Broad Stock Market Looking Healthy; Internet Sector Still Looks Weak

April 30, 1999

The broad U.S. stock market continued to show its underlying strength last week in the face of a bearish near-term technical picture. We had fully anticipated a sharp correction in most of the major stock indices, but instead we witnessed a display of raw power and overwhelming liquidity as stocks simply refused to trend lower. It now appears our long-standing forecast of an exceedingly bullish spring is still on target, and at this point any correction in the broad market will only be of brief duration and of inconsequential amplitude.

The Dow Jones Industrial index gave investors a scare last week after registering what looked to be a bearish topping pattern known as a "key reversal," which occurs when prices make an all-time high intraday only to fall back and close below the previous day's close (see our book, Technical Analysis of the Internet Stocks). When this occurs on high volume—which last Monday's trading on the NYSE did—it becomes even more ominous and almost always guarantees a reversal to lower levels. Yet the Dow simply refused to give an inch to the downside and held its own to hover within points of its previous all-time high by the end of the week. As of this writing (April 26) the Dow is millimeters away from a new closing high.

Further adding to this picture of strength in the broad market is the runup in the Dow Jones Transportation index which is now challenging its previous all-time high made last spring. This resurgence in the previously lagging Transports adds technical strength to the Dow Industrials upmove and provides a classic Dow Theory confirmation. Along with the Dow Jones Utilities, which also have been lagging but have shown signs of perking up lately, the overall outlook on the NYSE is consistent with what we would expect a firm bull market to be at this stage of the profit cycle.

Even more bullish last week was the NASDAQ Composite index which challenged its previous all-time high and today (April 26) set a new record, closing at 2652. Since this index contains most of the major tech and Internet stocks it is very important that we see strength in this index. On Monday alone, upside volume exceeded downside volume by a ratio 5 to 1, one of the best showings we've seen on the NASDAQ in months! This is a very bullish sign.

Equally bullish has been the pickup in the ratio of new highs-to-lows, which is now positive (after having been negative for much of the winter), as well as an improvement in market breadth on both the NASDAQ and the NYSE.

Cumulative volume readings for both indices remain positive. The CVI index for the NYSE—one of our number one indicators for determining market direction—is in the most bullish position it has been since last fall and is on the verge of exceeding its previous peak. This indicator, more than any other, lets us know where the money is flowing in the market. As any good technical analyst knows, it is money flow (or putting one's money where one's mouth is) that determines market direction more than anything else. As long as more money continues to flow into the broad market than out, the bull market will remain intact. Thus far this has been the case.

All the trendlines in the major indices remain unbroken, and momentum is clearly on the side of most U.S. equities at this point. Some exceptions exist, but they are in select sectors—most sectors in the U.S. stock market are in good shape.

Major support levels to keep an eye on at this point include the 10500 and the 10100 levels in the Dow, and 2632 and 2500 in the NASDAQ.

One of the most bullish features of the equities market is the surprising technical strength in the international markets. The strong upmoves in the stock indices of the Pacific Rim countries, as well as the nice recovery of the Russian stock index, the Hang Seng, the Nikkei and many others, leads us to believe that any pullback in the domestic market will be of a shallow nature and nothing to worry about. A bullish overseas market outlook is a strong confirmation for the U.S. market.

Now for the bad news. The Internet sector, as measured by our ISO Internet Index (a composite average of AOL, Dell, Amazon, Yahoo and Microsoft—the leading Internets), is looking weak and could commence falling at any time. It appears that some sort of distribution campaign is underway—perhaps designed to shake out the weak hands so that the stronger players can step in and buy back shares at lower prices. Whatever the reason, we see definite signs of distribution among the leading Internets. Trading volume for these stocks has been uncharacteristically weak during times when prices have been zooming higher—a bearish divergence. We advise lightening your exposure to the Internets at this time. The good news, of course, is that the strong overall U.S. and world equities picture should shield the Internets and tech stocks from any significant downturn; thus, the coming correction may only be of the minor variety. According to information provided by TrimTabs.com, estimated inflows for all equity funds had were $1.2 billion over the five day week ended Wednesday, April 21, 1999, vs. inflows of $5.1 billion during the prior week. Equity funds that invest primarily in U.S. stocks had inflows of $2.4 billion, compared with inflows of $4.9 billion during the prior period. While these figures are bearish on a very near-term basis, they by no means constitute a trend as the overall trend for mutual fund inflows is up. Nevertheless, we must be on guard against the possibility for a minor correction in the days ahead. All in all, the outlook for U.S. equities remains bright in the weeks ahead. Longer term, we look for the market to turn down hard in mid-to-late summer. The market has followed a definite pattern for each of the last couple of years whereby we have a market consolidation in the winter, an exceedingly bullish spring, a top in the summer and a mini-crash in the fall. This time, however, the crash will be for real as we are nearing the end of the great Supercycle bull market. The long-awaited crash scenario becomes a very real possibility once the blow-off phase of this market has reached maximum resolution, probably by fall of this year.

Why technical analysis is essential to price forecasting.

In the April 26 issue of the Wall Street Journal an article appeared on page B16, entitled "Chock Full O'Nuts Executive Draws Fire For Not Disclosing Sara Lee Overtures," is a case in point why an understanding of technical analysis is essential for predicting moves in stocks.

The article explains how the failure of Chock Full O'Nuts Chairman Norman Alexander furtively purchased half a million shares of his company without disclosing that the company had been the recipient of repeated buyout overtures from Sara Lee Corp. Naturally, shares of the stock skyrocketed on news of the buyout.

Calls were issued for his resignation by angry investors who were incensed that he could conduct an insider buying campaign without informing them via SEC reportings. These investors could have easily spotted the insider accumulation in Chock Full O'Nuts and bought shares in the company in time for the blastoff if they had possessed an understanding of good old fashioned chart reading. The chart for CFN took on the appearance of a classic "saucer bottom" formation—an accumulation pattern—at least several weeks before the buyout was announced.

With technical analysis you don't have to meticulously scan SEC filings and corporate prospectuses in order to profit from a strong stock. All you need to know is what the chart shows you. That alone will go far in allowing you to profit from the stock market. That is why we wrote Technical Analysis Simplified.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including most recently “2014: America’s Date With Destiny.” For more information visit www.clifdroke.com.

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