October Massacre Approaches

October 5, 2000

The termination of the 18-year-old equities bull market that we predicted for the September-October time frame is coming to pass. We have warned you since January that this fall would witness the most severe and cataclysmic stock market collapse since 1929, if not greater. That scenario is about to be realized. The fatal plunge should commence within two weeks of the time of this writing and will continue—with intermittent reactions—into November. Indeed, it will be most interesting to see if another of our earlier predictions will come to pass, namely that the U.S. presidential elections will be suspended when things get out of hand.

 

Nearly every technical indicator is sending an unavoidable premonitory warning to stay away from the stock market right now. The erosion in the current market from both a price and a volume perspective is nothing less than atrocious. While certain sure-fire short selling opportunities do present themselves, the most prudent posture right now is one of non-committal on either side of the market.

W.D. Gann, in his classic work, Truth of the Stock Tape, wrote the following bit of wisdom that we can all profit from: "Remember that wild, active markets are brought about by feverish manipulation, and that they increase the imagination, exaggerate your hopes, and take away all sense of reason and proportion. Therefore, in extreme markets try to keep a cool head. Remember that all things come to an end, and that a train going 60 miles an hour will cause a greater smash-up if it leaves the track than one traveling 5 miles an hour. Therefore, in a wild runaway market, jump before she bumps, for you will never be able to get out once the crash comes. When everybody wants to sell, and non one wants to buy, profits run into losses fast."

The internal indicators represent the essential propelling forces behind the tape itself. Consider the all-important cumulative volume momentum indicator—our most accurate. This indicator (which we aptly refer to as VOLMOM) is based on the principle that volume precedes price, and is constructed by subtracting declining volume from advancing volume on the NYSE, then making it into a rate of change oscillator. This indicator not only shows accumulation versus distribution, but also the momentum behind the buying and selling patterns on the NYSE. Right now, this indicator has deteriorated markedly, falling to a multi-month low by late last week. This indicates an inordinate amount of selling pressure on the exchanges. The 5-day VOLMOM has bounced higher, indicating immediate-term buying strength. However, the far more important 21-day VOLMOM, a measure of the intermediate-term trend, shows extreme weakness, having collapsed to a one-year low. Clearly, the insiders are unloading like there is no tomorrow. And if our analysis is correct, there is no tomorrow.

The advance/decline line on both the NYSE and the NASDAQ have also turned down after rallying impressively into summer. The internal erosion is even worse when viewed from a rate of change perspective. The NYSE new high-new low momentum indicator (which we call HIMOM), a reflection of the incremental strength of the market, has shown its lowest reading in several months, which reflects the strong selling urge among most investors. It also shows that the big blue-chip leaders are no longer leading the market. The HIMOM indicator measures the proverbial "last Indian standing." Even when distribution is widespread and market breadth is deteriorating, a high reading in the new highs/new lows index can keep the market afloat for some time. But when HIMOM starts to erode, the market has lost its last pillar of strength.

Take a look at the chart pattern of the NASDAQ 100 tracking stock, the QQQ. As prices have tried consistently to rally, each top has failed to reach the high set last winter. A fanline retracement, which involves drawing three successive lines on the chart with the top as a reference point, has acted to contain prices with the QQQ failing to penetrate the third fanline. Unless this fanline is penetrated, indicating that the bulk of the overhanging supply has been absorbed, there can be no continuation of the uptrend in the NASDAQ.

Notice also how trading volume has tended to taper off since the all-time high earlier this year. This same volume pattern can be seen in a number of actively traded stocks on both the NASDAQ and the NYSE alike. Each rally attempt has occurred on successively lower volume. This diminishing tendency in trading volume is a sign that the bull market is fast losing its legs.

It is true that the NASDAQ rallied nearly 200 points off its session lows last week on very high volume. Yet even this strong rally attempt could not close the NASDAQ above the previous day's close, and while the volume was high it did not match the volume extremes seen at other NASDAQ turning points in recent years (notably October 1998). And most of this volume was selling volume.

Interestingly, the mid-point of this parabola occurs at the last Kitchin Cycle (a.k.a., Business Cycle) bottom of 1994. This 3-4 year cycle, from which the 3-4 month cycle is a derivative, is due to bottom next early next year, yet another reason we believe the markets will be crashing into 2001. We have preached all year our belief that the markets would crash in either September or October, and it would appear this prediction is coming to pass. However, if there is one thing we have learned in recent years it is that anything can happen in a market environment in which so much is at stake. Literally, the entire future course of the nation is riding on the back of this market, so it would be foolish to assume the manipulators will simply stand aside and watch it crash. Assuredly, every effort will be made by them to keep this market afloat until the last possible minute when the long-wave economic cycles take over and steal the show.

From a short-term level, the chart of the NASDAQ tracking stock—the QQQ—shows a parabolic bowl formation, along with an intermediate-term upward trendline. The bowl allows for a low near the 87-88 area, while the trendline will support a decline to 84-85. It appears that this supporting floor will be soon broken.

The most critically important of the NASDAQ stocks, as we continue to point out, is Cisco Systems (CSCO), also the most actively traded and one of the most highly capitalized of the tech stocks. The new "old" saying is: "What good for Cisco is good for the NASDAQ," a sentiment with which we concur. If this market is to have an opportunity of advancing, Cisco must lead the way. We have already seen evidence that Cisco is enjoying institutional support right now, as every time its critical support zone is tested, heavy buying volume comes in to prevent a Cisco sell-off. However, Cisco is testing the outer rim of its parabolic bowl formation, and it makes us very nervous to note how trading volume picks up whenever this rim is touched, yet Cisco's price does not jump significantly. This is not the typical behavior of a stock firmly entrenched in a bull market. We make no judgments as to whether Cisco is about to undergo a major sell-off, but the fact that volume increases whenever the side of the bowl is met indicates we have correctly drawn the parameters of the bowl. A strongly "juiced" bowl should act as an electrical charger to boost prices considerably higher whenever the rim is touched. When this doesn't happen it is a sign that upside momentum is waning. It will take a tremendous amount of buying volume to push Cisco higher.

From a Dow Theory perspective, the Dow Jones Transportation Average is showing signs of weakness by failing to hold above its supporting floor of 2600. This important area has tended to mark the precise bottom of the 3-4 month cycle in the Transports for the past year. Last week did in fact witness a conspicuous spike in trading volume just as the Transports were approaching 2600 (volume, it will be remembered, always precedes price). We assumed that this volume spike would mark the bottom of itsintermediate cycle, yet the Transports have failed to rally after penetrating this level. A basic tenet of Dow Theory is that the Transports lead the Dow since the transportation sector is the backbone of industry and a critical component to our nation's financial health. The Transports subsequently failed to clear 2600; in fact, the index has fallen off sharply since then. This does not bode well for the U.S. business outlook.

Ford Motor Co. (F:NYSE) is the stock to watch on the NYSE transportation list It displays a massive contracting triangle pattern on its chart and it appears on the verge of a breakout, in one direction or the other. A breakdown through the supporting floor of $23 would be bearish. Ford could well be the stock that determines the fate of the Dow Jones Transports, and by extension, the U.S. industrial sector.

From a longer-term perspective, the U.S. economic outlook is bearish. The clearest proof of this is the chart showing the rate of change in the U.S. monetary base. The chart highlights the momentum of this long-term economic measure. The chart for the monetary base, as you can plainly see, is outright crashing and has just fallen to its lowest point (from a rate of change perspective) since 1981—the last time this country witnessed a serious recession. While the monetary base, which measures the amount of currency and coinage in circulation along with deposits at Federal Reserve banks, is not as important a measure as the M3 money supply itself, it nonetheless underscores a developing trend that few are cognizant of, namely, that deflation—and not inflation—is the underlying predominant force in the physical economy (notwithstanding pockets of inflation in the consumer markets). When the markets collapse under the weight of converging cycles of varying timeframes this month, it will leave huge collateral gaps due to the enormous debt that now exists. Since this debt must ultimately be serviced, the demand for money—once the dust finally settles—will be immense. With little physical money left in the economic system (as measured by the monetary base) one can only imagine what the consequences will be.

Our long-term investment stance remains unchanged: maintain heavy reserves of cash, along with an adequate hedge of precious metals. Safety should be our biggest priority. Positions may now be taken in the Rydex Ursa or Tempest Funds (the latter is 200 percent leveraged against the S&P 500 and provides a far greater potential for return than Ursa). Get ready for the biggest financial crash since 1929, a crash that will usher in a crisis of millennial proportions.

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.

The volume of all the gold ever mined can occupy a cube 63 feet on each side.

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