Recovery may be Afoot

October 27, 1999

We turned temporarily bearish in last week's newsletter, but it is beginning to appear as though our bearishness was unjustified. The past week in stocks was an extremely volatile one-probably the most volatile week since last October. Unlike last year, no clear-cut buy signal has been given in the form of a major technical reversal. At this time a year ago it was the Fed's interest rate cut that signaled the resumption of the major bull market. This time around there has been no such resounding event to signal the bull's resumption. However, a number of subtle, yet distinct, technical signals are being flashed across the board-particularly in the Internet sector-that would justify taking a more positive stance on the market.

There is an old adage on Wall Street that says that every bull market must climb a "wall of worry" in order to be sustainable. What this basically means is that the insiders and manipulators who engineer the serious stock market movements (and make no mistake about it, the stock market is ultimately a gigantic "conspiracy," in much the same way a gambling casino is) must constantly manufacture pseudo-worries and concerns in order to bait a certain segment of the investing public into either buying or selling. Without someone to buy from at constantly lower prices (or sell to at higher prices, as the case may be), and with no worries on the horizon to cause investors to second guess the soundness of their investments, the stock market would cease to operate efficiently, and it would simply not be worth participating in. So artificial "worries" are frequently created in order to provide fuel to sustain a bull market.

The "wall of worry" this time around appears center around the possibility of a Y2K computer "crisis." While precautions for this potentiality must be made in the name of prudence, we doubt anything serious will come of this. That's because the tape tells the story of significant insider accumulation of key stock sectors, including the financial sector (banks, brokers, insurance, etc.), the Internet sector, and certain areas in the entertainment industry. All of these sectors are financially sensitive, meaning they would be the first to suffer in a serious economic (read Y2K-related) downturn. And since the stock market discounts future events in advance, and since Y2K is only a coupleof months away, any probability of a Y2K crisis would be reflected in the tape at this point. While investors may be worried, the tape (which "tells all") is clearly not.

Make no mistake about it, there is still a tremendous amount of volatility and all-out fighting between the bulls and bears on Wall Street. The problems that have plagued the market over the summer have not fully been washed out yet. But the buyers are beginning to reassert themselves. Over the past week, our volume indicators began diverging and while the 5-day NYSE declining volume indicator is still rising, the far more important advancing volume indicator is also rising, which is bullish. The extremely important cumulative volume line (CVI) is also still technically in a bearish position; however, it is clearly forming a wedge pattern which almost always means some sort of technical bounce (if not an outright recovery) is imminent. Thus, based on our reading of trading volume we should begin to see a nice upward thrust in stocks over the next couple of weeks.

Interestingly, the charts showing market momentum are also starting to "wedge," which leads us to believe the sharp downward trend in momentum is coming to an end and that an upward bounce is likewise imminent. This would be favorable for stocks. Note in particular the clear declining wedge pattern in the chart showing 30-day Rate of Change (ROC). This implies at least some sort of move higher in the days ahead.

We must be careful to avoid calling the bear market dead in the water, for we have not quite yet seen enough evidence to justify that. It is possible that this latest technical move is only a bear market correction prior to a resumption of the downtrend. Nevertheless, the odds are beginning to favor a strong bull move that could propel us to new all-time highs in most major indices. We will know for sure-probably as early as this week-when the NASDAQ breaks its previous all-time high and the Dow Industrials follow suit.

Looking at our Internet charts, we see much that encourages while at the same time there exists a cause for concern. The encouraging aspect is that both of these charts are tracing out bullish triangle patterns. Our proprietary Internet Index chart is especially bullish since the volume pattern conforms perfectly with how this triangle should look: diminishing volume throughout the formation of the pattern, while the high points occur on high volume and the intervening low points occur on low volume.

The CBOE Internet chart, however, is a little less clear. While the chart pattern is technically bullish, the volume pattern could be interpreted as either bullish or bearish. The massive volume spike that occurred two weeks ago formed a one-day bar that saw the close at approximately the mid-point of the bar. This means there was a huge amount of both buying and selling but it is difficult, if not impossible, to determine which side got the upper hand. One thing is for certain, though. There was either a tremendous amount of accumulation or a tremendous amount of distribution. We won't know for sure until prices penetrate the upper boundary (resistance) of the triangle on high volume. We should know by the end of this week.

No sooner than we issued a sell recommendation for the Internet Fund [WWIFX] than we were whipsawed out of our position as the fund proceeded to turn around and make a new high on bullish technicals. We do not mean to make excuses, but this sort of thing happens from time to time. No one can call the market correctly 100% of the time, although we do try our best. With individual stocks, whipsaws are also likely to happen on occasion, but this is where protective stops come in handy.

The Dow Industrials saw an extremely volatile week characterized by much churning action, typical of market turning points. The two most significant Dow days were Thursday and Friday (Oct. 21-22). On these days volume was very high and the daily price range was quite wide. On Friday, the Dow closed near the top of its range, while Thursday saw a mid-range closing. Obviously, a considerably amount of leeway exists when interpreting bar charts without the benefit of actual upside versus downside figures, but a high-volume mid-range closing almost always represents a critical turning point in markets. At tops, it typically precedes a decline, and at bottoms it entails a reversal higher in most cases. That is where we are now-at a bottom. A high-volume penetration of the Dow's short-term downtrending resistance line only confirms that the trend-at least in the near-term-is heading higher.

We must always remember that insiders distribute their holdings at or shortly before tops: rarely will they take a loss of several hundred points (as in the case of the Dow) in order to fool the public. Their distribution campaigns tend to culminate at extreme tops; thus, this noticeable pickup in insider activity can only be interpreted as accumulation. At least, that's how we see it, until we are provided evidence to the contrary.

Several of the major computer hardware stocks, most notably IBM, experienced very bad performances this past week. IBM made headlines when its stock plunged nearly 20 points on record one-day volume to close at the $90 level. This produced a huge gap on its chart which can be interpreted any number of ways. We won't know for sure which way until later this week since gaps can only be analyzed in reference to subsequent price movement. While a further resumption downward is possible, we doubt this will happen since an important chart support zone ($85-$90) managed to hold up extremely well under the selling pressure. This indicates that, more than likely, the buying interests have already come in to pick up the battered stock, and this may account for the extremely high volume. Since IBM pretty much reflects the blue chip sector of the stock market-and in a sense, the state of the entire market itself-watch this stock extremely closely in the days ahead. If at any time IBM closes below $90, we'll know that further rough riding lies ahead for the broad market.

The charts for several major banking stocks, which are also good reflections of what is going on in the broad financial system, have been displaying a tremendous amount of churning action over the past few months. This is characterized by strong waves of buying and selling on fluctuating volume within a well-defined trading range. The problem with this type of action is that it makes predicting where prices will ultimately head nearly impossible. We won't know for sure until a breakout actually happens. We must warn you, however, that the outlook isn't necessarily bullish for these stocks. Chase Manhattan Bank, for instance, which is a major money center banking stock, seems to be showing a significant amount of distribution based on our tape reading. Another stock-American Express (not exactly a banking stock, but fairly close)-is displaying a rising wedge on its chart which normally carries bearish implications. Again, with all the diverging signals being flashed at the moment it is impossible right now to tell where these stocks may be headed. Caution is the key in such times as these.

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.

In the Aztec language the name for gold is teocuitlatl which means "excrement of the gods."

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