Financial Markets Forecast and Analysis

By: Robert McHugh | Sat, Feb 21, 2004
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Summary of Index Daily Closings for Week Ending February 20, 2004

Date DJIA Transports S&P NASDAQ Mar 30 Yr Treas
Feb 16 M A R K E T S   C L O S E D   P R E S I D E N T'S   D A Y
Feb 17 10714.88 2920.74 1156.98 2080.35 112^24
Feb 18 10671.99 2901.08 1151.81 2076.40 112^26
Feb 19 10753.60 2892.50 1147.06 2045.96 112^29
Feb 20 10619.03 2892.18 1144.11 2037.93 112^08


(Next Two Weeks)
Substantial Rise Low      
Market Rise Medium   Very High   80%
Sideways Medium   High   60%
Market Decline High   Medium   40%
Substantial Decline Medium   Low   20%
      Very Low Under   20%
(Next 12 Weeks)
TREND PROBABILITY   Substantial   800 points+ (DJIA)
Substantial Rise Low   Market Move   200 to 800 points (DJIA)
Market Rise Medium   Sideways   Up or Down 200 (DJIA)
Sideways Medium      
Market Decline High      
Substantial Decline High      

This week the Dow Jones Industrial Average fell 8.82 points, closing at 10,619.03. It was a key reversal week, which is Bearish, as it reached a new high for the rally, then closed down. Last week's Short-term Technical Indicator Index reading of negative (68.25) suggested that any rally would be reversed since we should expect a fall. This index has a two week horizon so we could see more decline next week. Inside this key reversal week, Thursday was a key reversal day, hitting a new high for this March 2003 rally of 10,753 before closing down for the day. It was also a "distribution" day where stocks declined on increasing volume. Distribution is the process where sophisticated investors sell into the ready hands of amateurs.

This rally is clearly running out of steam. With each new high in the S&P 500 and Dow Industrials, the number of stocks hitting new highs declines. Downside volume is on the rise. There may be one more push higher in these two averages, but if so, a sharp reversal like we saw this week is likely.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
Oct 17, 2003 (17.25) (35.83)   Scale
Oct 24, 2003 (27.63) (43.96)    
Oct 31, 2003 (21.38) (55.42)   (100) to +100
Nov 7, 2003 0.50 (53.47)    
Nov 14, 2003 (42.75) (52.33)   Negative  (Bearish)
Nov 21, 2003 0.38 (51.90)   Positive  (Bullish)
Dec 5, 2003 (31.75) (55.18)    
Dec 12, 2003 (5.83) (54.43)    
Dec 19, 2003 (6.50) (47.03)    
Jan 2, 2004 (48.17) (40.33)    
Jan 9, 2004 (96.50) (39.28)    
Jan 16, 2004 (20.00) (40.65)    
Jan 23, 2004 (8.13) (32.15)    
Jan 30, 2004 2.81 (25.98)    
Feb 6, 2004 11.75 (20.19)    
Feb 13, 2004 (68.25) (22.19)    
Feb 20, 2004 (30.00) (22.36)    

The Short-term and Intermediate-term Technical Indicator Indexes™ measure the relative weighted average of the technical indicators that, in this analyst's view, have the most reliable predictive value. Most technical analysis services hone in on one or two specific indicators. The TIIs are baskets of reliable indicators that are scored bullish to bearish, the more correlative assigned heavier weightings. The scale is rather simple, running from positive 100 (extreme bullishness) to negative 100 (extreme bearishness). TIIs are early warning signals of the equity markets' next moves.

This week the Short-term Technical Indicator Index comes in at negative (30.00), meaning we can expect the equity market to move down next week. This indicator is a useful predictor of equity market moves over the next two weeks, both as to direction and strength of move. For example, readings near zero indicate narrow sideways moves are probable. Readings closer to +/- 100 indicate with a higher degree of confidence that an impulsive move up or down is likely over the short run.

The Intermediate-term Technical Indicator Index is useful for monitoring what's over the horizon - over the next twelve weeks. It serves as an early warning system for unforeseen trend changes of considerable magnitude. This week the Intermediate-term TII comes in at negative (22.36), warning that a significant reversal remains at risk over the next three months. Massive increases in M-3 could mitigate the damage or the timing.

The next chart attempts to identify a high probability time for a major trend change. Markets generally move where technical analysis suggests, but determining when can be most problematic. For answers to when, one tool we can use is to turn to Fibonacci numbers and ratios. Leonardo Fibonacci was a 13th century Italian mathematician who observed that a preponderance of the physics that God set up in the laws of nature are in terms of what we now call Fibonacci numbers and ratios.

Fibonacci numbers are 1, 1, 2, 3, 5, 8, 13, 21, 34, etc... where the next sequential number is the sum of the immediate prior two numbers. Thus for example, 34 is the sum of 13 and 21. Further, the ratio of the preceding number to the next sequential number is always 61.8%, and is referred to as phi, while the number that is two sequences back is always 38.2% of that same number. For example, 13 is 38.2% of 34 and 21 is 61.8% of 34. The ratio 38.2% to 61.8% is known as the "golden ratio." Fibonacci numbers and ratios appear all over nature. For example, if we examine the human body we find five fingers, two legs, five extremities (including the head); the ratio of the belly button to the top of the head is 38.2% of a person's total height, etc... If we were to graph Fibonacci numbers in circle format, we would end up with spirals that resemble galaxies, hurricanes, sunflower patterns, pine cone patterns, etc... So there is real scientific basis behind applying Fibonacci numbers and ratios to the markets.

The above chart demonstrates that if the S&P 500 forms a top around 2/21/2004, the price action of the average would have formed a perfect Fibonacci golden ratio rectangle beginning at the top when the Bear market began on March 24, 2000. Further, if we examine each section of this golden ratio rectangle, we discover that they further subdivide into fractal golden ratio rectangles at significant lows. The low on 10/18/2000 in the subdivided left section interestingly occurs not only 38.2% of the time from the high at March 24th 2000 to the low at September 21st 2001, but is nearly 38.2 percent of the price move down from 3/24/2000 to 9/21/2001, the post 9/11 lows. The point is, key turn dates, key price trend reversals often occur at Fibonacci ratio points, and we've got one coming up now.

As interesting as these time analyses are, and as much as they raise probabilities for identifying turn dates, we must keep in mind that there are always other Fibonacci ratios coming along that might also fit with future dates, so don't go betting the house. That said, this one is particularly strong and worthy of defensive consideration.

For an in-depth study of how Fibonacci numbers appear in the physics of our universe and in the markets in the past, I recommend the book The Wave Principle of Human Social Behavior and the New Science of Socioeconomics, by Robert R. Prechter, Jr., New Castles Library, 2002.

The very interesting convergence of two simultaneous 50 percent retracements in the S&P 500 continues on track. The above chart was presented last week and is worth examining again. It shows the decline from March 24, 2000 to October 10, 2002 - call that move the 1.00 base move. Since then, the S&P has essentially retraced 50 percent of the decline in terms of price and time. Exact 50% retracements will be fulfilled if the Market reverses to the downside around February 20, 2004 +/- after hitting 1160. It essentially hit 1160 on February 11, 2004 by reaching1158.89. Quite often trend reversals occur on such patterned Fibonacci retracements. The fact that we are about to witness a two dimensional fractal (a miniature exact replica of a larger pattern) lends weight to the retracements' significance. Since now is the moment of reckoning, we soon should know. There are several other time identifiers for a trend turn that are pointing toward the end of next week, so if we get past February 20th and the market has a bit more rally left in it, this convergence can still essentially end up being accurate. Keep in mind, there are no guarantees. Identifying when is one of the hardest and least reliable exercises - and is often more obvious after the fact.

Last week it was reported that the University of Michigan measure of Consumer Confidence plunged. This week we saw a similar decline in the ABC/Money measure of Consumer Confidence. What does this mean?

The above chart shows a high degree of direct correlation between the Dow Jones Industrial Average and the Michigan Consumer Confidence Index. These two averages seem to work like the Dow Industrials and the Dow Transports - price action should be contemporaneous and confirming. Two divergences are noted over the past seven years. The first, in late 2000 into early 2001 occurred where the Confidence Index plunged nearly 20 percent five months before the DJIA followed. Going back to 1987, there were no other bearish convergences of note. We are currently sitting on another bearish divergence thanks to February 2004's ten percent plunge. Is this an anomaly? Or, is this a forewarning of an imminent 10 percent equity market correction? The timing of this divergence is fascinating given the myriad other time and price Bearish convergences/divergences occurring now within other indicators.

The Dow Theory Bearish Divergence between the price action of the Industrials and the Transports remains in full force. This is a particularly strong divergence. To eliminate this red flag, the Transports would have to rally 188 points, nearly 6.1 percent, and surpass its former high of 3080 before the Industrials and Transports both decline below 10,417 and 2815 respectively. The race is on. Either the Dow Transports are going to rally like mad (not looking very good) or the Dow Industrials (and the rest of the equity market) is about to take a dive. Take your pick. This divergence is telling us that there is something terribly wrong with the equity markets. Dow Jones Industrial Average Vs: The University of Michigan Consumer Confidence Index

The Economy:

Leading Indicators rose a healthy 0.5 percent in January 2004 according to The Conference Board, a private research group, following an up month in December. Stock gains in January were a key contributor as was the large rise in January's Consumer Confidence figure which we've already noted plunged in February. So take this number with a grain of salt. In looking at the stock market's performance since this number was released Thursday, apparently the equity market has.

The Consumer Price Index popped up in January, rising 0.5 percent after rising 0.2 percent in December, according to the Labor Department. If you pull out food and energy, the CPI still rose, up 0.2 percent in January. Energy price increases shouldn't be ignored. Take a look at crude oil. Take a look at the fuel-dependent Transportation stocks. This is a hidden tax on every American and could serve to dampen consumer spending, which represents 70 percent of GDP.

Housing Starts took a dive, down 7.9 percent in January, according to the Commerce Department. Building Permits also fell, down 2.8 percent. This may be an anomaly, as December's Housing Starts had set an all-time record. Low interest rates and growth in M-3 should keep this sector roaring. If it doesn't, if January is the start of a trend, then this economy is in worse shape than most realize.

Jobless Claims were reported at 344,000 for the week ended February 14th by the Labor Department. Last week's figure was, of course, adjusted up to 368,000. Continued Claims, those who have been out of work for more than a week, rose to a reported 3.19 million for the week ended February 7th, up slightly over 100,000 good folks. What is the reaction of our financial leaders? Well, one this week, St. Louis Federal Reserve President William Poole, was quoted by on Friday February 20th to have said in commenting on the massive shift in U.S. jobs overseas, "You have to regard this process in the sweep of U.S. history as desirable because we are all better off . . . It is not a process we should want to block or stop." Willie has a job, a good one at that, as a member of the Fed's powerful Open Market Operations Committee (they set interest rates). Where is his job located? Oh, we already established that, in St. Louis, MO., in the good ole USA.

With an attitude toward job losses like this, is it any wonder we learned on Tuesday that a second poll of Consumer Confidence, the ABC News and Money Magazine Consumer Comfort Index, plunged seven points, matching the sharpest decline in 18 years? When were those other similar declines? January 2001 and February 1990, two very weak economic periods.

Money Supply, The Dollar, & Gold:

M-3 rose substantially in the latest week, February 9th, up $14.5 billion, about an 8.5 percent annualized clip. Over the past two months, M-3 has exploded 128.7 billion, also at an 8.5 annualized growth rate. However, if you look at M-3 growth since August, we find that M-3 has plateaued. A correlation chart between M-3 growth and the DJIA was presented in September 26th's issue of this newsletter (available in the archive section at That analysis pointed out that whenever M-3 either declines or plateaus, equities decline. Obviously the master planners know this, which may be why we see interest rates at 46 year lows and M-3 growing gangbusters again in the face of a rip-roaring??? recovery. M-3 growth can mitigate equity market damage.

The Dollar will decline if M-3 continues to grow at this pace. Gold should rise as M-3 rises. With all this monetary inflation, everything should rise in price. However, with jobs in a structural crisis, incomes cannot rise. With interest rates low, income on savings and pensions (the elderly) cannot rise. Housing is going up but unless you own two properties, you aren't increasing earnings with that. You can borrow equity out, but if you sell, you'll have to transfer gains into the basis of another high priced home. The point is, it is very difficult to make money right now and that is the telltale signature of a Bear market. About all we are accomplishing in this recovery effort is to build debt. The reason for this policy? Because we were/are so close to the deflation precipice that it is mandatory to inflate our way out. But by inflating, by replacing income with debt as a means to acquire products, services and investments, we risk long-term economic instability. Remember, even the earnings improvements we see in corporate America are inflation assisted, thanks to a declining dollar.

Bonds and Interest rates:

Interest Rates must remain low. It is the plan of the masters. Period. Non-negotiable. Bonds should crumble under the shadows of the twin mega-deficits but they don't. Japan and other Asian nations are buying on our behalf. It's the deal. We export jobs overseas. They manufacture products and provide services that we pay for with printing-press dollars. They take these dollars and exchange them for U.S. government IOUs, i.e.. Bonds. The happy result: Bond prices are supported, long-term interest rates remain low, housing inflates, everyone borrows newfound equity out of their real estate to replace lost income from the exportation of jobs, consumers spend with borrowed money, and the world turns round and round. This is why William Poole says job exportation is good. Because if we stop the carousel and pull back those jobs, our friends overseas will stop buying our bonds and interest rates will rise and, well, all damnation will break loose . . . for example, an administration change.

Bottom Line:

Equity markets have reached several trend reversal turning dates, however with M-3 on the rapid rise, the probability of these turn dates being accurate for forecasting a resumption of the Bear market in equities is reduced . . . but still there. The Transportation Average divergence with the Dow Industrials is a major red flag. Equity markets know about M-3, yet still the divergence - a serious Dow Theory problem - continues in earnest. Neither the US Dollar nor Gold behaved as they should have given all the recently reported M-3 growth. Is something wrong with the M-3 number? If so, if M-3 is really not rising as we think, then equities are in a lot of trouble as the only safety net supporting this market may not really be there. Be very cautious here.

"For the life of the flesh is in the blood,
and I have given it to you on the altar to make atonement for your soul;
for it is the blood by reason of the life that makes atonement."
Leviticus 17:11

"In Him we have redemption through His blood,
the forgiveness of our trespasses, according to the riches
of His grace which He lavished upon us."

Ephesians 1:7,8

Key Economic Statistics
Date VIX Mar. U.S. $ Euro CRB Gold Silver Crude Oil 1 Week Avg.
9/26/03 22.21 94.25 114.45 240.50 380.8 5.14 28.16 8952.9 b
10/03/03 19.71 93.53 115.40 242.55 369.4 4.83 30.10 8950.4 b
10/10/03 18.51 91.79 117.85 246.75 374.1 4.90 31.99 8915.4 b
10/17/03 17.62 92.61 116.33 242.00 372.2 4.94 30.70 8903.5 b
10/24/03 17.70 91.46 118.04 249.50 389.2 5.16 30.16 8892.7 b
10/31/03 16.00 92.98 115.57 247.00 384.6 5.06 29.11 8876.5 b
11/07/03 16.84 93.20 115.11 249.75 383.4 5.05 30.85 8876.8 b
11/14/03 17.33 91.58 117.60 256.25 398.0 5.41 32.37 8860.6 b
11/21/03 18.98 90.72 119.09 250.50 396.0 5.29 31.61 8851.4 b
11/28/03 16.32 90.28 119.65 253.25 398.0 5.39 29.96 8850.0 b
12/05/03 17.23 89.17 121.60 256.00 407.3 5.49 30.73 8837.1 b
12/12/03 16.46 88.44 122.74 261.75 410.1 5.64 33.04 8838.4 b
12/19/03 15.71 88.53 123.58 259.50 409.9 5.72 33.02 8826.2 b
1/02/04 18.30 86.93 125.76 256.75 416.1 5.96 32.52 8832.6 b
1/09/04 16.79 85.40 128.19 266.50 426.8 6.49 34.31 8868.9 b
1/16/04 14.98 88.05 123.57 265.50 407.0 6.33 34.00 8896.9 b
1/23/04 14.88 88.81 125.81 266.50 408.0 6.36 34.94 8914.5 b
1/30/04 16.46 87.48 124.42 262.10 402.9 6.25 33.05 8948.9 b
2/06/04 16.00 86.15 126.83 260.50 403.6 6.27 32.43 8940.5 b
2/13/04 15.62 85.68 127.25 264.85 410.8 6.58 34.56 8954.9 b
2/20/04 16.05 87.40 126.96 264.50 397.5 6.53 34.25 -

Note: The VIX is showing some nervousness, the Dollar is up, Gold took a dive and Crude hit a new post Iraq War high on Thursday, Feb 19th, then backed off. If M-3 doesn't rise further, if deflation hits (cash becomes king), look for a flight to dollars (boosting its value) and a decline in Gold.

The Passion of The Christ is coming to theaters on February 25, 2004
Go to for more information


Robert McHugh

Author: Robert McHugh

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

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