Short-term Trend has Turned up; Longer Term Outlook Remains Bearish

August 17, 1999

Recovering from the deeply over-sold conditions of the past several weeks, the U.S. equities market registered a short-term bottom last week and momentum should carry the markets higher over the next week to one month, though there is no telling how high prices will carry.

Our short-term momentum indicators (10-day and 30-day Rate of Change (ROC)) gave us a buy signal late last week and should be sufficient to propel the broad market, including the Internet sector, into higher terrain over the next several days. 10-day momentum registered a bullish head and shoulders bottom pattern and is rocketing higher in linear fashion as we head into the middle of the month. 30-day volume, while not as bullish, is at least stabilizing from its recent declines. Also, the momentum indicators for many leading stocks registered double bottoms last week and were starting to trend higher from oversold levels, a bullish sign.

Coinciding with this bullish reading in momentum was a chorus of bearish rumblings from a multitude of analysts-including many formerly bullish ones-which should serve as a contrarian signal that the worst is behind us, at least for now.

Volume indicators, too, have perked up somewhat from their previously disturbing levels and while they are by no means sending all-out bullish signals they nevertheless appear to have bottomed in the short-term along with momentum. Our 5-day NYSE Advancing Volume chart broke out of a bullish wedge pattern last week and is now above its equilibrium line which places it in technically bullish territory (but just barely). We won't have a true bullish confirmation until advancing volume continues to trend higher over the next several days, but at least volume is confirming the immediate-term trend, which is up. Similarly, 5-day NYSE Declining Volume broke to the downside out of a rising wedge pattern last week. As long as declining volume is falling-which it is-the markets are not in any danger of collapsing any time soon. Cumulative volume, as measured by the CVI, is still in a technical downtrend but it was starting to pick up a bit as the week ended and had at least stopped plummeting as it had been for the past couple of weeks. As long as cumulative volume holds steady or trends higher the market is on a firm footing. The coming days will provide us more answers.

Trading volume itself on both the NYSE and NASDAQ has remained disturbingly thin throughout this summer's decline, which is curious to say the least. Perhaps this thin volume reflects widespread complacency and smug confidence on the part of traders and investors. Perhaps it is a phenomenon of summer trading in general, when many traders go on vacation. Whatever the reason, volume of traderepresents "tidal force" and is a reflection of the magnitude and conviction behind the prevailing price trend. For the last several weeks that trend has been toward lower prices, and volume never really got going behind declining prices, which no doubt prevented a more serious correction of the variety we saw last summer. However, volume has recently begun to pick up and most of the higher volume has come on days in which prices were higher, which could be an early indication that the long-term uptrend is still intact. Indeed, volume tends to move in the direction of the prevailing trend, and because volume never gained momentum during this summer's decline we surmise that the decline was nothing more than a correction in the market's ongoing bullish trend.

The Dow Jones Industrial (DJI) chart for the past year shows that its trendline stretching from last September until the present was broken last month. A second, trendline below that one was broken earlier this month. And a third trendline directly below the second one has thus far succeeded in supporting the price trend. Perhaps this qualifies as a bullish confirmation under the "Fanline Principle" (see our books, Technical Analysis Simplified and/or Elliott Wave Simplified for a detailed discussion of this important technical principle).

It cannot be denied, however, that the overall price pattern outlook for the major averages and the vast majority of actively traded stocks is potentially bearish, as many show textbook distribution patterns (specifically, of the rounding and head and shoulders variety). This must be kept foremost in our considerations for longer-term trading/investment positions and unless these patterns are nullified we must assume that the overall market outlook is bearish and subject to a breakdown sometime this year. In the immediate-term however, the outlook appears to be toward higher prices, though again there is no way of forecasting the amplitude of any subsequent upward movements.

The mutual fund outlook confirms this view. As we have mentioned in previous commentaries, the Rydex Ursa Fund-a bear market fund tied to the S&P 500-is tracing out on its chart what appears to be a long-term rounding bottom pattern, which implies a bear market could begin later this year (if it hasn't already). Conversely, the chart for the Rydex Nova Fund-a bull market fund-is tracing out a long-term distribution pattern. The short-term trends for each of these funds are bearish and bullish, respectively. But never lose sight of the longer-term implications.

The interest rate outlook is similarly bearish in the longer-term, as the yield on the 30-year T-bond has been trending higher since last October. Typically, bond prices peak (and yields bottom) about a year before stock prices do. Perhaps this fall will witness a breakdown in the stock averages. Again, only time will tell.

In the meantime, we continue to tread cautiously upon this market as it is clearly on its last legs. We are fully cognizant, however, that even a market in its death throes can stage a spectacular last-gasp rally before finally collapsing. Thus, we want to be in a position to capture any such gains should the market attempt a final rally. And from the looks of the indicators, it may be attempting to do just that.

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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