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October 5th, 2003
Table Of Contents:
Click on the section titles below to be automatically taken to that section:
General Market:
The market put on a huge rally last week off support levels that were noted on the daily charts. Surprisingly, based on the market indicies and sectors, the market looks bullish here. The Nasdaq, DOW, and S&P 500 have all formed nice Horizontal Rectangle patterns with clearly defined horizontal resistance. Also, most of the individual sectors have formed bullish patterns as well. If these patterns are broken to the upside, then the market will likely rally much longer (the Nasdaq could go to the 2000 plus area, the DOW could go to the the 10000 area, and the S&P 500 could see 1100-1200) amazing! When Horizontal Rectangles are broken to the upside, an average price rise of about 20% can be expected see the education section.
I know that the economy isn't good; jobs are going overseas, a falling Dollar, Huge government deficits, unimaginable consumer debt (credit cards, mortgage, etc) and low savings, war in Iraq, etc. Also the PE ratios of the indicies are in the 30's and 40's, now where near the historical low of about 8 near market bottoms.
So yes, I agree, the fundamentals are horrible, however, the charts of the US stock market are currently bullish and that's how we should continue to play this Market, on the long side, via breakouts.
Interestingly, starting this month, the market will officially be in a Bull Market! Yes, a Bull Market I said. A Bull Market is defined by an average rise of 20% or greater in a years time, the Nasadq, DOW, and S$P 500 are all up over 20% since last October.
Now, don't get me wrong, this is not the end of the Secular Bear Market (which lasts greater then 10 years) this is simply a Cyclical Bull Market inside the long term Secular Bear Market. Cyclical Bull Markets typically last between 1-3 years.
Secular Bear Markets typically have 3-4 Cyclical Bull Markets inside them, but the overall trend is down when all is averaged.
In my April 20th 2003 Newsletter, I wrote the following about this current market rally possibly being the start of a Cyclical Bull Market
the following is from my April 20th 2003 Newsletter:
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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."
VIX analysis:
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 20s and lower, while overly bearish levels are in the upper 40' 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 forecast 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.
Current Analysis:
The VIX (now called VXO for some reason) fell hard on Friday because of the rally. It looks like the VIX could continue to fall to support at 18.80, which would provide more upside to the market. The question is, will the VIX find support at 18.80 again, or will it crash through it? What it does will tell us alot about the markets future trend.
1) If the VIX finds support, then the market may not rally to new dizzying heights.
2) If the VIX falls and breaks support at 18.80. then the market will rally to new highs and kill the 'perma bears'.
we shall soon see.....
Nasdaq:
Wow, what a week, as the Nasdaq put on a massive rally off support near 1780, as noted by the red dotted line below. This Nasdaq bounce was almost too predictable off this support area (I even went long QQQ's on Monday). However, I did not expect it to rally this much.
Anyway, Friday was the big day last week, as the Nasdaq gapped up on positive employment numbers to close up over 44 points on nice volume.
The market does not want to die: The Nasdaq looks bullish once again and is forming a Horizontal Rectangle pattern with resistance at 1915. If the rectangle is broken to the upside, then the Nasdaq will likely rally to 1950 and probably even to 2000 and possibly greater.
I know the economy isn't really all that great; jobs leaving and going overseas, a falling Dollar, Huge government deficits, unimaginable consumer debt (credit cards, mortgage, etc) and low savings, war in Iraq, etc.
So yes, I agree, the fundamentals are not horrible, however, the charts of the US stock market are currently bullish and that's how we should continue to play this Market, on the long side, via breakouts.
On the 60 minute chart below, you can see the gap that was formed on Fridays massive rally. This gap could be filled, but may also be the start of a new up trend yet again.
Also note how Positive Divergence signaled the coming rally last week.
Like the Nasdaq, the QQQ's which represent 100 stocks in the Nasdaq, likewise is a strong looking charts.
An objective price target is about $40, this is based on the 20% rule for Horizontal Rectangles (only if broken to the upside).
The chart below is the tradeable fund SMH which represents the Semiconductor Sector. The Semiconductor sector strongly affects the direction of the Nasdaq. Current, the Semiconductor sector looks very strong, it has maintained a nice up trend and has formed a Bullish Flag.
It looks like this flag may be broken to the upside very soon, this will cause the Nasdaq and the general market to rally to new highs yet again.
Also, SMH is a tradeable stock, therefore you could also go long with a stop under the 200 MA or the up trend line.
An objective price target is about $45, this is based on the 20% rule for Bullish Flags (only if broken to the upside).
DOW daily chart:
Similar to the Nasdaq, the DOW has also formed a Horizontal Rectangle pattern - resistance is at 9690. If this pattern can be broken to the upside, then the DOW may eventually rally to 10000, but resistance has to be broken first. However, this still seems crazy to me. For now, we should continue to play breakouts, but eventually the market will put on a large correction.
While the Negative Divergence two weeks ago correctly signaled the pullback in late September, it was a short one.
Of course the DIA Diamonds has an identical chart to the DOW chart, except that you can directly buy this stock through stock, options, or futures.
The S&P 500 daily chart:
The S&P 500 also looks similar to the DOW chart. It has formed a Horizontal Rectangle pattern with resistance at about 1040.
What's crazy, is that a potential price target is about 1200 if the rectangle is broken to the upside, but that is hard to fathom at this point. Oh well, anyway the chart is bullish, thus we should continue to play Long.
Below is a long term chart of the S&P, not if current resistance at about 1040-1050 is cleared, the next resistance zone isn't until 1175! Crazy, crazy, crazy.
The Small Cap sector is also strong has a similar pattern to the S&P 500. The Small Cap sector is important because if it is not strong, then the market will soon falter. However, as you can see below, the small caps are doing just fine.
The Materials Sector has nice consolidation with support near 21.5 and resistance at 23.35 to form a Horizontal Rectangle pattern Since this is also an ETF, you can directly by this stock.
The Financial Sector makes up almost 20% of the S&P 50 and is also strong, thus supporting the S&P if it should break out. The XLF can also be traded as a stock.
The Energy Sector is forming a nice Symmetrical Triangle that will bode well for energy stocks if broken to the upside. The XLE can also be directly traded as a stock.
The Utilities Index is very strong, with a nice up trend and a current price target of 22.80. The XLU can also be directly traded
As you would expect, the CRB commodities index is strong.
Part 2: Gold Analysis
Wow, what a vicious pullback in Gold last week as Gold pulled back over $13 on Friday to close at $370 - Negative Divergence correctly signaled this pullback. This pullback can be contributed to many factors, gold stocks themselves were getting way over extended and the US Dollar hit support and is put on a nice bounce on Friday.
Support for Gold metal is the either the top of the triangle or the up trend line at about $360. After such a larger fall, Gold will probably need to consolidate for at least several before it forms a nice base and attempts to run to new highs. In the short term, Gold may drop a little more, but I suspect an oversold bounce will happen any day.
Below is a plot of the gold metal on a longer term basis. Basically you see the same technical picture as above, but on a muli-year expanded view.
Here you can see the red up trend support line. Note that if ths should fail, then a fall to the blue line could occur, that would be ugly.
The current weakness in Gold was signaled by Negative Divergence in the MACD and should have served as a warning last week.
The chart below is the same chart as above, though plotted on a weekly basis. This chart leads me to believe that the current pullback in Gold is temporary. Note, that there is no Negative Divergence in the weekly chart. This tells you that the longer term up trend is intact and that this is probably just a normal pullback.
The HUI has really taken a fall, from a high of 213 to a close of 189 on Friday - this too was signaled by Negative Divergence. How far will it fall? There is strong support at about 175 and 158, however, I doubt it will fall to former resistance at 158.
Also of interest is that a possible bullish Falling Wedge is forming - however I'm not yet convinced of this pattern, we'll soon find out.
I took a look at individual gold stocks and many of them look like they need to consolidate to form tradeable patterns - which will take time. It's thus hard to imagine the HUI rallying back to new highs so soon. I personally would like to see more consolidation to form a stronger pattern.
On a long term weekly chart, the pullback in the HUI is hardly noticeable. The up trend remains strong and this is most likely a needed pullback in the strong up trend - Gold is in a Bull Market.
Unfortunately you cannot play the HUI directly like you can with the XAU, you can only play the stocks within the HUI, (components of the HUI)
The XAU has a similar pattern to the HUI above, however I think it is a much stronger chart and will not pullback as far. The HUI has had its run, the XAU might be the next big runner once Gold rallies again.
The XAU also took a big dip last week, though its chart doesn't look as over extended as the HUI did. The XAU is near support at 89.10 of a multi year Ascending Triangle. I suspect that the XAU will be the next big runner.
The US Dollar:
The chart of the US Dollar below is amazing to me, as it has formed 4 Bearish Flags in a row.
The US Dollar hit support last week but put on a nice bounce on Friday, thus causing weakness in Gold.
I think the Dollar will eventually break it's support level at 91.80, however it could put on large bounce first, with the first resistance level at about 95. Also, one could also argue that this is a double bottom? I doubt it, but it could put on a decent rally, which would likely give Gold time to consolidate and form a tradable pattern again.
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