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August 04, 2007

Technical Market Report
by Mike Burk

The good news is:
• The current shakeout is a cycle event that, when it is complete, will enable the market to return to more typical patterns.

Short Term

In 1959 Joseph Granville laid out the parameters for a trading system that was popularized by Dick Fabian in the 1980's and to this day is promoted by Doug Fabian.

The original parameters were: buy when the Dow Jones Industrial Average (DJIA) crossed from below to above its simple 200 day moving average (SMA) and sell when it crossed from above to below its 200 day SMA.

As of Friday's close the DJIA was still above its 200 day SMA, however the S&P 500 (SPX) closed below its 200 day SMA for the first time since August 2006. The SPX implementation of the system is more widely followed so there may be a lot of selling on Monday.

Other than being very oversold there are no indications of a bottom.

Intermediate term

In 1978 new highs and new lows began being calculated on a trailing 52 week basis. Prior to then they were calculated from the first of the year to the middle of March of the following year then the period of calculation changed back to the first of the current year. That is in early March new highs and new lows were calculated from the first of the previous year. In late March they were calculated from the first of the current year. In the middle of March the calculation period changed from 14.5 months to 2.5 months. This makes new high and new low data prior to 1978 difficult to work with.

By looking at the number of new lows we can identify cycles of various lengths and magnitudes and the most prominent of these is the 4 year Presidential Cycle. The Presidential Cycle usually bottoms late in year 2 of the President's term. I have written a report on the Presidential Cycle that you can read at: http://alphaim.net/research/Pres_Cycle/index.html.

We can develop some expectations about how the bottom is likely to unfold by number of new lows generated at or near the low in the averages. A high number of new lows (greater than 250) at a price low implies a high likelihood of a retest of the previous low (a "W" bottom rather than a "V" bottom).

I use a 10% trend (19 day EMA) of new lows plotted on an inverted Y axis (up is good) as a new low indicator. The current value of that indicator (calculated from NYSE data) is 273 so we are well into the value range where a retest should be expected.

The charts below overlap covering 5 year periods showing every Presidential Cycle since 1978. There are 3 charts for each period, the first covers the past 5 years showing the SPX in blue and the new low indicator calculated from NYSE data (NY NL) in black. The second shows the NASDAQ composite (OTC) in orange and the new low indicator calculated from NASDAQ data in black. The third shows the Russell 2000 (R2K) in magenta, OTC in orange and the SPX in blue plotted on semi log scales so you can see the relative performance of the various market segments over the period. Dashed vertical red lines have been drawn on the 1st trading day of each year. The legend in the log chart shows the maximum draw down (MDD) for each index during the period covered by the chart and the compounded annual return (CAR) for the index over the period.

New lows have reached high levels very near a high in prices.

Small caps have been leading the way up.

1998 - 2003
Late 1999 was unusual because prices rose while new lows were increasing.

The late 1999 new low picture was not quite as distorted on the NASDAQ.

1994 - 1999
There was a late July low in 1998 that was retested in October.

1990 - 1995
In 1990 there were 2 retests of the low.

1986 - 1991
The October 19, 1987 crash low was retested on December 5, 1987.

1983 - 1988

1987 was the last time a Presidential Cycle low was realized in the 3rd year.

Prior to the 1987 crash the blue chips had outperformed the small caps for about 1.5 years, unlike recent behavior.

1978 - 1983

My R2K data does not go back to early 1978 but, in the previous log charts you can see there was very little difference between the R2K and OTC prior to the early 1990's when the OTC became a large cap tech index.

For 5 years beginning in 1978 the small caps had twice the return of the large caps.

Looking for parallels between the current period and other Presidential cycles, 1987 stands out because it was the last time the 4 year Presidential Cycle was extended for a year. However, the conditions leading to the 1987 crash were different. The blue chips had been outperforming for quite a while prior to the 1987 crash while the small caps have been the leaders in recent years. The manic nature of the market recently has been reminiscent of late 1999 and early 2000, but there has not been the prolonged concentration in a single sector like there was in 1999.

The high number of new lows and high value of the new low indicators suggests this bottom will take a little while to develop.

Seasonality

Next week includes the week prior to the 2nd Friday in August during the 3rd year of the Presidential Cycle.

The tables show the daily returns for the week during the 3rd year of the Presidential Cycle. OTC data covers the period from 1963 - 2003 and SPX data from 1955 - 2003. There are summaries for both the 3rd year of the Presidential Cycle and all years combined. Prior to 1953 the market traded 6 days a week so that data has been ignored.

During the 3rd year of the Presidential Cycle the OTC has been up 73% of the time during the coming week, but the SPX only 46% of the time. Average returns during the 3rd year of the Presidential Cycle have been ok, while the average over all years has been modest.

Report for the week before the 2nd Friday of August
The number following the year is the position in the presidential cycle.
Daily returns from Monday to 2nd Friday.

Mutual Fund

Compliance issues demand that I not mention the mutual fund that I manage by name or symbol in this letter.

To see a current chart of the fund go to: http://finance.yahoo.com/q/bc?s=APHAX&t=6m&l=on&z=m&q=l&c=.

For information about the fund go to: http://www.thealphafunds.com/index.htm. The fund now has service class shares available.

Conclusion

People stewing over last weeks losses may take the averages a little lower early next week. We are overdue for a rally to relieve the oversold condition.

I expect the major indices to be higher on Friday August 10 than they were on Friday August 3.

This report is free to anyone who wants it, so please tell your friends. They can sign up at: http://alphaim.net/signup.html. If it is not for you, reply with REMOVE in the subject line.

Last weeks positive forecast based on the expectation of a bounce from an oversold condition was a miss.

Mike Burk

Mike Burk is an employee and principal of Alpha Investment Management (Alpha) a registered investment advisor. Charts and figures presented herein are believed to be reliable but we cannot attest to their accuracy. Recent (last 10-15 yrs.) data has been supplied by CSI (csidata.com), FastTrack (fasttrack.net), Quotes Plus (qp2.com) and the Wall Street Journal (wsj.com). Historical data is from Barron's and ISI price books. The views expressed are provided for information purposes only and should not be construed in any way as investment advice. Furthermore, the opinions expressed may change without notice.

Copyright © 2003-2008 Mike Burk

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