Market Clues

As we look forward to 2005, we look back on 2004 as a year of base-building in the stock market, hopefully for a stronger economy in the New Year. We have seen the broad market put in another year of almost continuous new all-time high records as the blue chips continued to struggle.

The Value Line Index represents the broad market by equally-weighting each of over 1600 stocks. Despite the Crash of 1987 (wave 2) and the Bubble Burst of 2002 (wave 4), the trend has been relentlessly moving higher. That index is now moving closer to our bull market target of 1862 after closing at 1796 Thursday:

The broad market bull market has been the foundation of the economy. Will the end of this bull market mean the end of the entire bull market in stocks? Or, will it represent only a transition to a blue-chip led rally that puts the 2000 highs far below? After all, if the Dow had performed as well as the Value Line Index since the beginning of 2000, it would be at 20,131 today. Will the Dow finally play catch-up to the broad market in 2005?

We'll ring in the New Year this weekend with a discussion on these and other topics of interest. Stay tuned.

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Stock market action this week has been constructive overall, with the market rising and falling within a narrow range. This relieves pressure of profit-taking gradually and could allow the expected early January rally to extend further into 2005.

Action in the broad market was especially impressive as it closed slightly higher on the day. In fact, new all-time high records were set on most of the indices of the small- and mid-caps. This action was confirmed by new highs in the Advance-Decline Line, an indication that the bullish trend remains intact. New money which will come into the market in January appears likely to continue the rally.

Some blamed the drop in blue chips Wednesday on the rebounding oil market. Actually, the oil contract has found support at the rising polytrend support line:

Interest rates on the long bond have been in a rising short term trend in recent weeks. The bond market has been operating under the assumption that the recovery would falter, but the economic evidence indicates the market is wrong. Things are doing just fine in the economy, which suggests that the bond market has greatly underestimated the power of this economy and needs to adjust to the rising demand for money by ratcheting up rates. At times, the bond market leads the Fed in raising rates, but it appears the bond market has been behind the curve for about a year now and will have some catching up to do.

This rise has sent TYX more than halfway across the trend channel in the daily chart. We expect that as soon as rates reach that upper channel line, they will start moving down toward the bottom of the channel again:

We suspect rates will reach a short term maximum near the beginning of February. We have mentioned before that Profunds' RisingRates.com fund is the way to invest in a rising rate environment. That's because a standard bond fund will fall in price in a rising rate environment. This fund's NAV actually rises when bond prices fall.

An interesting pattern is forming in the NASDAQ-100 Index. We have been following it as it works its way toward a conclusion -- subscribers will find those comments on the Daily Chart Comments for NDX linked below:

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The stock market rally continued Tuesday as Monday's losses were reversed. This is in line with our expectations that the blue chips can continue higher into the first week of January. However, a growing number of bearish divergences are showing that this market is running on fumes right now:

In addition to the bearish divergences on momentum, Elliott Wave patterns, oscillators, etc., sentiment flipped around to the overly-bullish side on Tuesday. After two days of extremely bearish readings on the QQQQs, traders spent $5.48 for calls Tuesday for every dollar of puts they bought. That suggests these traders have thrown in the towel on their bearish impulses and have embraced the rally. That suggests the rally is not going to last much longer.

Despite the growing number of bearish indicators, however, this market is likely to continue higher due to the yearend influences. Money managers want to be fully invested at the end of the year and are throwing cash at anything that moves in the market. That also suggests that this artificial or "forced" buying will see them dump those shares overboard once 2005 is here.

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The Dollar Index, just as expected, showed weakness this week. Although we are many months away from a trend change in the Dollar Index, the extreme oversold condition of the index suggests a strong, countertrend rally is building up force to the upside:

Bond rates rose sharply as they crossed over the middle band of the three Bollinger Bands in the daily chart:

Overall, long term interest rates as represented by the TYX indicator are in a bottoming channel and are due to rise at an ever-quickening pace some months down the road. For now, the short term trend is up in rates into mid-January. A retest of the channel bottom is very possible thereafter. Thus, this remains a trading market for now. Investors who want to take advantage of the rising rate trend (the bulk of which will come some months down the line), can buy shares in the mutual fund RisingRates.com. This fund is a leveraged play (at 1.25×) on rising long term interest rates. We suggest either a scale-in approach, or simply waiting for rates to move back down to the bottom of the channel in the TYX chart to buy more.

The stock market on Monday took a breather in the Santa Claus Rally that got started last week. We're counting this as a minor pullback within the uptrend. However, while the blue chips are likely to continue to rally into a trading top next week, the broad market may top out this week. Still, we think higher highs are ahead as many of our indices still have slightly higher price targets which we think they can reach on this run up.

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The Dow Transportation Index -- "trannies", for short -- have broken out to the upside and are pointing the way for the rest of the market:

This is a clearly bullish indicator and should continue higher until November 2005. At that time, we may have a top forming, so we will have to reassess at that point.

The market has a very definite support line in the S&P 500 Index below which it must not fall in order to maintain the uptrend. That support line continues higher theoretically for several years -- it is yet to be seen how long the market can remain above it. But, as long as the market stays above, the trend will remain up.

As you can see, the bull market of the 'Thirties, which occured right in the middle of the Great Depression, was very strong and may be a good model for this bull market:

This week on our Detailed Comments Page for subscribers, we discuss some upcoming opportunities in several markets, plus ones to avoid:

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The rally in stocks just kept on grinding higher Wednesday. We expect this rally trend will continue for the rest of the year. Now, a trend is a central tendency and you will often see pullbacks within trends. So, not every day should be up. But, no major reversals should be expected until next year.

Strangely enough, the options speculators are expecting a reversal very soon. They've gotten more bearish on this week's rally than on any we've seen in a long time. Both OEX and QQQ specs are pouring more than twice as much money betting on the downside. Although these players have been more right than wrong recently, we suspect they're reverting to their old form -- wrong, that is -- and are going to regret ever giving up on the stock rally.

The Dow Industrials have been very strong compared to most of the market. That outperformance of the Dow was reflected in its ETF tracking stock, DIA:

This is a phenomenon we pointed out over a week ago. The old leaders are fading and the Dow is leading. That's something you see in the latter stages of a bull market, just before a big bear market. It's one reason we think this party is in its last stages.

Be sure to have a trailing stop under all long trading positions to take your profits off the table once this rally does finally end.

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That Santa Claus Rally we've been waiting for finally showed up at Wall & Broad Tuesday. The Dow leaped above its prior 2004 high as the rest of the market followed. The measured move target for the Dow is 11,577, although it won't get there in a straight line. But, this was an important milestone for the Dow since it confirms that the 4-year cycle peak has not yet occured. The 4-year cycle low occured in October 2002 and the next one is nominally due in 2006. However, we believe that a cycle inversion is potentially taking place which would extend this cycle by 50%, putting the next cycle low into 2008. That would leave a lot of upside potential in this market to be realized.

The S&P 500 Index already broke out to a new 2004 high and is well on its way to its very short term measured move target of 1223.38, likely to be achieved within a week:

If the SPX continues to move as it historically has under similar circumstances, an ultimate high in the 1390s can be expected to be achieved during 2005, most likely by May. And, higher prices than even that are possible, if not highly probable.

Trading is likely to be quiet Wednesday as most traders take off for the holidays, but the upward bias is likely to remain intact through the 30th of December.

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In the final stages of a bull market, the blue chips take over leadership of the rallies. That's what happened Monday as the Dow gained slightly and the former leaders slipped back. This is a continuation of last week's action, which saw the Dow outperform.

The Dow Industrials had been a poor performer until it finally bottomed in October. Is this period of outperformance a harbinger that the end of the bull run is near? Could be, but it also could simply be a normal sector rotation, or timeout for the leaders. The big question is whether or not the broad market is showing strong bearish divergence. On that score, we can say that things are not looking too bad quite yet. Indeed, things could be a lot worse:

As is clear on the chart, the Advance-Decline Line continues to make higher highs on new highs in price. A bull market often ends after a considerable bearish divergence (months or even years). That we are not seeing that yet suggests that, although this market is winded, it has a way to run higher. Two higher measured move targets could be acheived within the next week. A substantial retracement should follow thereafter.

The Death of Email and an Alternative

AOL users received none of the email messages we sent out over the weekend. This is just one more indication that email is a dying technology.

The alternative is alive and well (and free of spam): RSS. If you use RSS on My Yahoo!, just click here to get timely updates from us.

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Traditionally, Wall Street rallies during the last week of the year and the first two days of January. In fact, "If Santa Claus should fail to call, bears may come to Broad & Wall," according to traditional wisdom.

Last week, the market continued higher, but sold off into Quadruple Witching Options & Futures Expiration, most likely due to program traders who unwound positions put on earlier. This trend could continue for the first 2 or 3 days this coming week, which would setup a good base for the Santa Claus Rally to get started from.

The S&P 500 Equally-Weighted Index (ticker RSP) continues to outperform the capitalization-weighted S&P 500 Index (ticker SPY):

Long term interest rates continue to base along with the US Dollar Index. According to cycle analysts, bond prices are making 25-month and 6.125-year cycle crests at the present time and about to enter a bear market (a rising rate environment) that should last into 2006. Investors can benefit from rising rates in bond bear funds like RisingRates.com.

The Euro is forming a long term top, readying itself for a tumble versus the dollar. The Euro has been pushed far too high by the stubborness of the Chinese to let their currency rise versus the dollar, resulting in the Euro taking the brunt of effect of the weak dollar policy of the Bush Administration. Once the Euro tops out -- should occur within the next month -- it is very likely never going to reach these levels again. Investors will be able to sell the Euro short for a minimum 50% retracement of its recent rise against the US Dollar, for a potential profit of about $33,000 per Euro Currency contract.

As to exactly when we think the Euro will top out, we discuss that on this week's Detailed Comments Page .

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The US Dollar continued to work on turning the trend to the upside Thursday. The process could drag out for a couple or three more weeks (with the holiday period ahead, the central bankers can be expected to exert pressure to lift the dollar, which could trigger massive short-covering in 2005, sending the dollar higher and Euro lower). This action hammered the bond market off its highs -- interest rates off their lows -- from yesterday:

The Euro dropped sharply on the rising dollar, but still remains within its recent trading range. As long as the Euro remains in a trading range, we could have one more high around 1.36 basis the cash currency. That high could take place right around the end of the year or start of 2005. Most projections are being reeled into 2004 at the present time (see the Euro Cash and March Euro charts for details).

The Dow Industrials continued strong Thursday and is now approaching its yearly high, which it made back in January:

The NASDAQ-100 lead dog Index was weak Thursday. It's hard to say this is a sea change because it could just be program traders manipulating the index to expire the 40 options worthless on Friday. The QQQQ closed at 39.95 Thursday, so what do you think? Alternatively, they could have been buying cheap calls on the dip with an intent to bull the index higher on Friday and close those calls in the money. Certainly, the regular option sellers have lost control with Maximum Pain all the way down at 38 going into expiration.

While the Dow is still bullish, the divergences in the SPY, the exchange traded fund (ETF) for the S&P 500 Index, should give any bullish trader a pause. These divergences can continue for a while because the money is still coming into the blue chips, but it's clear that a big downturn is coming, probably right as 2005 begins:

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The stock market inched higher Wednesday as option sentiment went over the top. OEX speculators spent $3.65 for calls for each dollar of puts, while QQQQ traders lavished $12.56 on calls for each dollar of puts. This is a warning that this options expiration should begin some kind of short term pullback before the market moves higher.

It is apparent that a number of underinvested fund managers are putting money into the market now for the sole purpose of showing they were invested when the books are closed on 2004. This suggests that the trend should remain up into yearend, but also suggests that a number of positions put on during this month are likely to be summarily dumped in very early 2005.

The QQQQ showed a positive trend as the initial selloff was not followed through and volume picked up on the consolidation, a short term bullish sign:

Large Changes in Trend Ahead

The first quarter of 2005 promises considerable changes in various key markets, including the US Dollar. After a long term downtrend which started at the beginning of July 2001 -- a top we called several months in advance, by the way -- we are coming up on a sea change in the other direction. The US Dollar is forming a long term bottom, especially in relationship to the Euro. Now, over the past few years, the depreciation of the US Dollar has helped the US economy recover from the bust following the largest stock market Bubble in history. We were actually fortunate that under the Clinton Administration a true strong dollar policy put our currency in a position which allowed this huge depreciation to work wonders on the economy. Of course, that same strong dollar policy is responsible for moving factories and jobs offshore and that's something none of the politicians want to take credit for. But, the bottom line is that we had the power to change the course of the mothership and we did it.

The Europeans have taken the brunt of the dollar devaluation as the Euro has soared against the US Dollar. Europe is hurting and wants out of the game. And, it appears that they are going to get what they want. Very soon, the Euro is going to top out against the US Dollar and start a long decline. For those of you who trade foreign currencies, this is very good news because it means that long term trend-following positions can be put on which will generate profits for years to come, similar to the years of profits generated over the past four years of a strong Euro. But, we are transitioning through a period where the new trend has not yet taken hold, so with a neutral trend, only nimble traders with tight stops should be playing the currencies. Hopefully, by the time the trend up in the dollar becomes fully established, currency exchange-traded funds (ETFs) will be introduced on the stock exchange which can be traded by stock market investors. Until that happens, the futures and the interbank (FOREX) markets offer the best ways to play the currencies. Subscribers can find additional information about trading the Euro on the Daily Futures Charts page by clicking on the link "EC Cash Euro Currency".

The consequences upon the commodity markets cannot be overemphasized. During the decline in the dollar, many commodities, including gold and silver, made great gains at the expense of the dollar. In the coming rise of the dollar, those commodities are going to be in bear markets. Of course, there are commodities which did not benefit from the falling dollar, particularly in the grains (Corn, Soybeans, Wheat and Oats) and those markets are historically undervalued at the present time. That doesn't mean that they aren't going lower -- they probably are going to continue weak for at least a few more months. But, at current prices, the grains are discounting almost perfect growing conditions next year and the long term polytrendlines are pointing toward sea changes in those markets during the first quarter of 2005.

So, overall we have many, many markets which are making sea changes in trend. What does it all mean for the stock market? Well, we expect the stock market will end its recent bull market in the first half of 2005 and embark upon a decline very similar to the one it experienced from the 2000. However, this next decline will be worse because the small stocks which continued to rise during 2000-2002 will be entering declines and individual investors will have few options to avoid capital depreciation during the strong bear market to come. Still, it does appear that even the small stocks will remain in overall uptrends into mid-April, with the blue chips continuing higher into June. January is likely to present a buying opportunity in the stock market as 2005 starts off on a weak note.

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This week we have quadruple witching day on Friday and the market is moving toward a trading high going into that day:

This wave is unfolding in five Elliott waves up, so we expect three more peaks ahead. The high scheduled for Friday is likely to be only the first wave within wave 5. The last trading day of the year looks like it could be a wave three high, with the final peak, which will count as wave five, in very early January. That sequence will finish off several degrees of Elliott sequences, all the way back to at least mid-August, if not before that going back to October 2002. Thus, risk is very high going into this sequence of rallies.

This whole structure is setting up a very steep reversal, very similar to what we've seen already in the mining stocks. But, if the correction in January holds at critical support polytrendlines, we could have a stronger rally ahead to higher highs in 2005. Time projections for various indices point toward a trading low in mid-January.

The mining stocks may also be putting in a trading low in January as well:

The correction in the mining stocks may be over by late January, although there is a chance it may continue into June 2005.

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The S&P 500 Index broke out to the upside, confirming that we have completed four of five waves to the upside and are on the way higher:

The broad market lagged the gains in the blue chips, but our lead dog NASDAQ-100 Index stayed ahead slightly. Breadth was modest for a rally, which confirms the rally being a wave 5. Now, we expect higher prices for traders, but we also expect that this pattern, an Elliott Wave diagonal triangle, will be followed by a substantial return to the support trendline in January. So, traders should have a field day over the next month, first on the long side, and then on the short side.

Bonds, via the TYX Index, just touched the lower support line as that market is attempting to put in a top in price, a bottom in interest rates:

We expect the market is going to turnaround and head higher in rates, lower in price, very soon. And, once rates start up, they are going to trend higher until they surpass the rates of 1981 (15.21% on October 26, 1981). The way to play this is via a reverse bond fund like RisingRates.com. If you're trading futures, we like the ZB electronic bond contract traded on the Chicago Board of Trade for selling short.

XAU bounced as expected; this is giving investors who didn't sell before the fact one last chance to get out before the big plunge that's coming. We don't expect the XAU will be a buy again until January. In fact, the plunge in the XAU is just a preview of what's going to happen to the rest of the market once this fifth wave rally is finished!

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The stock market had a tough time on Friday as the Dow repeatedly rammed into the resistance trendline we showed Thursday until it finally cracked above it. The effort apparently exhausted the bulls, however, and the rally quickly failed and the index fell back to find temporary support on the old trendline:

Clearly, this is a market which has run out of gas, at least temporarily. And, it's not just the bulls who are exhausted -- the bears could not push the market lower. This "action" supports our wave 4 count in the S&P 500 Index:

Corrective waves are healthy. A rally here would not have much upside potential in the short term -- probably to the measured move target of 1223.30. So, if the market can control its impulses to run higher and actually heads lower now, it will "build cause" for a stronger rally to come in the January-February period. But, if the market decides to run to the upside here, it would finish off the leg which started at the mid-August trading cycle low -- it would count as wave 5 up and that will finish off what is probably a wave 1 overall in the larger wave (C) rally. If that happens, the market would then drop sharply into the 20-week cycle low.

Now, ideally, the next trading cycle low would come at the end of December, exactly 20 weeks after the mid-August low. But, we are getting some projections of a low around the 10th of January which seems to be a fairly probable time target on some of the leading individual stocks. If that happens to coincide with the market coming down to kiss the rising, bowl-shaped polytrendline (see the green square in the chart above, which is at that time and price intersection), it would be a perfect setup for a very strong bull market rally to follow in the first quarter of 2005.

As you might already know, this period of the year is seasonally weak in stocks going into the week before Christmas. It's a common misperception that the entire month of December is seasonally strong -- not true. It's only the first and last weeks of December which are seasonally strong. In fact, the middle half of December is almost as weak as the other half is strong! This is due to tax-loss selling by individuals. By selling now and waiting at least 30 days before repurchasing those shares, investors are able to take a deduction for losses on their 2004 income tax returns. From that point of view, a January 10th low makes good sense because that is about when investors would buy back those shares.

This week, subscribers will find a discussion of the economy, stocks, bonds, metals and other markets on our Detailed Comments Page.

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The blue chips rallied back, but left the broad market behind on Thursday. Moreover, the rally left a lot to be desired technically:

If the market elects to take the path of least resistance along that 10-week cycle envelope, we could see the stock market going downtown like the mining stocks did earlier. If so, fasten your seat belts for a rough ride below 10,000 by early January.

In this weekend's update for subscribers, we'll discuss several longer term plays we see setting up in various markets. And, we'll discuss the timing of the impending US Dollar Index bottom, which is certain to have a huge effect on all other markets in the months ahead.

Of course, we'll also discuss the polytrendline channel in the bond market, where the market is poised on a knife's edge trying to decide whether to rally or fade away. Thursday's action may have established a bottom in the long term interest rate channel, but the action going into the 15th of the month (Wednesday next week) will be key to determining just where rates are likely to head. One particular indicator in the bond market is saying the economy will be doing just fine for the next six months, causing rising interest rates and falling bond prices, but that a recession could be setting up to start in the second half of 2005 which could see bond prices rebound as stocks plunge in a replay of the 2000-2002 downturn. Nothing is set in stone, of course, but the Fed may not be in the best of positions to avert the next recession by the time it comes.

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Stocks in general bounced back from Tuesday's selloff, but the bounce was not very impressive. And, it was especially unimpressive in the Small Cap S&P 600 Index, an index which has led the bull market up until recently:

Sentiment was subdued even as the market bounced. If it had been extremely bullish, we would have to put on flak jackets now. Perhaps this is a wave 4 sideways correction just as we have been looking for in the blue chips. It does appear likely that the Small Caps are not going to regain their former luster anytime soon, though.

Yesterday, we showed you a chart of the XAU Gold Mining Stock Index and suggested it might bounce off a declining support trendline. It actually opened below that trendline, but did bounce back above it. Because of this trendline break and the high volume day, it is very likely we are going to see lower lows on XAU in the days ahead. Indications are that this correction could last into 2005 in the mining stocks.

The bonds were a bit stronger than we had anticipated as the TYX bond interest rate index broke slightly below our lower channel line. On the recent rise in rates, you'll recall that it broke slightly above the upper channel line before turning back down on the disappointing Employment Report. This market is heating up and getting more volatile. Combine that with the lack of a strong trend and you have a market which is subjecting traders to whipsaws in both directions. Wednesday's trigger was the big rally in the US Dollar, something we have been waiting for a long time. It appears that we have not quite reached the bottom yet in the Dollar Index, but we are beginning to refine our estimates of when that real countertrend rally will begin (subscribers, see the Daily DX Cash chart on the website for details). At least Wednesday's rally established another point to enter into the polytrendline calculation and it has yielded a turn date this month.

Summarizing, we have:

• a bond market in the process of establishing a downtrend, but not quite there yet.
• small stocks, represented by the S&P 600, which may have just about finished their bull market and could be heading much lower very soon.
• a broad stock market, represented by the Value Line, moving sideways in what is probably a wave 4 correction preceding a wave 5 rally that will end the bull market.
• a blue chip stock market, represented by the Dow Industrials, which could retest the bottom of the trading range into January, before surging much higher next year.
• a high tech sector still under pressure in its leading semiconductor sector.
• the US Dollar Index, deeply oversold, and heading for a big countertrend rally to as high as 98 in the months ahead.
• a gold market which is very vulnerable to a rise in the US Dollar.
• commodity markets which are shifting trends; grains likely to be ending their bear trends soon while industrial commodities ending their bull trends.

The next few months are going to see big trend changes in almost all markets. It will definitely be interesting.

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The wave 2/4 correction we've been watching develop since mid-November (the fact that a new high occured in the middle of the correction doesn't change the wave count, but does tell us the underlying trend is bullish) got a bit more serious on Tuesday as the Dow dropped 106, SPX 13, NDX 30, SML almost 7. Tuesday was, in fact, a Time Ratio turn point on the Dow Industrials, as well as a Bradley turn, so this downwave is coming right on schedule. If our wave count is correct, we are going to have a good buying opportunity upcoming this month as the 20-week trading cycle bottoms and turns up. The last landing of the 20-week cycle occured in mid-August. Just to refresh your memory, this is what that bottom looked like:

This next bottom is not going to be as dramatic as that August bottom, of course. The August bottom was a culmination of an 8-month corrective movement. This current correction comes after a 6-week up move in the broad market. So, we expect it to end in little more than a couple of weeks.

We mentioned the other day a couple of high probability trades on a seasonal basis. The market tends to drop between December 6th and 15th 87% of the time. And, it tends to bottom and rise between the 16th and January 6th 100% of the time. So far, the seasonals are on track, so we should look for a potential bottom around the 16th. That's the day before Quadruple Options and Futures Witching this quarter, so we'll have to watch carefully for the market to put in a bottom at that time. Otherwise, we'll be looking for the low to occur during the last two weeks of the month. Hopefully, the options specs will get bearish (they were only neutral Tuesday on a triple-digit decline in the Dow, so they are confirming that the correction has a lot further to go).

One of the leading sectors we follow is the NASDAQ-100 Index. It's making good progress toward the bottom of the trading channel:

The bottom of the channel could be in danger, however. Maximum Pain in the QQQQs is currently 38, which corresponds to 1520 on NDX. The price is just about where the lower Bollinger Band is currently on the chart above. Note the 20th brings a Time Ratio turning point in the NASDAQ and it may turn out to be a low.

One of the first sectors to break down was the XAU. It has a bit more to go before it finds any kind of support:

Although that downward-pointing trendline isn't likely to provide a lot of support, once the market reaches it, it could deflect the downtrend into the upward direction for a little while before the market rolls over and heads lower.

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For the past five years, since mid-December 1999, the broad market has outperformed the large cap blue chips. The small stocks have been the strongest part of the broad market as interest rates have trended lower and earnings rebounded out of the recent recession. But, the trend in bonds has just changed and interest rates are heading higher. Earnings momentum is slowing. Both of these suggest that the small cap stocks are going to underperform the blue chips at some point.

We now have evidence that we may be reaching that point for the small caps. Here is a chart of SML, the S&P 600 Small Cap Index, showing that we have reached the right side of the large T-theory "T" shown on the chart:

The Elliott Wave count would allow for one more rally following this corrective wave 4, but it's very likely that the blue chips are going to outperform the small caps on that next rally. In fact, our technical indicators suggest that the blue chips may continue higher until the second half of 2005. If you've been investing in the small caps, it has been a great ride, but it's a good time to consider rebalancing your portfolio to overweight the blue chips and underweight the small caps no later than the next trading low due later this month.

Monday's market ended mixed, with strength in the NASDAQ keeping its head above water while the blue chips suffered a minor retracement. With options expiration coming at the end of next week, the market is entering a consolidation which we're counting as a wave 4 in the broad market and a wave 2 in the blue chips. The 20-week trading cycle low, due by the end of December, is likely to kick off a powerful rally in the blue chips and a lesser one in the broad market. The fact that option speculators turned overly-bearish so quickly suggests limited downside risk (or potential) here. If the market is able to maintain a shallow retracement, the rally to follow is likely to be even more powerful.

Clarification: Bond Futures Naming Confusion

Although most traders and brokers call it a 30-year bond, the futures contract actually represents a duration closer to 20 years, which is why we called it a 20-year bond futures contract. Sorry for the confusion. The government hasn't issued a true 30-year Treasury bond in many years. The bond futures contract moves are about equivalent to moves on a 16-year government bond, in fact. The ticker symbol ZB stands for the electronic contract which trades from 7 pm - 4 pm Central Time Sunday through Friday. US is the ticker symbol for the pit-traded bond contract, trading from 7:20 am - 2 pm Central Time. Central Time is US Eastern Time minus one hour, or UK time minus 6 hours. Source: http://www.cbot.com/cbot/pub/page/1,3181,932,00.html (Chicago Board of Trade Trading Hours / Symbols).

The stock market equivalent is TLT, which stands for "iShares Lehman 20-Year Treasury Bond Fund".

We have updated our chart comments on ZBH5/Daily and TYX/15minute charts for subscribers.

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In this week's Detailed Comments Page, we discuss a seasonal trade which has never lost money. However, that doesn't mean it's not risky -- it is. But, for as long as we've been following the stock market, this seasonal tendency has always turned a profit.

Market Reacts to Good Earnings News From Intel

Don't watch the news -- instead, watch the market's reaction to the news. Thursday evening, Intel reported better than expected earnings and surged back toward overhead resistance. But, it couldn't breech that overhead resistance and closed Friday a penny above its low for the day. The market is sending a message: Intel is not the clear winner in the semiconductor space. And, perhaps, the semiconductor business slump is worsening. We think, however, that a long term cycle is bottoming in the semiconductors which could lead to another leg up getting started next year.

The bond market certainly thinks business in general isn't that great. We advised taking profits on bond short positions before the release of Friday's Employment Report for November -- and that was a timely harvest indeed. When the Labor Department reported only 112,000 new jobs were created -- while the consensus expected well over 200,000 -- the bond market reacted by rallying sharply higher, forcing shorts to become unwilling buyers to cover their positions.

Frankly, we think the bond market still has it wrong. First of all, one month's numbers are highly erratic, so we shouldn't read too much into a month where "only" 112,000 jobs were created. Second, this number comes from the establishment survey only; the separate household survey came in with a whopping job creation number of 483,000. Now, admittedly, one or both of these surveys are wrong. We suspect, though, that averaging the two numbers would give a better estimate of the real rate of job growth. Since the average is 297,500, we think the bond market is celebrating a bit prematurely.

Other indicators of economic activity point toward a strong economy. Our own Federal Reserve Repo Balance Chart (FRBREPO) indicates an economy humming along fairly well, but perhaps resting just a bit after a sprint:

One thing about it, though, is that even a brief dip in repos translates into either consolidation or outright decline in economically-sensitive stocks. This agrees with the technical indicators, which are pointing toward rough times in the stock market ahead, a discussion we get into in more detail this weekend for subscribers (use the Detailed Comments link).

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The Small Cap stocks have been leading the market higher for several years, but our long term chart finds them very close to a top. The bullish view would have them correct sideways and surge in a last rally into February:

The mining stocks, though, could have finished a very significant top which could take them far lower than the gold bulls think possible:

The bond market is nervously awaiting the release Friday morning of the Monthly Employment Report, which we will discuss in this weekend's update. The market's reaction will determine whether the nascent bear trend in bond prices will continue for the short term. We think the downslide could extend for one more week, but a reaction rally is becoming ever more likely. The next high will probably be a great short selling opportunity in bond futures -- correspondingly, a great buying opportunity in RisingRates.com, the ProFund which moves up along with rising long term bond rates. Yesterday, the fund rose another ½% as bond prices fell 0.40%. But, just as the trend is not well-established and no market moves in a straight line, a rally against the major trend at this point could be quite substantial and not only give normal bond mutual fund holders a chance at a graceful exit, but also give investors a chance to buy this reverse bond fund at lower prices.

In the meantime, if you're trading bond futures, we see some risk to shorts in the release Friday morning and would tend to move to the sidelines to avoid potentially large price gaps following the 8:30 a.m. (ET) release.

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We expected that this period of the month, which we euphemistically call the Monthly Buying Spree, would see the stock market rally (the MBS runs all week this month). This call hadn't been looking too great until Wednesday. But, the market finally came through with the Dow closing up 162, S&Ps up 16, NASDAQ up 35, Value Line up almost 26, etc. So, we have a buying spree finally kicking into gear. The sentiment figures Tuesday suggested the Spree might fail (OEX traders were extremely bullish, which is contrarian bearish), but, strangely enough, the OEX traders have been making money over the last month or so. Whether this rally is worth being in on the long side, though, depends only on your investment horizon.

We got an enquiry about that subject Wednesday, so we thought we'd clarify. It boils down to whether you are investing versus trading. We consider this stock market at these overvalued levels a traders' market only. Investors with a long term investment horizon have no business being in this overvalued market. The reason is that investors don't use stop loss orders (this is an observed and irrefutable fact of human nature), and they need to move to the sidelines when stocks get into la-la land -- in other words, right now, with stocks priced to perfection and full of risk for the bull. A little while down the road, this market is going to be plunging thousands of points lower. Investment in this market is just not worth it if you're in it for the long haul, which is why we advised investors to be completely in cash as far as their stock market allocation is concerned. We just don't think the last 10% of this bull market is worth the risk from an investment perspective -- just like we didn't think the last few points of bull market in March 2000 were worth the risk. The NASDAQ dropped over 80% from those levels.

Now, trading is a completely different game and if you take a trading view toward stocks, you should definitely be fully invested in the stock market -- with a trailing stop loss order on each separate position (whether that's stock index futures or individual stocks) in place and active (mentally, if you're trading individual stocks; physically, if you're into stock index futures). We are in a powerful wave 5 rally in stocks that is going much higher over the short term. That is, it's going higher until it doesn't. As a trader you're ready to reverse positions in a flash and get short the market. It's like the veteran traders say, you can't be either a bear or a bull because you can't afford to stick with a losing position. A 5% rally in the stock index futures could translate into a 50% gain in your account, so you definitely don't want to sit it out. On the other hand, you'll be just as happy to have your trailing stop loss order hit, take your profits and sell this market short because you know the potential on the downside far exceeds the potential on the upside. That's exactly the way you should think as a trader -- never get married to your position.

The bottom line here is that stocks have a little bit higher to go, but are going to be far lower in the future.

It's the same story in the bond market, where we advised investors to be 100% short the bonds. This is a long term trend that's just beginning to develop. Since we're near the beginning, we think a large retracement is very possible, and should provide an excellent secondary entry point. By the way, RisingRates.com, the reverse bond mutual fund we alerted mutual fund investors to, was up another .78% again. Not too bad for a trend just developing (and after several days of fat gains on the short side), but we do caution you that a steep retracement (bond prices should bounce back) is coming. So, if you're trading, your trailing stop loss order will take profits for you.

NASDAQ Pulls a Fast One

On Wednesday, NASDAQ changed the ticker symbol for the most popular ETF in history. QQQ is now QQQQ. Wierd. Because of this change, we don't have charts available for the new symbol yet.

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