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Dow Jones Still in Distribution; Investors Still Enamored with Market

July 4, 1998

Stocks continued sideways last week as the ongoing, multi-week distribution phase of the equities mania continued apace with enlightened pros dumping shares on the benighted masses who constitute the buying segment of the market. This distribution pattern, which we have described at length in recent issues, should be considered the terminal phase of the 20-year-old bull market in equities. How much longer it will last before completing we won't venture to guess, but it could happen at any time now.

Market action of recent days, particularly in the S&P 500, has made us a bit nervous and we confess to wavering momentarily in our prediction that the bull has ended. Nevertheless, we continue to "bite the bullet" and hold firm to our assertion that the bull market is technically over and is merely distributing prior to the inevitable collapse. Admittedly, this is a brave and potentially foolhardy stance, especially considering that market analysts of greater stature than us are predicting one final run to new all-time highs in the indexes before the long-overdue crash. Still, our instincts—cultivated from countless hours of watching the ticker—tell us the end has nearly arrived and the highs for this bull market are in place. We'll all know whether this assessment is true or not by week's end. If, as many analysts predict, the market makes one more move to the upside to new highs, the bull market will probably be prolonged until summer's end.

A number of distinct and very bearish topping formations have appeared in several key indices over the past few weeks, as we continue to point out. Investors Business Daily's Mutual Fund Index has registered a head and shoulders top and is currently trading below its 50 day moving average while barely trading above its 200 day moving average. The relative strength indicator for this fund index compared to the S&P 500 is also looking bearish.

R.E. McMaster, editor of The Reaper newsletter, points out that most mutual funds topped out months ago and are actually in the infant stages of what could be classified as bear markets. The same can also be said for the majority of stocks on the NYSE. McMaster points out that 80 percent of them are down 10 percent or more from their 52-week highs while 56 percent are down 15 percent or more. On the NASDAQ, 87 percent of stocks are down 10 percent or more and 73 percent are down 15 percent or more. That translates into a loss of $600 billion of stock values in the past two months! The index showing the cash-to-asset ratio of stock mutual funds is at its lowest level in 22 years, also a bearish indicator. Most astonishing, the Bradley Long-term Model of the stock market is calling for a top in the U.S. stock market this month, according to McMaster.

Another stock market index which shows a head and shoulders top is the Value Line index. This, coupled with H&S tops in the NASDAQ index and the Russell 2000 index make a very compelling case that the bear market in U.S. equities is already upon us, though in a largely unrecognizable form to most investors. Indeed, Robert Prechter of the Elliott Wave Theorist has stated that the fall in the Russell 2000 index and the substantial drop in the advance-decline line confirm that small stocks have begun a bear market.

Overseas, the Tokyo Nikkei index has experienced a considerable run-up of late, coming off of recent lows below 15,000 to register a close of 16,511 on Friday, June 16. Hong Kong's Hang Seng index fell 226 points to close at 8,639 on Friday after enjoying a minor runup of several hundred points during the previous week. While it may seem that the Nikkei is recovering from its recent spate of declines, do not be thinking that the bear market is over for Japan. We see this recent price action as nothing more than a bear market rally and we fully expect the see at least one more significant move the downside to register a new all-time low before the Nikkei can truly be considered to have found a bottom. Short sellers should begin looking for entries to profit from these latest attempts to rally. On Japan's fiscal front, bankruptcies were up 26 percent in April from 1997 and the country's economy has contracted by 0.3% for the fiscal year ended March 1998, the first such downturn in 23 years. Japan is entering what is shaping up to be a severe recession which will have profound consequences for them, the Orient, and before long, the entire global economy. In what one analyst called a "leveraged Ponzi scheme," the IMF loaned Japan a $125 billion "stimulus" package designed to bail out their troubled financial sector. Bob Chapman of the International Forecaster predicted the package would help "for three months" and pointed out that the $230 billion stimulus package of six years ago did not accomplish the desired goal. Chapman predicts a weaker yen, which will lead to a second Asian crisis and even more bankruptcies and defaults. He summarized it well in stating, "Japan has a structural systemic problem, which is what plagues the entire monetary system."

Elsewhere on the international front, Russia has entered a gut-wrenching bear market and may prove to be the proverbial straw that breaks the camel's back as far as the global financial structure goes. The Russian Times Index has fallen dramatically over the past several months and is now entering a critical stage where further devaluation threatens the solvency of the entire country. The IMF recently released a $670 million rescue package for the country but further relief could be stalled for several months. As Russia or Brazil goes, so goes the rest of the third world. Keep your eyes steadfastly on this volatile country in the weeks ahead. In closing, we make a general observation concerning the state of the U.S. economy. Do not be fooled by the recent low unemployment figures which purportedly show the lowest unemployment rate in U.S. history. As we have pointed before, this phenomenon is attributable to statistical shenanigans and accounting trickery more than anything else. Rust Belt states which reflect the health of industrial manufacturing in the U.S. have been carefully deleted from the federal government's model of counting unemployment and the number of respondents queried for unemployment has been cut drastically, giving a misleading picture of the working sector. Further, our industrial base has been severely eroding over the past several years with countless manufacturing jobs either disappearing or heading overseas or to Mexico; thus, an important element of our economic strength has been destroyed. The National Association of Purchasing Management Index, which measures manufacturing in the U.S., has registered a head and shoulders top and has been sliding for more than a year which portends a weakening economy. Most jobs in the U.S. are in the low-paying service sector which is extremely dependent upon a strong economy for continued growth and sustainability.

Recent debacles in the transportation sector—the General Motors strike and the Union Pacific/Southern Pacific railroad logjam being the most notable examples—are further eroding our country's economic strength. It won't be long until all of these problems begin manifesting in the general economy the stock market to a large degree. When it does, the facade of economic growth and prosperity that we have enjoyed for so long will finally be stripped away and the true condition of our country will be revealed. Will you be prepared?

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 “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit

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