Market Clues

The broad stock market historically closes up on the last trading day of the month 70% of the time. But, on Tuesday, it closed down. That is not bullish and suggests the correction is gaining momentum to the downside. We expect the market will be sliding until the end of the year.

Confirmation that the stock market is skidding lower comes from our sentiment gauge, which registered 2.01 for the OEX Dollar-Weighted Call-Put Ratio, which means that almost exactly twice as much money was going into OEX Call options (bets the market is going higher) versus OEX Put options (bets the market is going to crash). When specs bet twice as much money on one side or the other, you will almost always see it head in the opposite direction.

The bond market also continued down and the bond mutual fund we recommended a couple of weeks ago (RisingRates.com) jumped 1.4% for the day. Now, that's great news, but the TYX Index (an index of 30-year bond interest rate) is nearing the top of the rising channel and although it should hit the top of the channel on this run, will probably turn before too long and head back to the other side of the channel. And that probably will happen when stock investors start bailing out of their shares and want to put that money to work in the bond market as a "safe haven".

If you missed getting short the bonds (via the mutual fund or the futures), you should get many more chances in the future, so stay patient and wait for the market to come to you. The same applies to the stock market, as it appears to be heading back to the lower half of the 1100s on the S&P 500 Index by the end of December. We could very well have a powerful rally kickoff 2005.

Rising rates in the bond market are going to support a very strong rally in the US Dollar Index and pummel Gold and mining shares into the ground once again. We expect up to a 40% crash in the mining shares to separate the weak hands from their gold and silver stocks. And, we'll be there to pick up the Pieces of Eight ("http://www.piecesofeight.us/PofE.html").

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Bond prices dropped like a rock Monday morning and RisingRates.com did exactly what it was supposed to -- it rose ¾% for the day as it moved inversely to bond prices. Regular bond funds, however, took it on the chin, just as they should when rates rise. We look on the bond bear market as a long-lasting affair that will take interest rates above the last cyclical high of 15.21% reached in October 1981. Of course, it may take several years to get there and we regard our bearish bond position as a long term core position. As we think the trend is just getting started, there will be many retracements allowing additions to bear positions in bonds. But, it is nice to see the bond market doing so well for us this early on.

Since the stock market is enjoying another Monthly Buying Spree which should last into Friday, there's a positive bias to the market this week. Bonds trade opposite to stocks, which is a short term bearish factor for bonds. Next week, stocks should be on the downslide and that will help bonds recover somewhat.

The stock market was neutral for the day with some indices rising modestly (NASDAQ and the broad market Value Line) and others plummeting (the Dow Industrials on the back of disappointing Christmas sales at Wal-Mart -- or, at least that's the rationalization being offered).

We expect this week to have a positive bias in the stock market, but to be the last hurrah before a return to the mid-1100s on the S&P 500 Index toward the end of December. The path to get there should be quite twisty and only profitable for daytraders or those on vacation.

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Monthly Buying Spree, Though, Could Setup a More Significant Decline in December

The market drifted to a higher high on very light volume Friday, which is bearish behavior for the day after Thanksgiving and suggests we are about to see the second shoe drop in the current correction which started in mid-November.

Ideally, for the bullish case, we would like to see the market move lower to work off the accumulated excesses. We have the Monthly Buying Spree to look forward to this coming week and it could levitate stocks into the second week of December. Cyclically, a top in early December, followed by a decline throughout the rest of December would create the right conditions for a very powerful leg up in early 2005. The best policy here is to remain cautious and assume the market is trading very close to its ultimate high for this decade. In fact, even if we do get one more strong rally out of stocks in January, that should be the high point in stocks until the early 'Teens.

If there's one lesson from this chart, it's that the market is in the upper half of its historic valuation range, an area it has spent very little time in during the past century. Now, here we're speaking technically, but fundamentals back that assertion up. The long bond bull market from 1981-2003 sent interest rates skidding from the high teens to the sub-4% area. Stock price-earnings (PE) ratios depend upon interest rates; when interest rates fall, PE ratios rise (and vice versa). During the bond bull market, PE ratios expanded from well below 7 in 1982 to record highs in 2000. Now that we're in a bond bear market which should last at least sixteen years, PE ratios are contracting from their current inflated levels back to below 7.

Now, you can argue that PE ratios also depend upon earnings -- and you'd be absolutely right to say so. However, the earnings growth rate forecast is for momentum there to be slowing drastically over the next year (even dipping below zero if we enter a recession in 2005), so rising interest rates combined with a slowing growth rate in earnings is likely to cause a substantial downward trend in stock prices over the next year and for many years to come. Yes, there will be cyclical bull markets just as we have seen over the last two years. But, the downward trend (called a secular bear market) will dominate, limiting rallies and causing a gradual movement back into the lower half of that long term chart above.

We agree with John Mauldin, author of the best-selling book, Bull's Eye Investing, that we are in for a "Muddle-Through" stock market. And, the polytrendline shown above suggests the stock market will simply move sideways for the next decade, confirming Mauldin's thesis from a technical perspective.

Dollar Decline Helps Manufacturing

During the long bull market of the 'Nineties in the US Dollar, manufacturing in the US declined significantly as factories were exported to lower cost countries. This process went to an extreme and we're seeing a swing back toward a more fairly-valued US Dollar right now. Evidence that the damage done by the strong dollar is now being undone comes from a report Friday that BMW is planning to build a new factory in the US. The wild swing in the Euro -- up by over 60% from its low five years ago -- is hurting European manufacturing competitiveness and forcing them to move factories to lower cost nations, with the US now being counted as relatively lower cost.

This is a preview of what's to come in the future as the Asian nations are forced to revalue their currencies higher. But, it's likely that the central banks will mount a concerted campaign to raise the value of the US Dollar. One major reason they need to do this is that their holdings of US Treasurys are underwater -- the bankers are looking at significant paper losses if they sell now. Once they have levitated the value of the dollar, they will be able to unload their treasury paper and realize significantly lower losses. The question of timing comes up here -- when are they most likely to do this?

Historically, the central bankers like to intervene during illiquid trading periods, such as around holidays, because they get the biggest bang for the buck at those times when the large speculators are on holiday, such as Christmastime. Another time they like to do this is at the beginning of the year. Large speculative funds, most of whom receive their income from a percentage of profits earned during the calendar year, have been heavily short the US Dollar all year. If they roll their short positions over to 2005, they will have booked huge paper profits for 2004. Their 2005 profit/loss position shows no such gains yet. Thus, a significant move in the US Dollar against their 2005 short positions could trigger a massive short covering rally in the large speculative hedge funds as they manage their losses with stops. The central bankers are likely to take advantage of this dynamic in January and force a short-covering rally in the dollar.

Rising Rates Dept

The bond market looks like a disaster in the making -- and a huge profit opportunity for investors:

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All US markets will be closed for the Thanksgiving Holiday Thursday.

Wednesday's session saw stock prices drift to new all-time highs on some indices on light volume. This is typical of a holiday market and is not particularly bearish or bullish. Friday could see continued drift. But, to get a handle on the overall trend, we turn our attention back to London and the FTSE-100, which continues to exhibit all of the telltale characteristics of a bull market in its final stages:

Remember that London is a great leading indicator for the US stock market. If that continues, it implies a rally into the end of December, but probably not much beyond that timeframe. Since the 20-week cycle would ideally bottom at the end of December, a rally in December would imply that cycle is inverting and a high would occur at the time a low is expected at the end of the year -- and that's a factor which warns that the bull market trend is ending (cycle inversions tend to occur when one trend is ending and another beginning).

Our preferred count for the London market identifies this rally as a diagonal triangle. There are much more bullish alternate counts possible, but we believe probability greatly favors the preferred count at this time due to the signs of distribution in the recent wave 3 rally. The strength of the coming wave 5 rally will help confirm or deny this interpretation. If wave 5 exhibits substantial internal strength, we will be quick to turn bullish on the market, but for now, we lean toward a much less bullish interpretation of the pattern.

The diagonal triangle is a distinctive Elliott Wave formation with a strong message to all investors: once it completes wave 5 up, it will lead to a minimum retracement of 100% -- in other words, back to the price area where it started wave 1 (the end of wave B in the chart below). And, the retracement does not have to stop there. In the case of the current market, this diagonal triangle counts as a wave C up from the 2003 low and thus ends a larger wave (B):

The more bullish alternate interpretation would have a nested 1, 2, i, ii, ... sequence here. If that is the case, a powerful wave 3 rally would carry the FTSE-100 much higher. So, the line in the sand is clearly drawn and we should know the answer to this puzzle by early December at the latest. The bottom line is that although the larger pattern may be bearish, we should have one more rally within the pattern which could be short (and not very sweet), or it could be explosive. Thus, nimble investors should get an opportunity to move back into the market next week as long as they are careful to use protective stop-out points (either mental stops in the cash stock market or actual trailing-stop orders in the futures market).

Our next update will be this weekend.

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Light volume and early closings are on tap for US markets Wednesday and Friday, with all exchanges closed Thursday in observance of that quintessential holiday, Thanksgiving. Traders are cautioned that this is an excellent time for a holiday from the markets as light volume is not conducive to profitable trading.

Much is being made of the weak dollar. This period reminds us very much of the last period when the US Dollar was very weak. The Chicken Littles were wrong, though. And, when the dollar soared in the 'Nineties, we warned that it was greatly overvalued, but with a first class Bubble in effect, money poured into the red-hot US stock market as foreigners saw double bubble returns from an appreciating dollar as well as their Internet stocks. From the major peak in the Dollar Index on the Fourth of July 2001, a date forecast to be the top by our polytrendline projection, the Dollar Index has fallen 31.38% as of the close Tuesday. Almost all of the "fluff" added to the dollar has been removed and, predictably, the Chicken Littles are bemoaning the fate of the world's reserve currency, just as they did before.

This is where technical analysis wins out, though. Our long term polytrendline for the Euro points to a peak in that currency coming up very soon:

This coming top in the Euro appears to be as significant as its bottom over 4 years ago (October 2000 low to present = 58.19% rise based upon cash prices). And, unless fiat currency is being repudiated (we don't think it likely just yet), this is also bad news for the precious metals. In fact, long term trends are likely to be changing significantly over the next few months. 2005 looks to be quite a different year than either 2003 or 2004.

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We suggested that if the market could work sideways here it would have one more rally left in it. And, Monday's rebound from support levels definitely points toward such a scenario.

The London market, in the form of the FTSE-100 Index, continues to be a wonderful leading indicator for world markets. The pattern appears to be a diagonal triangle now in its 4th wave, a flat corrective wave which kills time rather than price (and that's a deadly prescription for an option speculator, although just the medicine for the option hedger):

Thus, a neutral trend into the 20-week cycle low due at the end of December would setup a final, 5th wave rally to a higher high (barring a 5th wave failure) next year. If the pattern continues, that would imply a wave (B) peak in the first quarter, followed by the beginning of wave (C) down, a major bear market similar to, and possibly stronger than, the 2000-2002 wave (A) down, into the 4-year cycle low due in October 2006.

Bonds

The bond market rallied Monday, a move we continue to see as countertrend (subscribers can view details, with comments, on the TYX 15-Minute and daily charts on the website). However, even if we are correct that bond prices are in a bear market, the recent short term rise in rates only retraced 50% of the prior decline, so any trend here is still fairly weak at best. We are looking for a test of the lower polytrendline channel in the TYX Index daily chart to sell the long bond short with a close, money management protective stop. Since the December series expires soon, we would prefer a position in the March 2005 futures contract, symbol ZBH5 for the electronic market, USH5 for the pit-traded bond. For mutual fund investors, http://RisingRates.com represents an alternative, a fund where share prices rise as interest rates rise, unlike the traditional bond fund which falls in price as rates rise.

We see the rise in rates as a very long term trend. And, we're right at the beginning of this long trend. Our intention is to build up a long term short position in the bond market at appropriate points. Thus, patience is required, but should be amply rewarded over the long term.

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Alan Greenspan decided it was time to say what everyone else had been saying for years --

"It seems persuasive that, given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point".

"This situation suggests that international investors will eventually adjust their accumulation of dollar assets or ... seek higher dollar returns to offset concentration risk, elevating the cost of financing of the U.S. current account deficit and rendering it increasingly less tenable".

In other words, when the Fed head speaks, everyone listens.

The nascent dollar rebound reversed course very quickly and DX headed down to a new low on the Greenspan quote:

But, now that the words have been spoken by Alan Greenspan, the markets can get on with their business. And, the markets' business is to discount the future, which has already been done in the case of DX: most of the last few years, the US Dollar has been going down in anticipation of the day when the crowd realizes what Greenspan said. Thus, the crowd, which is comfortably short the dollar, is about to get the big surprise: a strong dollar.

Confirmation that the dollar is in the process of turning comes from the open interest in DX futures. Large speculators, who had been heavily short DX, actually have started buying those contracts to close out the trade -- it's the only way they can realize their paper profits. It may take them several weeks to complete this process, but it takes a while to turn a tanker.

It's in the best interest of central bankers around the world to force the big speculators to cover their shorts in the US Dollar to avoid a crash scenario that would plunge the planet into a multiyear depression. Thus, it's not fundamentals which dictate a rally in the dollar -- it's self-preservation that does.

The effects of a soaring dollar will be wide-reaching and will include a plunge in the price of precious metals and many foreign currencies (not necessarily all, however). We discuss those markets in this weekend's Detailed Comments.

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Many markets showed strong signs that a change in trend was taking place Thursday. The Dollar Index formed five waves down on Wednesday and rallied sharply higher Thursday, which suggests that the long-awaited turn to the bullish mode is occuring now. This put pressure on currencies, Gold and Silver, and very likely formed an intermediate term top in the metals which is best counted as a wave B to precede a sharp decline in wave C to new lows.

It's probably no coincidence that the first Gold ETF started trading on Thursday. Introduction of new ways to invest often occur at significant turning points. For example, the introduction of short selling to the Japanese market at the beginning of 1990 coincided with the absolute top in their stock market and the beginning of a devastating bear market which is still in progress. It's not that the short sellers got the upper hand, however; the problem the Japanese had was that, without short sellers on the way up, prices got far above where they should have been.

And, the Gold ETF may be sending a similar signal now. That's because the underwriters had to buy the metal to back up the shares they offered for sale Thursday. That buying demand probably extended the wave B rally far beyond where it naturally would have gone. Now that the shares are being sold to the public, however, those same underwriters are free to sell gold and pocket the profits (read the prospectus and you'll find the promoters have an "interesting" way of extracting their fees -- by selling gold!). Thus, the buyers turn to sellers and Gold starts down the slippery slope.

The stock market is also looking very weak now as most technical indicators are bearish. Sentiment is so bullish (as a contrary indicator, that's not bullish) that WhisperNumber.com actually made the statement earlier in the week that investors should expect either a crash or a steep correction. Our own sentiment numbers show a similar exhiliration amongst speculators that points to a very significant top in the market. OEX players are still far into the overly-bullish category. QQQ players, who have better track records, are also extremely bullish. With the market up substantially from its August lows, this is not the smart money who's doing the buying -- it's the Johnny-Come-Latelies of the world. The time to be super bullish is long past. Even the chart of the Dow is screaming sell:

One of the greatest stock market technicians of all-time, Joe Granville, gave a fascinating radio interview to Tom O'Brien of TFNN.com -- available in the TFNN archives (second hour of Thursday afternoon's show). He stated that his stock market indicators which called the market top in early 2004 are giving him the same bearish readings right now. All we can say is that anyone who contemplates buying stocks right now is flirting with real trouble. When the market goes down, even technically strong stocks can stagnate, if not falter. A rising tide lifts all boats; a receding one acts in a similar way.

This short term bearishness doesn't mean we are turning long term bearish just yet, however. We still hold out hope that a sideways correction here could setup a monster rally later on. But, with the next major trading low due in late December, it appears that the upside in the stock market is very limited until we get to January. But, realize that this move up from the mid-2004 lows is the very last leg up before a devastating bear market which is slated to start in 2005 and which should coincide with the next recession to hit the US economy. And, this time, the federal government is very ill-prepared to deal with it, unlike the 2000-2002 recession which was relatively mild because of massive tax cuts, a huge increase in government spending and substantial interest rate cuts -- all of which are not possible to repeat this time around. In other words, Make hay while the sun still shines, for it won't be shining much longer.

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Risk is extremely high right now in the stock market. We appear to be at a top of significance. Now, it may just precede a 1-2 month correction into the 20-week trading cycle low (ideally due at the end of December). But, it could also easily be the top of the entire bull market of the last two years. Thus, it's important to not be drawn into the frenzy.

And, a frenzy it is. OEX traders have been making money and that tells you something is wrong. On Wednesday, almost four times as much of their money went into upside bets as downside ones. It's very rare that the OEX crowd is right and we think this is a red flag for this market. True, the QQQ traders were right Tuesday -- they bought a boatload of calls and we did have an early rally on Wednesday. But, they have now turned bearish.

The Value Line, in case you didn't know it, made yet another new all-time high Wednesday. What is that, the 100th day since 2000 that the Value Line has made a new high? This index completely ignored the blue chips in their bear market of 2000-2002 and just kept chugging higher like the Energizer bunny. In fact, if you had bought the Value Line on the day the Dow made its all-time high in 2000, you would be up 66% as of the close Wednesday on an unleveraged basis (hundreds of percentage points in the futures). Of course, you'd still be underwater in the Dow, the S&P 500 and the NASDAQ.

So, when we say we might be looking at a long term top in the Value Line, you'd better pay attention:

Today, we updated chart comments on the bond market (TYX and TLT, in particular) for subscribers (links below or on the main website page).

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Usually, the sentiment figures we keep for the QQQs are not something we want to raise a contrary flag upon. However, Tuesday's aberrant ratio of over 9 times as much money going into QQQ calls as puts suggests that bullishness has reached ridiculous levels in the bull rally of the NASDAQ-100 Index -- and that even the best of crowds can go astray. Moreover, there is technical evidence for a more substantial pullback in the QQQs (although it may not reach Maximum Pain by Friday's expiration):

Despite the bad news on Producer Prices (they were up far more than the consensus Tuesday morning), the stock and bond markets took the news rather well -- considering the bearish implications longer term. Are these markets reacting appropriately? Probably not, but we'll never argue with the market (although we won't hesitate to say we disagree with it). Despite the sea change in trend in the bond market (rising interest rates and falling bond prices), the market is taking the bad news well. We wonder if it will continue to do so when faced with rising Consumer Prices? We will see.

The economy seems to be in a generally rising trend if the Federal Reserve's injections of temporary funds into the money markets is a good clue (and, of course, we think it is):

Apparently, the bond market is not yet convinced of the strength of the recovery. By the time they are, rising interest rates are likely to make mincemeat of bond funds (and bond bulls, for that matter). Of course, rising rates are likely to send the new reverse bond mutual fund (RisingRates.com) soaring higher. The only thing that is going to stand in the way of the trend, as we see it, is a return of deflation. That risk appears to be receding, with the risk of rising rates growing by the day (especially with lower oil prices). Higher stock prices are also an indicator that the risk of deflation is receding.

The Dollar Index (DX) came very close to our downside measured move target on Tuesday:

An ideal setup would be for the oscillator to show bullish divergence in the 40-50 area as we work into that Time Ratio Low. Sometimes it happens, sometimes it doesn't. We will see. DX should bend that resistance line up and give us another indicator of when the trading low is due by the rollup from down to up in the coming days, helping to narrow the range of time in which to expect the low.

A helpful subscriber sent us a link to some commentary by a money manager you might find interesting. It's McHugh's Financial Markets Forecast & Analysis ("http://www.technicalindicatorindex.com/). He agrees with us for the most part. We'd of course prefer to find someone who disagrees, but we were impressed with Mr McHugh's analysis enough to pass along the reference to you to investigate yourself. We could not find an RSS link to his site, unfortunately.

Subscribers, be sure to check out the chart links for additional comments.

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If you're interested in time cycle forecasts, we received a reference to a web article from a reader over the weekend which makes for some interesting reading: The Magnificent Seven -- The Last Stagecoach out of Dodge (?) (""http://www.financialsense.com/fsu/editorials/rinehart/2004/1011.html"). The article is part of a series by Dr. Stephen Rinehart, whose time cycle model has been very accurate this year in forecasting the stock market. Of interest is his projection that a number of long term time cycles are peaking now (this week) in the stock market. Quoting from the article:

"Chart 1 shows the predicted (detrended) waveform for the NYSE Composite Index thru 2005. A top is being predicted for late Nov 2004 (hey, the elections are over -- how long do you think this free ride will last people!?). This is probably the formation of a right shoulder of a ten-year formation in the NYSE Composite Index. There is a (probably) lower second top in July 2005 but after Dec 2004 the trend becomes downward in the NYSE Composite Index (for years to come after 2006)."

Now, while we would have to see confirming indicators to turn bearish, we recognize that time cycles do have some predictive value (although our own cyclic model has not approached its former accuracy in some years, probably a reflection of the intense levels of money being pumped into the market in order to avoid a deflationary depression by the Federal Reserve). And, the current rally has shown considerable excess and is clearly not a sustainable situation -- true bull markets with the current levels of upward momentum tend to burn themselves out like a skyrocket, spectacular while they last but a very brief period of time.

And, we believe that if you are bullish, you should examine all of the arguments the bears have to offer in order to discover a potential flaw in your reasoning (just as if you are bearish, you must be cognizant of all the bulls' arguments as well). This is an excellent article which suggests that what we are seeing right now is the final flameout of the bull market.

In any case, the market has come a long way in a very short period of time and is showing strong signs of turning down, with perhaps an early Tuesday pop fly rally putting a cap on it for a while -- perhaps a long while if Dr. Rinehart's model is correct. Thus, we suggest that as far as the stock market is concerned, a slide into late December is a very real possibility (the nominal trading cycle low is due at the end of December).

The bond market, after confirming it is in a bear trend, recovered some more on Monday. If you're invested in bonds until they mature, you have nothing to worry about: your principal is very likely to be safe. But, if you're invested in bonds and don't intend to hold them until maturity, you have an excellent opportunity now to sell. We suggest that for trend-followers in the bond futures markets, a great opportunity to sell the bond market short is just around the corner.

But, what about bond mutual funds? The standard bond fund is likely to return very low single-digits, or negative returns, in the future. But, do not despair, a new type of bond fund which rises in value along with interest rates has come on the scene. It's RisingRates.com and it's a new fund from the ProFunds family.

Mining stocks appear to have topped and reversed into a bear mode now:

With mining stocks topping along with bonds, is a rally in the US Dollar about to launch? It certainly appears that such an event is coming soon as well.

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The recent rally, which we believe was due to short covering, has likely run its course for now. However, it gives us a glimpse of what's to come after a minor correction.

The Dow, which has yet to break out of its trading range and has been the weakest index of all this year, may be gearing up to take the lead once again:

Sentiment remains overly-bullish for the OEX pit, which is a very unusual situation (usually, OEX traders lose a lot of money). QQQ options are also overvalued if the Maximum Pain price of 36 is a guide (QQQ closed Friday at 38.66 and could drop 6.88% this week if they reach that typical Maximum Pain price level by expiration Friday).

It's time to fasten seat belts: this week could be a very rough ride in the stock market!

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Additional comments for subscribers can be found in this weekend's Detailed Comments . . . .

The stock market bulls came out to play on the semi-holiday (Veterans' Day) Thursday. Bond traders were away, which probably eased the upward motion as the S&P 500, after consolidating sideways for a week inside the upper Bollinger Band, surged back toward it:

Since this is the fifth wave up, stocks are close to the resistance trendline and volume is slackening, we should see a larger correction in coming days. But, that correction will be setting up a stronger rally that is likely to see substantially higher highs:

In order to see the trend, sometimes it helps to step back and get the big picture.

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Wednesday's market was characterized by levitation as the strongest sectors actually gained a slight bit of ground. However, the leading sectors (Semiconductors and the NASDAQ-100) indicated lower prices ahead as we head into options expiration at the end of next week:

Above, we illustrate the recent chart pattern of the Semiconductor Holders (SMH). This index stock topped on the 3rd of November and has been gradually accelerating lower. Intel's announcement of an increase in their dividend was the latest bad news to hit the sector. An increase in dividends is the kiss of death for a growth stock and investors sold on the news.

Semiconductors also tend to be about the only sector which leads the NASDAQ-100 Index (or, QQQs, the tracking stock which mimics the NASDAQ-100 at 1/40th its value). Since we are expecting the QQQs to be moving about 5% lower over the next week, the weakness in semiconductors is confirming evidence of that move. However, notice the bowl-shaped polytrendline which could conceivably support the SMH. A break down below it would add evidence to confirm the short term bearish trend.

While we are getting that expected (and welcome) correction, the underlying economy continues to show strength after the stronger than expected Employment Report last week. The Federal Reserve boosted its short term lending rate by 14.28% Wednesday to 2.0%. That's a smaller hike than prior ones on a percentage basis. However, prior hikes in short term rates were muted by long term rates continuing to trend lower. Right now, long term rates have broken out to the upside, which could spell trouble for the economy late in 2005 or in 2006. Just like the series of rate hikes in 2000 just as the economy was keeling over into recession, the current ones are likely to be undone before too much longer. The only question will be how long it takes the Fed to realize the error they have made. Let's hope they learned a lesson from their Y2K blunders. If not, well, they can always throw money out of helicopters (yes, Virginia, they are on record as saying they would do that if need be).

For now, though, the short term economic indicators are strong, with the Federal Reserve Temporary Repo Balance breaking out of its downtrend Wednesday morning. This should help stocks recover following the end of the current correction.

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The market has stalled at the recent short term top and continues to churn at that level. QQQs fell 8¢ Tuesday to close at $37.92, while the Russell 2000 rose slightly. We previously erred in saying RUT had made a new all-time high, but it was only a yearly high (its all-time high was 614.16 in 2000 -- Friday's intraday high of 607.25 left it shy of that mark, but above 2004's prior high of 606.42).

A helpful reader sent us confirmation that November QQQ options' "Maximum Pain" price this month (the price at which speculators will lose the maximum amount of money in QQQ options) is indeed 36. Tuesday's close left the index stock about 5% above Max Pain, so there should be a 5% decline over the next week to bring the QQQ into "alignment" with option short sellers' best interests (viz., maximum profits). When the underlying trend is neutral, short sellers are able to "drive" the stock into the price which maximizes their profits. And, given the extremely overbought character of the market right now, it appears likely that they will succeed this month.

This year's pattern in the blue chips shows the influence of a major cycle bottoming in August:

You might recall a very similar polytrendline which bottomed in 2002 -- the 4-year cycle. Our assumption here is that this one represents the bottoming of the 2-year subharmonic cycle. The latter is powerful on a short term basis. However, its upside pressure tends to last only a few months -- after all, we have passed the midpoint of the 4-year cycle now, which is due to land in October 2006. We have enjoyed nice gains so far, but are being extra cautious not to give them back here. If the market dips back to the support zones in the chart above, we'll probably look to buy back in for a yearend rally into January or February. After that, the going is likely to get tougher as this bull market grinds to an end and the economy rolls over into recession.

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The government collects data on public sentiment through the CFTC weekly Commitments of Traders Report. The report breaks players in stock index futures into three groups: Small Traders, Commercial Hedgers and Large Speculators. The latter two groups are the ones to watch. Commercial Hedgers are long term participants and, as such, typically take positions opposite the other two. However, over the long term, commercial hedgers are in tune with the longer term trend, so they are the group to watch. Large Speculators are trend-followers and, while often right on the short term direction of the market, are always wrong at significant turns. The small traders can be right or wrong, but are also generally wrong at turns.

Last week, while commercials went from a very slight short position in the big S&P contract to a modestly long position (bullish), their massive short position in the S&P e-mini increased to a lopsided 307,053 long to 580,081 contract short position (up 30,925 on the long side and 70,529 on the short side). Now, that's extremely bearish for the long term stock market trend.

It wasn't only the commercials who were adding to shorts though: large speculators increased their net short position as well (they are now 121,156 long to 179,411 short, an increase of 11,200 contacts long to 21,032 short). Only the small traders were net bullish (395,029 long to 63,746 short contracts).

Anyone still bullish right now should take a look at these figures. They are not supportive of the bullish case -- at all. They are, however, in agreement with other sentiment surveys which show the public investor is extremely bullish on stocks. And, that is a type of trader that loses money most of the time. While the Elliott Wave pattern in the major indices allows for more upside potential here, the rally is growing long in tooth at the present time. Not only that, but the long term wave pattern is nearing completion. When the pattern does reverse course, the downside could be very substantial, including a retest of the October 2002 lows. The bulk of the money we've made has been in the broad market. In the last week, we've seen a sea change where the laggard blue chips have gained ground at the expense of the broad market. This can, as we've said, continue for a while. But, the narrowing in breadth is a warning that the entire bull market momentum is waning. Investors should be taking a trading viewpoint on this market and not holding long term long (bullish) positions right now because we are approaching a key turn to the downside soon. Short term trading positions on the long side are fine -- just realize that we are nearing the end of the bull market soon.

Seasonal influences are a positive which could keep the market going up into January or February, but we suspect just as much trading money is going to be made on the short side over the next few weeks as the long side.

Option Expiration and Maximum Pain

Option expiration is at the end of next week. Unfortunately, the site we use for Maximum Pain figures isn't available right now due to severe software problems at the CBOE website (the latter use Microsoft software to "power" their website, so it's no wonder they're having severe problems). Hopefully, we will have Maximum Pain figures available soon. We suspect that the QQQs are trading well above max pain right now and are going to head down severely into the end of next week. According to Tim Ord, support in the QQQs should be around 36. They ended Monday at 38, so there is some downside potential there.

Bradley Turning Point

Our version of the Bradley has been very accurate lately at picking turning points as compared to some other versions we've seen on the web. Ours pointed to the 4th for a turning point, ±4 calendar days, while others point toward the 11th. Time will tell, as they say. So far, the high was on the 5th.

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Despite the obvious hatred of Bush outside the US (as well as clear disapproval inside the US amongst a significant minority of the country's voters), world stock markets let out a sigh of relief this week and sent stocks soaring on Election results. Now, please realize that we're on record as favoring an alternative to who the puppetmasters selected for the menu this year -- and that makes us about as objective toward the political scene as you possibly hope for (we detest both the major US parties and their lack of viable presidential candidates). So, when we say the markets love Bush, you have to realize that's an observation based upon fact, not an endorsement of the Administration.

The stock markets were clearly favoring four more years of Bush. Even the French seemed to endorse the man they love to hate:

If the bearish divergence between price and oscillator in the chart above is valid -- and we think it is -- this exuberance isn't going to last much longer, especially in France.

The British were more predictably elated at the prospect of four more years:

The bearish signs evident on these charts suggest the party could be over rather quickly, with the bulls who stayed too late (or who got in recently) likely to suffer a bad hangover.

The picture was pretty much the same in the German DAX:

What's ahead: a 4th wave correction (iv of 3 of C of (B)). It should be a flat (see Elliott Wave Principle for a definition). The wave 1 high should not be violated in this correction or the market's outlook is far more bearish than we think it is. But, we may be very close to the ultimate highs right now, so it pays to be extra cautious. It's a secular bear market after all is said and done.

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The blue chips rallied on Thursday, with the Dow gaining 1.75%. But, the NASDAQ-100 gained less than half that (0.8%). In fact, while the Dow moved back to challenge its September high, the NASDAQ failed to exceed yesterday's high. That's bearish divergence. When the lead dogs don't bark, we've found in the past that risk favors holding cash and not stocks. That divergence can certainly continue, but has always been resolved, as far as we can recall, by the blue chips "catching-down" rather than the other way 'round.

It's always easy to take profits and move to cash by selling into a rally after the kind of gains we've made since buying in mid-August. And, that's what we've done. We suspect most buyers Thursday were pretty bullish (although it's possible most could have been bears doing some short covering to stop losses). We are not bullish, at least short term. We still see several storm clouds hanging over the stock market which could cause this market to rest and rest at lower levels in the month ahead. Perhaps it's only a brief pause before further gains, but the market seems tired and quite stretched after this run to new highs.

The glaring divergence between our lead dog indices, the NASDAQ-100 Index (QQQ) and the Semiconductor Index (SOX) on the one hand, and the blue chip Dow and S&P 500 on the other, continued on Thursday. The lead dogs held back as the Dow and S&P 500 "broke out" to the upside. This is not the kind of breakout that should inspire bullishness, no more than an army would be inspired by its generals leading the charge as the troops turned tail and ran for cover. We want to see the elite units break out and lead the charge. Our lead dogs tend to top, on average, two trading days before intermediate tops in the blue chips. Thursday's rally failed to take out Wednesday's highs on both dogs, so the countdown timer is definitely running.

The rally made the OEX traders very happy. They paid more than twice as much money for calls as puts, betting that this rally will go far higher before it's over. They may be right (their batting average is close to zero and can be safely faded as long as you use a stop loss order), but the rally started in mid-August 12 weeks ago, so while it has been a fairly decent rally (and we've profited from buying in just as the lows were being made in what turned out to be the strongest sector in the market), rallies never last forever and it is definitely possible for the market to take a rest at this point. Come to think of it, maybe that's why the blue chips are so strong now -- after all, they've been sitting on the bench resting during most of the rally. Now that the first team is on the bench resting and the second team is on the field, we're ready to pull in our horns short term and put our profits in cash. Perhaps you want to bet on the second team performing as well as the first team? It's always your call, of course.

A fundamental indicator we keep says the economy may be slowing here: the FRBREPO Index, which is based upon the Fed's Temporary Repo balance, fluttered higher recently, but has fallen back into the vicinity of the lows again, suggesting that the "Indian Summer" rise in the economy was not in fact sustainable. No matter how Friday's Employment Report turns out, this does not look bullish for stocks on the short term. A slowing economy is not a recipe for higher earnings:

We're happy to sit on a pile of cash for now and look for stocks to come back to buy later on.

Speaking of the ER (Employment Report), which will be released Friday morning at 8:30 Eastern/7:30 Central, the market seems to expect robust jobs growth to show up. It's interesting to look at the "phantom jobs" which will be added to the reported jobs figure to come up with the bottom line. In the report released in early November 2003, the Labor Department figured they had missed 45,000 jobs and added them into the figure they reported. On Friday morning, they will probably use a similar value, perhaps just a few thousand higher. Thus, it will have taken quite a surge in hiring in October as compared to September for the stock and bond markets' expectations to be fulfilled. Disappointment at the jobs figures could lead to selling in the stock market and buying in the bond market Friday morning. In any case, the markets' reaction to the news is the key element to watch after the report is released. If the FRBREPO Index is telling us anything, it's saying it's not very likely that as many new jobs were created in October as the market seems to expect.

Gold stocks retested their former support line from underneath Thursday and couldn't break through, falling back to the middle of the day's range. We're counting the bear market rally in mining stocks as finished and wave (C) to the downside underway. Considering that gold itself is moving to recovery highs while the stocks are failing to is a classic case of bearish divergence and projects much lower prices for both the metal and the stocks.

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This month's Buying Spree ended Wednesday as the market moved into new high territory on the S&P 600 Small Cap Index (ticker IJR in the stock market). Although it took a serpentine path to its new high -- with an intraday collapse on Tuesday and a complete recovery and then some on Wednesday -- the market is at resistance, at a price where Fibonacci relationships suggest, at the very least, a pause to refresh, a Time Ratio High (various indices have that high Wednesday, Thursday or Friday), a Bradley turn date Thursday and weakness in our lead dog indices (SOX and NDX). These factors have raised the intermediate term risks here substantially.

Tuesday's selloff and Wednesday's complete turnaround looks like a case of market manipulation to us, but we have no proof of that. Still, it's very suspicious behavior on the part of journalists to conduct very sloppy exit poll interviews (proved later in the evening to be totally wrong), then leak the report an hour or two before the market closes (causing an intraday mini-crash Tuesday afternoon). This looks like a case of some journalists who were getting short and then priming the pump with deliberate lies to send the market plunging. After the polls closed and the truth emerged, it was clear very quickly that the Kerry camp had big worries and the Bush camp was still in the race. This caused the futures markets to soar sharply higher, recovering all of the prior losses by midnight.

In any case, the market did rally sharply higher on the Bush win. We had expected a recovery back to the highs. We were also looking for a breakout above resistance to confirm a stronger trend. We did not get it. This is a bearish development, so perhaps we will get a buying opportunity coming up next month at lower price levels, perhaps considerably lower.

The economy is beginning to look weak again. This is behind the Dollar Index's retest of the lower area of the trading range and although it's part of a bottoming process, it is bearish short term. The precious metals bounced on USD weakness as it moves inversely to DX. As we've shown recently, the mining stocks have topped and are heading lower. They are likely to be much cheaper to buy next year.

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The stock market started up in a 5th wave triangle thrust rally in the morning, but it quickly collapsed Tuesday afternoon as word of a strong Democratic turnout hit the NYSE. As we expected, a Kerry victory was greeted as bad news by the market:

However, since the results of the election may not be known for a very long time (i.e., after the court battles have ended), the market's reaction was probably premature. We may see a reversal to the upside Wednesday as part of a topping process. So, that's our expectation: a market with no direction whatsoever for Wednesday, possibly Thursday. Unless the market can breakout to the upside here, we are preparing to liquidate or hedge stock market investments in preparation for what could be a strong downmove in the market.

In fact, the possibility that we may have seen the end of the entire bull market rise since October 2002 is a very real one. Thus, it's prudent to be very cautious here until the dust settles.

Gold Stocks

The gold mining stocks were very weak Tuesday as the XAU broke below support:

This was not totally unexpected as a Time Ratio Low was due Tuesday. But, the break below support confirms that the wave B rally is over and wave C to the downside has begun, echoing the wave A decline of half a year ago. Gold stocks are likely to attempt to retest the old support line from underneath in the very short term, but we don't hold out much hope of anything but a waterfall liquidation decline in the weeks and months ahead in the sector.

On the bright side, mining stocks should be great buys at the bottom!

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We were startled to hear David Favor of CNBC's Squawx Box say that investors should "buy a boatload of S&P puts" Monday morning. If that accurately reflects the mood of investors, the market uptrend should continue. The last time we heard a CNBC personality recommend selling the market short, the Dow rose 3,000 points thereafter. So, maybe this is a good contrary indicator.

Indeed, Favor's pessimism was reflected in our OEX Dollar-Weighted Call-Put figures Monday. Put purchases totaled $12,801,800 to only $8,273,790 for calls and that imbalance suggests the market can continue higher before correcting. And, if Bush emerges victorious, the downside risk may be quite limited.

However, from the look of things, the most likely outcome will be no decision. With armies of lawyers gathering, ready to do battle 'til "none are left standing", the next man to occupy the White House may not be known for some time. Since the market abhors uncertainty, only a Bush victory is likely to propel the market to solid gains. Perhaps the OEX players will be right, just this once?

In any case, we have some specific projections for this week and they involve a potential stock market high this week:

The gold and silver sector mining stocks appear especially vulnerable after a bounce rally:

We have reserved more specific commentary for subscribers -- see the Quarter-Hourly Chart Comments link below.

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