2003 LOOKS BETTER THAN LAST YEAR
BUT STILL AWAITING MONTHLY BULL SIGNAL
John J. Murphy
SOME MONTHLY SIGNALS ARE POSITIVE -- EXCEPT FOR MACD LINES... What better time to review the market's longer range trend than the start of a new year - and after three years of decline. We think the best way to do that is to look at monthly charts -- and their accompanying technical indicators. We're applying four of our favorite technical tools to a monthly S&P 500 chart. The good news comes from our two momentum oscillators -- RSI and stochastics. The 14-month RSI line has been dropping throughout the three-year bear market. However, it's starting to rise again from oversold territory under 30. The 14-month stochastic lines have turned positive from oversold territory under 20 (and show positive divergence). That suggests to us that the downside momentum which characterized the three-year downtrend has abated enough to at least stabilize the market. That leads us to believe that the coming year may not be a great one, but it will probably be better than any of the last three. Our main attention, however, is focused on the monthly MACD lines (under the price chart). The MACD lines are slower to cross than stochastic lines, but their crossings are more reliable -- and longer lasting. The MACD lines turned bearish at the start of 2000 -- and have remained bearish since then. The MACD histogram (which measures the difference between the two MACD lines) is rising -- which is often a prelude to a bullish crossing. However, that bullish crossing hasn't happened yet. We think that's a necessary ingedient in a technical recipe for a major market bottom. The monthly price bars are also stabilizing above their lower Bollinger Band. To reverse the bear trend, however, the S&P price has to exceed the dashed middle line, which represents the 20-month moving average. We suspect that the coming year will probably be more flat -- than down or up. That, however, will still be a better environment than we've seen since 2000. We also believe that environment will lead to better trading opportunities in certain stock sectors and industry groups -- as well as individual stocks. Our job in the coming year will be to find those profitable situations. We also think bonds will underperform stocks this year.

BONDS ARE PEAKING... Since 1998, bonds and stocks have been moving in opposite directions. If that trend continues this year (which we suspect it will), any strength in stocks should be accompanied by weakness in bond prices. The bond chart seems to favor that conclusion. This year's rally in bonds has run into a stiff resistance barrier at its 1998 peak -- and has shown signs of weakening. The monthly RSI and stochastic lines are showing negative divergence from overbought territory. The monthly MACD lines are still positive, but are well below the levels hit in 1998. We take that as another sign of negative divergence. Another negative factor for bond prices is the sharp rise in commodity prices.

COMMODITY RALLY BAD FOR BONDS... The CRB Commodity Index bottomed late last year and bounced off its previous low hit in early 1999. After rising throughout the year, the CRB Index broke through its year 2000 high during the fourth quarter. That's a signal that commodity prices should continue to climb. Historically, rising commodity prices have coincided with rising interest rates -- and falling bond prices.

FROM DEFLATION TO REFLATION -- A WEAKER DOLLAR... Throughout the past year, the main threat to the financial markets came from deflation. We think that threat (which came from Asia) helped explain why lower interest rates didn't help stocks throughout the entire bear market. In a deflation, bond prices rise while stocks fall. With commodity prices now on the rise, the threat from deflation appears diminished. The new word this year will be "reflation". That arises from steps taken by central bankers to fight off deflationary tendencies from falling prices. We suspect part of that strategy has been allowing the dollar to fall. A falling dollar helps push commodity prices higher (especially gold). We expect the dollar to weaken throughout the year. That should keep a floor under commodity prices, but should be bad for bonds. A weaker dollar should also be a depressant on the stock market. While that probably won't push stock prices to new lows, it may be enough to prevent a major stock market advance this year. The final chart shows the Dollar Index breaking a rising support line in effect since 1995. While the monthly stochastics lines look oversold, the monthly MACD lines are firmly bearish.


January 6, 2003

John J. Murphy, CNBC-TV's technical analyst for many years, and Greg Morris offer money managment and market services at MURPHYMORRIS.COM , email address orders@murphymorris.com.