Market Clues

For most of the day Tuesday, it looked like we would get another up day on the market, but the lingering geomagnetic storm apparently caused some investors to pull the trigger and take some very nice short term trading profits from the rally of the last month. Even so, the broad market remained very strong with the Russell 2000 moving up by 0.62% compared to the Dow, the Value Line gaining 0.52% versus the Dow and S&P 600 outperforming the S&P 500 by 0.60%.

Not everybody was interested in buying puts Tuesday (of course, the Homer Simpsons plunged into OEX puts with a 1.39 ratio of put dollars to call dollars) -- someone bought boatloads of calls on the QQQQ (NASDAQ-100 tracking ETF). By the end of the day, over 5 times as much money went into calls on the Qs compared to puts. This is reminiscent of the early days of this move (in 2003) when a very big buyer of QQQ call options turned out to be dead right about the direction of the NASDAQ.

Our read on this market says the same buyer may very well be making another very big bet on direction here -- and is likely to be just as right as before.

The pattern in the market indices is corrective near term, so with the storm's lingering effects likely to last all of this holiday-shortened week, this month's buying spree may be attenuated, but all of our indicators say this is just a minor pullback which builds strength for the next leg up:

For additional commentary for subscribers only, please use this link: Daily Chart Comments (comments there may be posted by the next US trading session).

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posted by Bob Carver  # 6:02 PM

We didn't plan on sending out an update on the holiday, but we thought you should know that a geomagnetic storm has been brewing Monday which has the potential to cause some investors to sell. However, the storm seems to be settling down and may have only a transitory impact on the markets.

It looks like there won't be a "United States of Europe" anytime soon -- the French had the good sense to reject the European Constitution. That result was well expected, but still sent the Euro sliding and the US Dollar Index rising. Even Gold slipped a bit on the news.

Given the 70% chance that stocks will finish higher on the last day of the month, we still expect Tuesday to be an up day on Wall Street.

For additional commentary for subscribers only, please use this link: Daily Chart Comments (comments there may be posted by the next US trading session).

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posted by Bob Carver  # 8:19 PM

Note that all markets will be closed Monday for Memorial Day.

It seems like the whole month of May was a buying spree, but we're now coming to the end of May and you know what that means. It's no accident that 70% of all months see a phenomenon we've labeled the Monthly Buying Spree which starts on the last two days of the waning month and ends on the third day of the waxing month. That's when end-of-month pension and 401-k contributions come pouring in to mutual funds. Tuesday will be the last trading day of May, and considering how underinvested most fund managers were in May, some are going to continue scrambling to keep up with the market rally in the last month of the quarter (June). It may have been prudent to sell stocks in March at the last all-time high, but it sure doesn't guarantee a job when the market hits new all-time highs in June or July! In case you haven't noticed, the broad market is now within 2% of setting a new all-time high record once again, so any mutual fund manager who has cash to invest would be wise to do some buying now to show how smart they were (whether they were or not) when the end of June "portfolio snapshot" is taken. So, we should expect the overall trend, although getting a bit long of tooth, to continue on the upside.

"Homer Simpson" doesn't agree, however -- that's our pet name for OEX traders because of their propensity to do exactly the wrong thing at the wrong time. They've been disbelieving this rally right from the bottom back in April and buying puts whenever the market slows its advance just a wee bit. Of course, a few traders may make a few pennies here and there with downside bets if they're very nimble -- no market can go up constantly, so the swift might just eke out a bit of change from time to time. But, the majority loses money betting on the downside in a strong uptrend. On Friday, Homer only spent 62¢ on calls for every dollar he spent on puts as the minor advance emboldened him to call yet another top. That's heartening to the bulls since these traders have yet to figure out that the market is rallying for a reason. One day they will be right and the market will correct. But don't hold your breath -- just look on a correction as a buying opportunity.

We've been busy getting another graduation out of the way and will have our normal weekend Detailed Comments posted sometime on Sunday the 29th.

For additional commentary for subscribers only, please use this link: Daily Chart Comments (comments there may be posted by the next US trading session).

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posted by Bob Carver  # 6:12 PM

GDP growth for the first quarter was revised to 3½% Thursday morning, dissipating latent fears of a slowing economy. Growth has now been above trend for a solid eight quarters and is promising to continue rising. While the Fed has been raising short term interest rates in baby steps, rates are still very accomodative. And, low long term mortgage rates have allowed the housing boom (or bubble, as you may call it) to continue. The combination has helped send the stock market higher, but the rally that started a month ago is going to be built on solid growth not dependent upon low interest rates.

The standout performers in this rally have been the high tech sectors, in particular the Semiconductor Index (SOX), whose recovery has been long anticipated. It's showing signs of breaking a long term resistance line now and that is a very bullish long term signal:

The breakout is confirming that the business cycle has bottomed and is now pushing the economy and the stock market higher. That cycle was due to bottom last year and the Semiconductor Index made its cycle low in September 2004, right on schedule. The recent correction low held above last year's low. We should be in the "Sweet Spot" of the expansion now and expect to see business starting to accelerate in the months ahead. This should allow the Fed to continue to raise rates until they have a comfortable cushion above the nominal inflation rate, which probably means we have at least 5-6 more rate hikes to go. During an acceleration in the business cycle, long term interest rates should reverse course (they've been heading down in recent weeks) and start to accelerate along with business activity.

In recent days, the option traders have been a good guide to where the market is going -- opposite to the direction of their buys. The minor dip this week sent speculators scurrying into puts, even as late as Thursday morning. By the end of the day, they were buying calls, but this doesn't mean the rally is over. Typically, the specs will realize the error of their ways soon enough to make a little money on the rally. We would get concerned when they are so bullish they are pouring twice as much money into calls as puts.

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posted by Bob Carver  # 10:52 PM

Bearish option sentiment provided a nice floor under the stock market Wednesday as most indices gave back just a minor percentage of their recent robust gains. This is great news as the market is now moving into the strongest 5-day stretch of the month and the Memorial Day Holiday, traditionally a strong period.

While the stock market has made great gains lately, many commodity markets have been held down by the strong US Dollar Index, which has been moving in a countertrend rally and dragging the mining stocks down. That appears to be ending soon and the mining shares are beginning to reflect a renewed optimism building toward gold and silver. The Dollar Index has been approaching that major downtrend resistance line in our chart and, so far, that line has been impenetrable. Note that this polytrend resistance line is a exclusive feature of our site and is formed from the reaction highs of the prior bear market rallies in the Dollar Index. A similar downtrend line in the S&P 500 formed in the 2000-2002 wave down which flattened out and began turning up at the exact time of the final bottom in that bear market. This line also flattens and bottoms, but that's for a future discussion. Right now, the Dollar Index needs to stay down for many of the commodity markets to turn up:

For Thursday, we suspect the stock market is going to make a stand and rally into a high in early June, at which time a large consolidation is likely to occur.

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posted by Bob Carver  # 11:06 PM

The market as a whole consolidated gains Tuesday as the Dow gave up 20, but the S&P 500 rose 21¢, NASDAQ-100 was up 5¼, the Value Line levitated 87¢, and the star of the day, the Semiconductor Index, vaulted over 6½. The fact that the broad market and the NASDAQ, especially the Semiconductors, held on for gains, is definitely a bullish factor, especially with the Memorial Day weekend upcoming (holiday weekends are typically positive for the market).

While the market found resistance to going down, the Homer Simpsons of the OEX options pit turned even more bearish Tuesday. They poured only 74¢ into calls for every dollar into puts, which is an underlying positive.

The stock market is taking a brief rest here as it gears up for further gains. What will power those gains? We think it will be money coming out of the bond market. The bond market is at Bubble levels with the economy picking up steam, but 10-year rates are sitting at 4%. When bond investors start to see capital losses on rising interest rates, we suspect they will be forced to sell and put at least some of that money to work in the stock market, sending stocks soaring much higher.

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posted by Bob Carver  # 11:07 PM

The stock market waddled higher Monday without much conviction. This is clearly a market which needs to take a break after a relentless rally. Whether it will or not is the question. It certainly would be healthy to see a pullback, both from the point of view of relieving the overbought condition, but also to embolden the bears to sell the market short. The reason is simple: short sellers have to buy to cover losing positions; the more shorts there are in the market, the more buyers there will be for the next rally.

Technically, the NASDAQ has been leading the way higher since the bottom last month. Monday was the first day when the volume oscillator for the NASDAQ-100 actually turned down. Now, that's not really a sell signal, but it does suggest some period of consolidation is occuring. Perhaps it will be enough to entice a few bears into the water. A pullback would be a healthy development over the next few days and would help setup the next rally. Still, the trend is your friend -- until it isn't. And, the trend is definitely pointed up:

Interestingly, the Homer Simpsons of the OEX pit have turned dead neutral after only a very brief foray into overly-bullish territory last week. That suggests a deep-seated pessimism toward the rally that should lend strength to any pullback.

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posted by Bob Carver  # 9:52 PM

The rally slowed Friday as short term traders took profits on trading gains, but the NASDAQ continued to creep up the hill as it continues to rise out of a deeply oversold condition. The Dow finished off about 21, S&P 500 down 1.8, Value Line off 15¢ (RSP was up 19¢), but the NASDAQ-100 gained 6.63 (QQQQ up 14.8¢) and the Semiconductors were up over 5 points (a 1.22% advance) on the day (SMH gained 35¢). For the week, the latter two indices each tacked on a gain of about 4%.

Arguably, the stock market had been moving in a long, sideways trading range ever since the January 2004 highs. Last month's bottom can be considered the centerpost of a Magic T. In T-Theory, the cash buildup, or accumulation, phase on the left side of a Magic T will equal the rally, or distribution, phase on the right side of that T. That simple concept has proved remarkable in its predictive ability over the last few decades of market activity. Indeed, the creator of the theory, Terry Laundry, has used the technique to amass great wealth both for himself and for investors over the years. We are in the "Sweet Spot" of the stock market right now as that right side of the T has just started to work the "Profit Magic" part of Magic T Theory. The right sides of these T's extend well into 2006, projecting an overall uptrend for one more year. And, the Breadth T projects a peak in 2007, so the uptrend could continue for two more years. Of course, as you should know, the market never moves in a straight line -- it always bobs and weaves like a prize fighter. Knowing the trend is important because it tells you whether your strategy should be to "buy the dips" or "sell the rallies". We have, of course, been buying the dips.

In this week's Detailed Comments , we concentrate on stock sectors using the Volume Oscillator. This is an extension of Terry's own Volume Oscillator indicator in fact. The Volume Oscillator can be applied to the whole market by using the advancing and declining volume statistics and is a great guide to tell you when to be in or out of the whole market. We have extended this concept to several stock sectors and our experience over the last few intermediate market cycles shows it is a valid extension. By using sectors, both gains and losses are magnified, so it is important to use care with your money management when approaching the market from this perspective.

New readers of this publication need to realize that there are two very different approaches that we distinguish and we want to reiterate these definitions to make sure you understand them:

1. Investor. An investor buys and sells based upon the quality of the investment. If an investment which is held goes down in price, the investor is pleased because it presents an opportunity to buy more at a cheaper price -- as long as the reason for buying is still operative (it may not be, but an investor would likely have already sold).

2. Trader. A trader buys and sells based upon price and other indicators. If a security which is bought goes down too much (a value pre-defined by the trader based upon that individual's own situation), it is sold immediately to cut losses without any second guessing.

As long as you are clear on what approach you are taking, your decisions should be easier. You may have multiple accounts. Some may be for trading and others for investing. Never confuse the two approaches. If we say a particular ETF or stock is good to buy and you are a trader, you should always use a trailing stop loss order (preferably held by your broker's computer to enter as a market order when your stop is hit) to protect your account equity. If you are an investor, you need to pay attention that the reason for holding that investment hasn't changed.

For additional commentary for subscribers only, please use this link: Daily Chart Comments (comments there may be posted by the next US trading session).

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posted by Bob Carver  # 5:11 PM

Stocks closed up only slightly Thursday as the short term rally is getting a bit winded after a sprint up the hill. Bonds, however, fell back and that's a great trend to see, since it means some money may be coming out of bonds to move into stocks. That's a factor which can fuel the stock market advance over the intermediate term.

Option sentiment is registering at warning levels now as the Homer Simpsons of trading (OEX speculators) poured just about twice as much money into calls (bets on the upside) as puts (bets on the downside). When that happens in a strong uptrend, you can count on a minor dip to occur starting within about two trading days. If it's a bear market rally, that kind of reading will usually see an immediate reversal the very next day. So, one measure of just how strong the market is will be to gauge how long it takes before the market enters a correction.

Longer term, the market is showing signs that a solid intermediate term advance has begun. Terry Laundry's Magic T's project advances into September 2005, April 2006 and into 2007. You can hear Terry's weekly audio commentary by visiting his blog at Terry Laundry's T Theory Observations (that's http://ttheory.typepad.com/terry_laundrys_t_theory_o for those reading this in plain text). There you will find a chart similar to the following one:

The difference between Terry's Volume Oscillator and ours is that we use the up and down volumes of the individual stocks which make up the index (in this case, the S&P 500 Index) to input into a slightly modified version of Terry's formula. We do the same for the other indices we track on the Daily Volume Oscillator Charts page. Currently, here are the indices we're keeping daily volume oscillators updated on:

• BTK: Biotech (AMEX)
• COMPQ: NASDAQ Composite
• DJ: Dow Industrials
• HUI: Gold BUGS
• NDX: NASDAQ-100
• NYA: NYSE Composite
• OIX: Oil
• RUT: Russell 2000
• SOX: Semiconductor
• SPX: S&P 500
• TRAN: Dow Transports
• UTIL: Dow Utilities
• VLE: Value Line
• XAU: Gold and Silver Sector

All of the above indices have corresponding ETFs which you can buy and sell like stocks. This allows you the ease of trading the entire index in one convenient security -- it's a mutual fund which trades as a stock, which means you don't have to wait until the close to get a price and get in or get out. And, since the shares track the index they're based upon, you have some degree of diversification. Of course, some indices are more diversified than others. For instance, the Russell 2000 Index represents 2000 stocks and the S&P 500 five hundred. But, the Dow Industrials represents only 30 stocks. And, of course, in the narrow indices, such as Oil, the whole group can move quite rapidly due to the fact that all stocks in the sector are being affected by common forces, such as the price of oil. That's a double-edged sword, of course, since if you're right, you make big gains; if you're wrong, you take more heat.

The idea of the volume oscillators on these indices is that you want to be buying the sector when the volume is coming into the sector on price weakness and pushing the oscillator up (higher lows on the oscillator, especially if it is pushing up to the zero line or above, while price is pushing to new lows, is what you're looking for). And, you will want to be selling when the volume is flowing out of the sector on price strength. These two patterns represent bullish and bearish divergence, respectively. Every day, after our computers have crunched the numbers, you can check out the charts to see how your sectors are performing.

We hope to add some more ETFs to the list of volume oscillators we chart each day. That will depend upon being able to keep the component list for each ETF up to date. It appears that the Merrill Lynch HOLDRS may qualify for inclusion.

For additional commentary for subscribers only, please use this link: Daily Chart Comments (comments there may be posted by the next US trading session).

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posted by Bob Carver  # 10:01 PM

Wednesday was probably the Point of Recognition Day on Wall Street. The Dow tacked on another 132, NASDAQ-100 was up by 19, S&P 500 gained almost a dozen and the Value Line soared by almost 30 points. The Homer Simpsons (OEX option speculators) finally decided it was time, after almost three weeks of rally, to actually start favoring calls over puts, but have not yet reached overly-bullish levels just yet.

We mentioned that the Rydex S&P 500 ETF was a better market tracker than the SPYs a couple of days ago and a caller to Tom O'Brien's Wednesday afternoon program on http://www.TFNN.com/ noted that we had mentioned this ETF, but that the volume in this stock is a bit on the light side, especially compared to its sister, SPY (S&P 500 Depositary Receipts). We'd like to make a couple of points here. First, if you're a trader, you probably are indeed more interested in SPY because of its deep liquidity. RSP is more for the long term investor who simply wishes to buy for the longer term moves and to match market performance, rather than buying and selling to catch the short term dips and rises. Thus, short term liquidity of RSP is of little importance to someone with a much longer investment horizon. Second, if you're analyzing movements of RSP itself, you should probably be using volume in its underlying component issues rather than just the ETF itself because it's those underlying components which provide the pricing for the S&P 500 Equally-Weighted Index upon which RSP is based. You'll find that our SPXVOLOSC (S&P 500 Volume Oscillator) chart uses the volumes of the individual S&P 500 component stocks to create that oscillator (it's on the Daily Volume Oscillator Charts page, along with the other volume oscillator charts); it should track volume patterns in the Equally-Weighted Index as well (if not better) than in the cap-weighted version.

A good example of someone who might be interested in buying and holding the Rydex ETF would be an index fund manager who simply wants to outperform the S&P 500 Index itself by a couple of percentage points (on average). The manager would aim to be as fully invested at all times as possible -- folks who invest in index funds do so to participate in market moves, not to have their cash sit on the sidelines. There is nothing worse to a long term investor than to buy shares in a fund and have the manager sit on a pile of cash while watching the bull market rocket higher. This is not a hypothetical example: the Transamerica Blue Chip Fund had a bearish manager who kept 30% of his investable funds in cash during the biggest bull market of the 20th Century!

We're not advocating a long term buy and hold philosophy because we recognize that the occasional bear market will come along -- or even the garden-variety correction like we just had. But, if you want guaranteed participation in the market, you have to be aboard an investment which moves with the market. And, that's what an ETF like the Rydex is good for. Of course, if you're a good stock picker, you can go for individual issues. Just remember than most professional managers actually underperform the S&P 500 Index.

And, then, there are the other sector ETFs to choose from if you want to actually beat the market. These offer additional potential gains (as well as risk of additional losses when you're wrong). But, they offer some diversification so that if you do choose the wrong sector, you are protected from a total disaster by having many different stocks in the mix.

Last month, we suggested buying the SMHs (Semiconductor HOLDRS). They're up 12% off the bottom, a very nice move in three weeks. We based that suggestion upon the very bullish divergence which we saw showing up on the SOX Index, one of the indices for which we provide a daily Volume Oscillator chart update (each Volume Oscillator Index has an associated ETF which you can buy and sell which is shown on the chart page). Here's the latest SOX Volume Oscillator Chart:

As you can see SOX has retraced almost 62% of the loss sustained in the last downwave, a normal resistance price. But, no bearish divergence is showing up yet. This is bullish for both SMH and QQQQ, the NASDAQ-100 tracking stock, because the Semiconductor Index tends to be a leading index for the NASDAQ-100 Index (which, in turn, tends to be a great leading index for the rest of the stock market).

For additional commentary for subscribers only, please use this link: Daily Chart Comments (comments there may be posted by the next US trading session).

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posted by Bob Carver  # 9:46 PM

Announcement: Mr. Carver will appear on Tom O'Brien's Wednesday afternoon radio show right after the market close. Check it out at http://www.TFNN.com.

Stocks continued to rock 'n' roll up the hill Tuesday, with the Dow up 80 points, NASDAQ-100 tacking on 9½, S&P 500 gaining 8.11 and the Value Line adding almost 11.

The big surprise is that the bond market is still hanging tough. The old rule of thumb used to be that the bond interest rate should be about 3% plus the inflation rate. With inflation now running at 3.1% according to the BLS (Bureau of Labor Statistics, keeper of the various measures of price inflation), bonds should be yielding 6.1%. Instead, they're yielding 4.47%, or only a measly 1.38% over inflation. And, that's if you use the government's own inflation numbers! Ten-year notes are yielding even less. Has the law of supply and demand been repealed?

The explanation is simple enough, though. When you print enough paper money, the old laws of supply and demand need not apply -- for a while, that is. As long as the participants in this grand economic experiment in fiat money agree to call this concept of money "real", the game can continue longer than any reasonable observer might expect.

Once again, John Mauldin has ferreted out the facts behind the Fed's machinations in reflating the world's economy out of its deflationary dive of 2000-2003. In the article entitled, "How Japan financed global reflation" by Richard Duncan, found on John's Outside the Box website, the explanation of how the Japanese printed ¥35 trillion ($320 billion), then bought US Treasury bonds with the money, is laid out in all its gory detail for everyone to see.

That huge influx of "cash" was enough to cover the huge shortfall in financing the wars and the tax cuts of recent years. But, Alan what have you done for us lately? What the Fed is doing right now to keep the Treasury balls in the air isn't exactly clear, but it appears to involve Caribbean hedge funds, who now are the 3rd largest holder of US government debt, right behind Japan and China. And, there's some s

posted by Bob Carver  # 10:08 PM

While the weekend geomagnetic storm might have disturbed investors in some places (namely, Asia, Australia and Europe) on Monday, the US market took it all in stride and powered higher. Although we thought the markets would end lower, the Dow closed up 112, NASDAQ-100 slipped higher by 10, the Value Line added 20 and the S&P 500 tagged along for an 11.64 point boost. This market has a reservoir of optimism that just won't quit.

But, those "Homer Simpsons" of short term trading, OEX speculators, after a few weeks of trying to call tops and buy puts were at it again in force on Monday. For most of the day they poured almost 4 times as much money into downside bets -- even with the Dow up over a hundred points for most of that time -- before finally, just before the closing bell, a few threw in the towel and conceded that the bulls might have made a point. By the end of the day, those sad sacks had spent only 43¢ on calls for every dollar they wasted on puts.

Now, we're right in the middle of the timeframe where we should be seeing a 9-month cycle bottom. Ideally, most of that cycle's downside energy has already been spent and the near term trend is basically pretty neutral here. But, the odd dip is likely to retest support and that's where we'd suggest that, if you aren't already fully invested, would be a good chance to get aboard the train.

We read an interesting piece this weekend in John Mauldin's Thoughts From the Frontline e-letter (http://www.frontlinethoughts.com/index.asp). It spoke about how the capitalization-weighted indices, due to a flawed design, would never beat the "market" (ironically, the foremost capitalization-weighted index, the S&P 500, is sometimes held out to be the "market" itself). The reason is pretty simple: cap-weighted indices overweight stocks which are overvalued and underweight stocks which are undervalued by the nature of their construction. It turns out that almost any other method of constructing a stock index is superior to capitalization-weighting. How's that for irony?

What this boils down to is that if you want to do as well as the "market", you're not likely to do so by investing in the S&P 500 Index. But, in order to do as well as the market, what are your alternatives? One we've always liked has been the Value Line Index, which has indeed trounced the S&P 500 Index over the years. But, it's only a thinly-traded futures contract and thus not very suitable for the average investor.

It turns out that one way (of many different approaches) to beat the S&P 500 Index is to equally-weight each stock in the index (that's exactly how Value Line does it, in fact). Most think the Value Line is such a great performer because small stocks have a higher weighting. That's probably not the case, though. It's that equal-weighting bit, in fact. And, those folks at Rydex figured it out some years ago, then created an ETF (Exchange-Traded Fund, which is a stock that trades like a mutual fund and can be bought and sold anytime the exchange is open) which equally-weights each of the 500 stocks in the S&P 500 Index. Its ticker is RSP and the chart looks an awful lot like the Value Line, as a matter of fact:

Note that the polytrendline the fund bounced off of could lead it higher until July of next year. That is, as long as it holds above it.

Housekeeping: We added a geomagnetic storm indicator on the Trading Page. Sometimes these storms can cause investors to sell. Sometimes they're finished selling already, which may very well be the case in the US right now if you can judge by Monday's rally. In any case, the weekend storm seems to be diminishing substantially now. And, the 45-day storm forecast from the US Air Force suggests clear sailing ahead (except for a minor storm near the end of the month -- see the 27th and 28th of May).

For additional commentary for subscribers only, please use this link: Daily Chart Comments (comments there may be posted by the next US trading session).

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posted by Bob Carver  # 7:42 PM

Announcement: Elliott Wave International's best timing service, the European Forecast, is having a Free Week starting Wednesday, May 18th. To sign up for it, join Club EWI if you haven't done so already.

The "Conundrum" continued last week. That's the very unusual behavior of the bond market where long term interest rates are not moving up while shorter term interest rates are doing so at the Federal Reserve's measured pace of hiking shortest term overnight lending rates. Alan Greenspan gave the process that moniker and it has stuck. With the Fed fighting the bond market to hike rates, something will have to give, eventually -- and it isn't going to be the Fed.

Why is that so? There is a dominant 60-year cycle in long term interest rates and that cycle bottomed two years ago:

As you can see, the 10-year note rate has risen off that low in 2003 at a "measured pace" as the bond market resists the upward pressure placed on it by the Fed. This is unlike the last low in the 1950s where long term rates zoomed higher. Undoubtedly, the behavior of this Fed in hiking rates in baby steps has a lot to do with this behavior. Investors got used to low rates and easy money in the "carry trade" and are very reluctant to change gears. It may take a real shock to the system to get the long term bond rates climbing substantially higher.

After months of worrying about a slowing economy, last week's news indicated just the opposite was occuring. Jobs are being created (perhaps not as rapidly as the Labor Dept thinks they are, but the trend is still very positive), companies' earnings are increasing faster than analysts' estimates, the money supply is expanding at a decent clip, retail sales are growing faster than expected, but the market is still looking for a return to recession. And that is keeping interest rates lower than the Fed would like. Low interest rates stimulate the economy and, at this point, the stimulation may be too much to keep inflation in check. Current rates are still stimulative because they are below the rate of inflation. In a typical recovery, rates will move above the rate of inflation by 2-3%. The Fed, in fact, may be forced to start raising rates at a more rapid pace. That would certainly shock the bond market and lead to higher rates across the yield curve.

In any case, a certain amount of increase in inflation would be good for the stock market and bad for bonds. Pricing power on the part of businesses would do a lot to boost earnings and employment and lead to higher stock prices, just as it did in the 'Fifties and 'Sixties after the last 60-year interest rate cycle bottom.

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posted by Bob Carver  # 6:03 PM

Good news was bad news for stocks -- or so it would seem -- on Thursday. Retail sales showed a robust and expanding economy, while jobless claims came in slightly higher than expected. But, in truth, we simply saw that second shoe (wave c) drop in stocks.

The big winner was the US Dollar Index, which broke out above resistance and appears headed for further gains. As we have mentioned, strength in the US Dollar translates to weakness in stocks. This breakout doesn't change the larger trend, but will setup better prices at which to sell the dollar short.

As we head into the ideal landing zone for the 9-month cycle in stocks, we look for bearish sentiment to build. On Thursday, the Homer Simpsons (OEX option speculators) turned slightly bullish -- and, after disbelieving the rally for weeks, just look where it got them -- a Dow down triple digits once again. It might be next week before we get the next turn up, although there is a chance we're very close to the end of wave c down right now (Thursday was the center date of a Bradley turning point, with a leeway of ±4 calendar days). This bottom is beginning to look like a reverse "head and shoulders" -- if it is, we're forming the right shoulder right now.

The market is certainly obliging investors by giving ample opportunities to buy for the larger trend up. The NASDAQ-100 Index, which has lagged all year, turned out to be the strongest of all this week as it is holding against the selling pressure very, very well. Typically, NDX will turn up ahead of the general market, making it our "lead dog" index.

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posted by Bob Carver  # 11:04 PM

The minor correction which started Tuesday in stocks continued Wednesday morning, but stocks found major footing and rallied back to close at a slight positive for the day. We're counting the correction as an "a" and "b" wave so far, with a retest of the lows ahead in wave "c". This will finish off a minor second wave. With the 9-month cycle due to land any day now, once it turns up, the rally could go like a rocket.

The Homer Simpsons (option speculators), as usual concentrated on buying puts in the morning selloff. By afternoon, those puts were losing value quite rapidly and overall the OEX number ended neutral. After a rally of about 5% in the last couple of weeks, it's quite amazing that these option players are still bearish, but as long as they are, this market can climb the wall of worry.

Interest rates plunged along with stock prices as a pair of lost Cessna 152 pilots sent Congresscritters and the Vice President fleeing for shelter in Washington. Panic mode turned to rally mode as soon as it was clear that the all-clear was for real. But, this incident serves to illustrate that bonds and stocks continue to move in opposite directions: bond prices go up as stocks decline and bond prices go down as stock prices rise. The same is true for the US Dollar Index: as it rises, stocks go down. Wednesday morning's good news (trade deficit narrowed 9.2% which will cause the GDP growth rate to be revised upward from 3.1% to 3.7% in the First Quarter) sent stocks lower. Yes, good news was bad news for stocks. But, that's the nature of corrections: keep investors guessing. The Dollar went up on the strong economic news, sending stocks lower.

The following chart illustrates the downtrend in IEF, a bond equivalent stock that tracks the 7-10 year Treasury Note price. Every time the shares test that overhead resistance line, they tumble, while the rest of the stock market rallies:

This is a trend that is likely to last for the next 25-35 years as the 60-year cycle in interest rates bottomed last year and carries interest rates higher (prices lower) on a long term trend basis. How high will the 10-year note rate go? It's difficult to say with precision, but the last cyclical peak should be exceeded. That last peak was 15.84% on the 10-year note in the early 'Eighties. Expect to see bond prices decline by at least 70% -- and probably more -- from the current historically very low 4.20% yield.

That's why we suggest you only hold bonds until maturity. The risk of capital loss will be great if you sell with substantial time to maturity remaining on those bonds.

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posted by Bob Carver  # 10:33 PM

The broad market continues to lead the way up as the expected correction of the first wave up in a powerful wave 3 advance finally took the market lower Tuesday. We say that the broad market is leading because the Relative Strength lines of all of the broad market indices are continuing to move higher versus their blue chip brethren. That's always a bullish sign for the larger trend. This correction we're in is likely to last all week, but always remember: surprises are in the direction of the underlying trend.

We were asked to present a longer term Elliott Wave count and we reluctantly provide the following chart. We believe Elliott Wave is a fine technique when used in its proper place, of course, but it is so often used improperly that we tend to minimize its usage. However, when its myriad interpretations can be dovetailed with excellent, objective indicators, we think it has its place. In the following chart, you will note that we count the current advance as beginning at the March 2003 low while most Elliotteers insist on counting the start at the October 2002 low. We diverge for a very good reason in our opinion: our polytrend resistance line which formed along the reaction highs of 2000-2002 -- and which we published in Fall 2002 -- clearly projected with pinpoint accuracy the bottom for the month of March 2003 -- and that bottom marked the beginning of a sustained surge to the upside. Thus, to our way of thinking, that last wave down into March 2003 was simply the dying impulse of the downside move from 2000. That it couldn't even drive the market to a new low fits extremely well with the power of the rally that came after that bottom. Thus, in Elliott Wave terms, we count that last plunge as a "failed fifth wave" and the orthodox end of the move from the 2000 peak. The exact labeling of that move is unnecessary at this time and is more of a distraction to the long term investor.

The rally, which we count as a wave A up (although it could just as easily be a wave 1 -- the difference at this point is entirely academic) ran into stiff resistance in early 2004, not coincidentally when it ran into that same 2000-2002 resistance polytrendline. That encounter sent the market sliding sideways to down into an August 2004 low (October 2004 for the Dow). We count that sideways correction as a flat wave B (or a wave 2 without significant alteration of expected outcomes). And, as in the chart in yesterday's update, the August-December 2004 rally was a lower degree wave 1 of C up, the correction into late April a wave 2 of C down, and the current rally a wave 3 of C up (alternatively, a wave 3 of 3 up).

We're sure to get howls of protest from the permabear Elliotteers, but arguing Elliott Wave counts is little different than the clerical debates of the Middle Ages over the number of angels who can dance on the head of a pin. When it comes to making money in the markets, Elliott has its place at the table, but not close to the head of the table by any means.

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posted by Bob Carver  # 10:25 PM

The Homer Simpsons of stocks -- OEX speculators -- stayed bearish Monday and lent buying power to the advance as the broad market moved higher.

Although we believe Elliott Wave is a useful tool, it's not the primary tool in our technical toolbox. In fact, any interpretation of the waves must be confirmed by other (independent) tools, such as volume and sentiment. But, for those keeping track of the count at home, here is the count we have in the broad market Value Line Index:

So far, both the volume oscillator and sentiment are confirming that we are starting wave (3) to the upside.

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posted by Bob Carver  # 11:05 PM

Although commodities have been hot (the recent correction is just a normal bull market correction and a great opportunity to buy the dip), most investors don't have the time or account sizes to really "get in the game". Up until recently, you either had to trade the futures directly, or have a net worth of millions of dollars (a so-called "accredited investor") to invest in a managed futures fund.

According to the May 2005 issue of Futures magazine, Jim Rogers' new book, Hot Commodities, was a result of the trends he witnessed in his travels around the world. In 1998 he created The Rogers International Commodities Index (RICI) and has launched several funds based upon the index. The RICI has returned 205.73% since its launch in August 1998, outperforming all other major indices. Rogers expects the bull market in commodities to last another 10-15 years, with periodic corrections (cyclical bear markets) punctuating the long term uptrend.

A new fund, Superfund (http://www.superfund.net/), promises to bring the bull market in commodities to the average investor. Geoffrey Adler, a representative with the fund (telephone 1-888-507-8737 toll-free or 1-212-750-6300 non-toll-free; or email geoffrey.adler@superfund.com), provided us with information about the fund. We found that the fund's investments are based upon trend-following signals originating solely from a technical analysis system. The advantage of that kind of a system is that it removes emotion from investment decisions and based them solely upon a well-tested, sound money management system with a proven track record. We favor that over fund managers because in general fund managers underperform relative to market benchmarks.

Although some states are more restrictive, in general the minimum amount required for investment in the fund is only $5000 (contact the fund for specific state requirements). Although the fund has just started up in the US, it has been in operation outside the US for several years and has shown better performance overall than most US stock funds. In fact, one of the big benefits of commodity investments is to counterbalance stock market returns, which tend to vary dramatically depending upon bull and bear markets. Stocks, bonds and commodities tend to move in different cycles, with commodities outperforming in some phases while stocks and/or bonds may be underperforming. Thus, commodities act as a counterbalance to the other two investment classes. An analogy would be to a stool with four legs: cash, stocks, bonds and commodities. Even if one leg gives way, the other three should help hold the stool up.

Incidentally, Superfund has other, more aggressive funds, but they are not yet available to US investors. Foreign investors should contact the fund for information about those funds. Geoffrey invites investors to visit him at Superfund's Investor Center at 489 Fifth Avenue in New York City -- tell him Bob Carver sent you.

Employment Numbers: Garbage As Usual

The government released new jobs estimates on Friday, which purported to show extremely strong job gains of about 100,000 more than expected. Unfortunately, as usual the press failed to report the fact that these figures are far from accurate (previous months' reported jobs figures were revised significantly higher than initially reported, for example, supporting our contention concerning the "garbage" data that's being reported). The actual new jobs figure reported to the US Labor Dept was only 17,000 -- the remainder "ghost jobs" were inferred by their so-called "Birth/Death Model", which added 257,000 uncounted jobs to the meager number actually reported. This is not acceptable data in our opinion and creates excessive volatility as well as mistaken perceptions in the public. How is the average citizen, not to mention employers, going to make correct employment decisions when these garbage numbers are being fed to them as truth? The press should treat these releases with extreme skepticism. Instead, journalists, like Pavlov's dogs, lap up these government figures and convey them to the public as "facts". This leads to errors of judgment, such as the impression in early February that the economy was undergoing an intense slowdown in new job creation -- it wasn't the economy that was slowing down, it was the Birth/Death Model which subtracted a whopping 280,000 jobs from the actual figure in January. Did some employers fail to hire because they believed the government? We don't know, but that's entirely possible. Certainly, the bond market reacted to the perceived "slowing" in the economy by cutting long term interest rates and neutralizing the Fed's rate hike campaign to slow the economy. It's time the press started acting responsibly and reporting the error bar that's associated with these garbage numbers coming from the government. Alternatively, the US Labor Dept should take the responsible action of deferring reporting of new jobs figures until they are certain they have the facts -- the first Friday after the end of the month they're reporting is too soon to report this garbage.

In any case, markets traded as if the figures were facts. The bond market sold off, raising long term interest rates. The stock market was caught between a rock and a hard place: the news was good for it meant the economy zoomed out of a presumed "soft spot", but if the huge gain in new jobs was viewed as potentially inflationary by the Fed, they would accelerate the rate hikes and slow the economy, possibly overdoing it just like they did in 2000 and pushing the economy back down the Slippery Slope of recession. This caused the stock market to go into a tight trading range, ending the day about where it began. Judging by prior experience, the Labor Dept is likely to revise these latest figures substantially lower in a couple of months, long after the damage to stocks is done. This is likely going to cast a pall over the stock market in the weeks to come.

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posted by Bob Carver  # 5:54 PM

The surge off last week's bottom projects an advance to early October, according to Terry Laundry's "Magic T Theory." With most speculators now bearish, we're sure we will hear more screams of anguish, as well as subscription cancellations, from bearish readers, but that's exactly what the technical indicators are saying and we give it to you straight and unadulterated. The picture on the S&P 500 Index is extremely bullish right now:

The strategy here in stocks is simple: buy the dips for the larger trend up, something we've been doing consistently during the recent correction. While we think the emphasis is likely to shift to the large cap stocks, the small and mid cap stocks which have led this bull market are likely to continue higher (and, because they are deeply oversold, might even outperform into September). We have added links to ETFs -- shares which mimic a sector or market index -- for the sector volume oscillators on the website, so you will find it easier to locate those stocks. Most folks will find it easier and safer to invest in funds which track an index rather than individual stocks. These funds track an index like a mutual fund, but trade like stocks on the exchange, so you don't have to wait until the end of the day to switch into and out of them. Of course, a commission might have to be paid (some folks have stock accounts where no commission is charged) unlike a traditional fund.

Most of our short term trading indicators switched to bearish mode Thursday, but that doesn't affect the larger trend at all. Indeed, the overhead resistance polytrendline on the Russell 2000 Index turned out to be incredibly accurate. The market has rallied straight up to that bottoming curve, hit it square on Thursday and pulled straight back.

That confirms it is a valid polytrendline and that it represents a short term cycle which has bottomed. Although one shouldn't expect the market to hug that line as it accelerates higher -- the market zigs and zags to shake the weak hands off -- the fact that the polytrendline is accelerating higher should bias your trading to the bullish side in coming days. Look on any retests of the recent lows as a gift buying opportunity for the next big rally.

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posted by Bob Carver  # 10:32 PM

We expected the bears would muster one more wave of selling for the market, but they were in full retreat Wednesday. The battle they had so valiantly fought was lost and now the bulls are enjoying the spoils of victory.

We don't mind being wrong as long as we make money. And, we made a lot of money on Wednesday's rally. In our investment accounts we are fully invested and putting new cash to work buying the market whenever new cash is available. Yes, we've had to put up with a bit of a correction in the last few months, but compared to many we've seen over the years, this was a mild one indeed.

Trading-wise, only one of our short term indicators had been on a sell signal (Oddball) coming into Wednesday. It threw in the towel Wednesday morning and flipped back into the bullish camp in time to join the parade to higher prices. Amazingly, option traders remain disbelievers and were still pouring far more money into downside bets even after the market has risen so far above last week's lows. That's definitely a reassuring sign of the health of the rally. Recall, it was just a few weeks ago that those same Homer Simpsons of trading were mistakenly buying calls on dips at higher levels. That they are even more eagerly buying puts on rallies is bullish indeed.

The NYSE Composite Index chart below demonstrates one measure which shows that the bulls have regained control of the market from the hands of the bears:

As we mentioned in yesterday's update, many of our volume oscillators are showing strong bullish divergence and Wednesday's rally certainly put an exclamation point on that statement. But, we must recognize that no market rally goes straight up and we must expect periodic pullbacks to refresh the sideline cash. The 39-week cycle low is due in the next week or two and that may provide a retest of the recent lows in some sectors. If the strong buying patterns evident on our sector volume oscillators continue, investors can buy the dips with assurance that the larger trend remains strongly on the upside. And, subscribers will find they can concentrate their buying in ETFs in some of the most beaten-up sectors this year, which are showing very strong buying power coming in. Visit our Daily Volume Oscillator Charts Page to review what's hot and what's not in stock sector investing. Remember, you can get a list of ETFs by entering "ETF" in our company name search box on the website main page, then use your browser to search for a string. For example, to search for an ETF which tracks the NYSE Composite, enter "ETF" and get a list of all ETFs in our database, then use your browser's Find function to look for "NYSE". You'll find that the ETF with ticker symbol NYC is an iShares ETF for the NYSE 100 Index Fund and NY is the ticker for the iShares ETF for the NYSE Composite Index Fund.

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posted by Bob Carver  # 10:50 PM

Everyone expected the Fed to hike short term rates this time, so the only question was how to interpret the statement accompanying the release. Honestly, there was no information that hadn't been foreseen, but the market reacted by gyrating wildly for a few minutes, then settled about even with where it began the day.

Recent action in the market has been constructive, but probably doesn't represent a real change in trend. That means the correction is likely to continue. Still, the number of bullishly-diverging sectors is impressive and leads us to think that the coming second leg up (the first leg up was March 2003-January 2004) may be quite spectacular once it gets started.

But, there is likely to be one sector which is conspicuously absent from the party: utilities. This sector has been a big gainer since the lows, up 120% since October 2002. But, the bearish divergence which is evident on its volume oscillator can mean only one thing: a major bear market in utilities is beginning now.

In a typical market progression, the Utilities will top first, then, about a month or so later, the bond market. Finally, the rest of the stock market will top about 9 months later. These intervals are not exact, of course, and the typical sequence is caused by the Fed hiking interest rates too high. It isn't certain that the Fed will continue hiking rates for the next 9 months, or even for the next two, for that matter, so this cycle could conceivably see a longer rise in the stock market ahead. We'll have a good idea of exactly when the top will come by watching the interest rate spread relationships we talked about yesterday.

As far as the beginning of month rally is concerned, it's probably over now and the market is likely to be working lower into the 9-month cycle low from here.

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posted by Bob Carver  # 10:03 PM

Recent weakness in the stock market suggests that a potential recession may be on the way. That certainly seems to be the interpretation that a falling stock market and a rising bond market would imply, but are the markets reading the tea leaves correctly?

We suspect the recession is coming, but it may be considerably further in the future than many think it is. Evidence for this comes from the relationship between long term interest rates and short term interest rates. Normally, long term rates stay above short term rates due to the potential for inflation to exact a higher toll over the longer term. But, when long term rates dip under shorter term rates, a condition known as an "inverted yield curve", a recession is usually at hand. The following chart which compares the 10-year Treasury note rate with the 5-year rate shows how that relationship has coincided with the onset of recessions over the past five decades:

As you can see, the spread has been plummeting in recent months from the very high levels reached after the Fed goosed the economy to get it moving in the last recession. But, observe that the spread is still fairly high on a historical basis. In fact, the spread was lower during most of the 'Nineties. So, we can't really say that this indicator is telling us a recession is imminent.

This is an indicator the Fed keeps an eye on. It is strongly suggesting that they may very well be coming to the end of their "measured rate hikes" for the time being. One or two more may be in the pipeline just to keep inflation at bay, but the falling rate spread is a yellow caution flag that the Fed is likely to take to heart.

The bottom line is that this economic expansion has to be given the benefit of the doubt until clear signs of a recession, including an inverted yield curve, are present. The long term T of Terry Laundry's still appears to be on track for a rising stock market for at least the next year, if not two years:

Among our many thousands of charts on the website, you will find daily updated spreads charts for both bonds and interest rates, as well as many futures spreads as well. Spreads offer excellent profit opportunities along with lower volatility (and much lower margin requirements) than most other investments. These spreads can be found on our Daily Spreads Charts page available to subscribers only.

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posted by Bob Carver  # 7:57 PM