Wow, what a week for the market, notice that the Nasdaq broke the formidable and important resistance of 1470, this is significant - the Nasdaq looks great on a technical basis. A downtrend is defined by a series of lower highs and lower lows, with the Nasdaq breaking 1470, this series of lower highs has now been broken and sets the stage for even more gains.

So what's going to happen now?

Since the Nasdaq broke 1470, this sets the stage for it to run to 1520, which is the November high and the current price target. Support is now the broken resistance line at 1470 or the uptrend line in purple. If the VIX falls to 20, I think the Nasdaq will see 1520 at least. Also if the US dollar bounces or consolidates as evident from the Positive Divergence, this could help keep the market up for a few weeks yet.

The DOW also looks good on a technical basis, though not as good as the Nasdaq. Notice how the DOW had formed two triangles, Symmetrical and Ascending that were both broken to the upside. I guess the only thing I would have liked to see if more volume, but the chart is still bullish in the short term. The DOW now has a price target of 8870 denoted by the red dotted line, will it make it that far, who knows, but that is the next closest resistance area.

On a short term basis, you can see how the DOW broke through an Ascending Triangle on a 60 minute graph. Stochastics are overbought, but could stay in this area for awhile, however I could see a pullback very soon to retest the broken support.

The S&P 500 graph below is not a nice looking chart if you are bullish on the market. The S&P has formed what appears to be another Rising Wedge. If this is the true pattern, then the market has most likely seen it's highs or is very close to them.

What's interesting is that this pattern is not seen on either the DOW or Nasdaq, again a few more trading days may confirm this pattern. Also of interest, notice how the point of the Rising Wedge hits the 935 resistance exactly? Also note that sometimes these Wedges break to the upside rather than the downside, therefore it's possible this will happen. I guess all we need is a few more trading days for confirmation.

Obviously 935 is the price target for the S&P in the near future. This level is significant if it is broken because it would be a new high for the S&P.

On a short term basis, the S&P 500 broke through an Ascending Triangle on a 60 minute basis. Support is now the broken resistance at 925 or the uptrend line. If the uptrend line is broken, the red dotted lines may act as support.

Now let's look at the ultra long term: On a short term basis, the S&P target is 935, however the strong resistance and long term price target is 965 which is the neckline of the large head and shoulders pattern on the S&P. If the VIX cooperates, this level could be seen on the S&P, or at least 935.

Also you might want to note the sectors below, especially some of the tradeable sector EFT's or Holders. The Biotech sector broke out, and I went long BBH and PPH, you might also want to check out other sectors charts such as XLE, XLB. Sector charts can be nice to trade in that they will offer stability, i.e they will never gap down 50%, like can happen with individual stocks. Therefore you can put a larger % of your capital into them.

Just click on the chart symbols in the tables below to pull up a real time chart from Stockcharts.com

Part 3. Gold, analysis

Watch the US dollar carefully, if it strengthens as evident by the Positive Divergence, gold could weaken again, and so would gold stocks themselves.

Gold has done well in the short term as evident by the chart below, however it may need to consolidate some, again watch that US dollar carefully.

If you hold gold stocks, it is safe to hold them as long as the XAU and HUI remain above their respective long term uptrend lines. As long as they remain above their uptrend lines, gold stocks can be held. If however these lines are broken, I would exit gold stocks. refer to the XAU and HUI charts below:

The CRB or Commodities index is trying to hold onto the support at the 50 MA, it's uncanny how the 50 MA is acting as strong support. The CRB is in a critical zone at this point: If the CRB breaks the 50 MA, then gold will probably weaken, but if it can bounce, gold's strength will probably continue.

This chart is also a good example of how moving averages can act as support or resistance areas (Breakpoints). Keith and I typically include the 50 and 200 day MA's in our charts because of this reason.


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