Indicators Still Weak Top may have been Seen

August 11, 1999

The U.S. equities market last week resumed its technical weakness but provided further clues as to where its intermediate-term trend may be pointing.

For the week the Dow Jones Industrials finished at 10714-59 points higher than the previous week's close. The NASDAQ Composite finished at 2547-91 points lower than last week's close. The Dow Transports finished at 3220 and the Dow Utilities closed at 318.38.

In a word, the predominant characteristic of trading over the past two weeks has been that of a churning market. On any given trading day a number of leading stocks could be pushed higher on high volume only to fall by an equal or greater amount the following day on equally high volume. It has been nothing less than an all-out tug-of-war between the bears and the bulls. This is the type of activity that typifies major tops and precedes big declines.

Our belief that the U.S. stock market is near or at its peak is manifest in the charts of several listed stocks on the exchanges. A great number of them-including the indexes themselves-are tracing out classic head and shoulders patterns. This strongly implies that stock prices have seen their highs and that the distribution process is nearly complete.

The S&P 500 index is tracing out on the charts what appears to be a classic broadening top pattern. This same pattern (with minor variations) can also be seen in the charts of several actively-traded industrial stocks, most notably Union Carbide, which saw an extraordinary amount of trading activity last week on high volume (one could almost say "blowoff" volume).

Our leading technical indicators are still flashing sell signals and are telling us to stay away from the long side of the market. Market momentum, as measured by the 10-day and 30-day Rate of Change (ROC) indicators is still in a downward trend; however, a corrective bounce in the stock market could be expected this week due to the position of these indicators. The 30-day ROC is actually above its equilibrium line, which is technically bullish. Ten-day ROC is still well below zero, but is beginning to turn up slightly and is above its 10-day moving average. This implies that short-term cycles are bottoming and are beginning to turn up in the market's favor.

Volume, as measured by 5-day NYSE advancing and declining volume, is confirming the downward trend in price and is therefore in a bearish position. Cumulative volume, as measured by the CVI, is falling rapidly out of a bearish rising wedge pattern. The weight of evidence is clearly on the bearish side right now.

What, then, does this mean for us as investors? Should we buy into the market as long as momentum is on the market's side? In this case, we would answer in the negative. When volume patterns are net negative and point to distribution, we should use any uptick in short-term momentum to establish short positions. As a note of caution, we would add that this should be done very carefully.

One thing that gives us a broader perspective of the market's technical position is to look at how the leading mutual funds are trading relative to the broad market. For instance, a leading hedge fund-the Rydex Ursa Fund, which is inversely correlated to the S&P 500-is tracing out on its chart what looks to be a rounding bottom pattern. The Ursa Fund is also trading above its 30-day moving average, has a positive MACD and shows a bullish momentum chart. In other words, based on the technical patterns visible in the Ursa Fund's chart, the broad market is in a bearish position. Conversely, the Rydex Nova Fund-which tracks the S&P 500 with a positive correlation-is currently in a bearish position, trading below its 30-day moving average and showing a bearish MACD and momentum indicator. This also confirms that the broad market is in a weak position. The prudent course in this case dictates that we should shy away from long commitments until the market gives us a bullish confirmation to do so. The wise thing to do is either stay 100% in cash or enter selective short positions (we are still not ready to go fully short).

The Internet Fund (WWIFX) is likewise in a bearish position relative to the broad market. It is currently in a downtrend, is trading below its 30-day moving average, and has a bearish MACD and momentum indicator. Avoid (or sell short) this fund for now.

The Internet sector itself is still flashing mixed signals but is technically in bearish territory. We should avoid long commitments to this sector until things clear up. There has been a tremendous amount of churning activity in the leading Internet stocks over the past two or three weeks and this could be a sign of distribution, though we really won't know for sure until the tape clears up enough for us to get a decisive reading. There is simply too much chaos and confusion among the nets right now and this alone is reason enough to stay safely on the sidelines until we get a clearer signal one way or another.

Confirming the bearish trend in the U.S. equities market is the Treasury bond market, which continues to see rising yields (and falling prices) in the face of a rising interest rate trend. Yields in the 30-year T-bond have been in a rising trend since last fall, and rising yields typically serve as a leading indicator for the U.S. stock market. In this case the rising bond yield serves as confirmation of the bearish trend in stocks. Further confirming the bearish equities trend is the falling dollar and the increasingly bullish tenor of commodity prices, coming off of a long-term falling trend.

Indeed, bearish signals are numerous and provide sufficient reason why we should avoid the long side of the stock market for now.

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 www.clifdroke.com.

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