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Dow Turning Point Ahead?

December 22, 1998

For market technicians, the single most crucial and sought-after skill is the ability to discern and forecast turning points in market trends. To a pure technical analyst, being able to consistently find turning points just before they actually occur (or very shortly thereafter) represents the crowning achievement of our trade, the ability for which we all aspire. So it comes as no surprise that the obsession of ever serious technical analyst at the present time is to try and find a turning point in this extremely overbought and seriously overvalued market. And we believe we are on the very threshold of just such a turning point, and in fact, it may have already occurred.

In our last letter, we surmised the Dow may have already begun the second phase of the bear market which technically (we believe) began this summer. During the past four weeks the Dow has proceeded to trace out five distinctive Elliott Waves downward to complete what we interpret to be the first "leg" of the second phase of its bear market. At the moment, the Dow is in a minor corrective mode and rose the better part of last week to gain approximately 200 points from the previous week. The Dow closed for the week of Dec. 14 at 8903 (reaching an intraday high of 8928 for the week).

The Dow Jones Transportation Average likewise closed higher after a precipitous decline last week, recovering nearly 150 points to close for the week at 3009. The Dow Utilities, likewise, also closed higher, breaking away from a multi-week consolidation pattern to finish at 313.29 at the close of Friday, Dec. 18.

What does all of this imply? For weeks now—ever since the Dow and most major U.S. equities indices bottomed in September—we have all been inundated by a multiplicity of market opinion (from highly respected analysts, we might add) ranging from a Dow 14,611 to a "sideways" Dow to a market crash. It has been exceedingly difficult to gain a firm grasp of this market with so much divergence of opinion (not to mention actual technical divergences) and we confess our confusion as well in the early stages of the market's autumn rally. However, we are now firmly convinced that we have arrived at a firm grasp as to where the Dow may be headed in the weeks ahead. And our stance remains firmly bearish.

At first glance, some bullish potential still remains in some of the broad market indices. The Nasdaq composite index, by far the most bullish of all the major indices, looks to still be headed higher in the next few days. Its intraday chart of Dec. 18 showed a bullish flag continuation pattern that should carry the index to around the 2100 market at best. However, the one-year line chart for the Nasdaq shows what appears to be an upward-sloping broadening top currently in formation (which translates into a complex head and shoulders top). This forecasts a reversal lower in the very near future—perhaps as soon as late December/early January.

The Wilshire 5000 index—a broad, unweighted measure of the health of the entire U.S. business sector—shows an even more clearly developing complex head and shoulders pattern with a slightly uneven inverted triangle currently in development. Since this index fell this summer in a clear Elliott Wave five-wave downward sequence, we assert a bear market is technically underway in the Wilshire 5000, recent highs notwithstanding.

The Russell 2000 small-cap index, up to now one of the most bearish of the indices, has performed quite bullishly in recent weeks (the index was up 3.64% on Friday alone) and could well be headed higher based on the apparent rectangle formation in its chart. This pattern, which represents consolidation, means one of two things: a sharp breakout to the upside or downside. Usually, such patterns are of the continuation variety, meaning that prices will continue higher once the consolidation stage has reached resolution. However, they occasionally forecast declines (as Edwards & Magee inform us). If the Russell 2000 is to move higher, it will probably achieve a double top at its previous all-time high based on the minimum measuring implications of the current pattern. However, since the 50% retracement level has been reached it may well represent a turning point. Time will tell.

The Dow Jones Transportations have also traced out a clear five waves down from their previous all-time high and appear to have stalled out at the Fibonacci 62% retracement level—a psychologically important one. Successive attempts at overcoming this barrier ended in failure and the Transports fell nearly 300 points before recovering approximately 50% of those losses during last week. The Fibonacci 50% retracement level at approximately 3017 was nearly reached on an intraday basis last week (the 62% retracement level lies at approximately 3051), so perhaps the Transports will now stall out and continue their previous decline. If that is not to be the case, the Transports may retrace all the way to the 3158 level—the 62% retracement of its entire fall from its previous all-time high of 3701 (we were mistaken in previously labeling 3106 as that level). And, as in the other indexes, the Transports appear also to be tracing out a complex head and shoulders pattern that further adds to the weight of evidence that this index has seen its bear market rally high.

Finally, the Dow Industrials are tracing out a clear, albeit compact, head and shoulders topping pattern that appears to be already completed. The pattern is clearly delineated and volume action on each of the "shoulders" and the "head" has been as it should be (i.e., most volume on the left shoulder, lower volume on the head and right shoulder). The neckline has been penetrated already by at least 3% (an Edwards and Magee sell signal) and a bearish flag (possibly a wedge or pennant) is currently forming with implications for a further decline once the pattern is completed. The minimum measuring implications of this head and shoulders formation in the Dow (if indeed it is an H&S) is a Dow of 8300-8400. This would bring the Dow down to a previous level of consolidation chart support where it would likely form another consolidation before continuing its decline to even lower levels.

From a socio-cultural perspective, we continue to note the bearish currents of mass psychology currently surrounding the globe. Several conspicuous developments in recent months smack of a gradual change in investor psychology from bullish to bearish. As previously pointed out, the NBA basketball strike is one such leading indicator of a change in psychology (the last such strike occurring in 1929—the year of the Wall Street crash). Hemlines in women's clothing are falling—another historically reliable bear market indicator.

And, most recently, we note that relationships between men and women are changing. For instance, U.S. News & World Report recently carried a cover story dealing with "office romance" and how, throughout corporate America, "men and women are still finding romance in the workplace despite cultural taboos and political correctness." In the Dec. 16 Wall Street Journal a front page feature article detailed the "second career" of a successful female entrepreneur who is literally spending all of her time and efforts at finding a husband, while treating the hunting process like a business venture. During the '80s and '90s bull markets it seemed that all the emphasis was being placed on putting the career first ahead of dating and family life. It may be too early to tell, but this could be reflective of a change in social mood commensurate with a bear market. Bob Prechter and Pete Kendall, two market analysts who also specialize in relations between popular culture trends and investor psychology, have pointed out that bear markets typically bring men and women closer together, while bull markets keep them farther apart. This trend towards men and women "coming together" then could well represent just such a change.

One further indication of a change in mass mood is the growing trend of interest in religion, especially among teenagers both here and abroad. A recent newspaper article carried a story explaining the growing devotion of Hispanic teenagers to their native Roman Catholic religion after decades of ignoring it. In the Dec. 18 edition of the Wall Street Journal, an article entitled "Rebels With a Cause" examined the increasing trend toward church attendance among American youth—long renowned for their materialism and shunning of traditional religion. Bear markets are characterized by introspection and an emphasis on the spiritual (in contrast t bull markets which emphasize the material and are characterized by ebullience and extroversion). Son once again we have evidence of a change in mass psychology commensurate with a bear market.

Finally, we would be remiss if we did not comment on the latest development in the ongoing Clinton impeachment saga and Iraqi conflict. Many of our readers have sent e-mails expressing incredulity that the Dow could keep rising in the face of impeachment hearings (the first in 130 years) and the bombing of Iraq. We respond by asserting that the stock market—that veritable crystal ball that discounts everything (outside of acts of God) in advance—has already responded to the impeachment hearings and Iraqi war—regardless of their respective outcomes. The stock market (unlike the humans which aggregately compose it) is not reactive in nature. It does not respond to exogenous events such as current news and developments. It anticipates them and responds before the events even happen. So perhaps the Dow's summer decline was the result of the Dow foreseeing the impeachment of Bill Clinton (at least in some measure) as well as the Iraqi conflict. And perhaps the Dow's subsequent rebound to new all- time highs was the result of the market's foreseeing a positive resolution to these negative events (whatever that may be). Only the future will tell us for certain. But for now, we remain satisfied with the "bloodless verdict" that only the market can return and which cannot be influenced directly by current news events regardless of their import. And while the markets may have sent a positive signal this fall, it is beginning to look like the market sees something very negative on the horizon.

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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