Financial Markets Forecast and Analysis

By: Robert McHugh | Sun, Mar 14, 2004
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Summary of Index Daily Closings for Week Ending Mar 12, 2004

Date DJIA Transports S&P NASDAQ Jun 30 Yr Treas
Mar 8 10529.48 2868.65 1147.20 2008.78 114^05
Mar 9 10456.96 2834.30 1140.57 1995.16 115^13
Mar 10 10296.89 2788.48 1123.90 1964.15 115^09
Mar 11 10128.30 2796.00 1106.77 1943.89 115^06
Mar 12 10240.08 2863.09 1120.60 1984.71 114^30


(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 we saw confirmation of the major trend reversal we've been expecting in equities, the end of the year long Bear market rally, almost exactly to the day. Last year's rally started on March 11th and this year's reversal was confirmed on March 10th. The Dow Jones Industrial Average finished down 355.47 points for the week, closing at 10,240.08. Having hit an intraday high of 10,753 on February 19th, 2004, the market did a slow turn for three weeks then dove headfirst this week into Bear market country. While this week's sell off was impressive, the move down from February 19th is barely 5 percent. The point is, we have a long way further lower to go. As always the question is when.

Tuesday, Wednesday and Thursday were "distribution" days, where the pros sold equities to the amateurs, evidenced by declining prices on increasing volume. Wednesday and Thursday were " distribution" days on the big board, the NYSE dropping on rising volume. Several highly reliable intermediate trend sell signals were triggered this week, meaning that even if we see a bounce off this week's oversold levels, the bounce should not reach new highs, and should be relatively short lived.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
Nov 7, 2003 0.50 (53.47)   Scale
Nov 14, 2003 (42.75) (52.33)    
Nov 21, 2003 0.38 (51.90)   (100) to +100
Dec 5, 2003 (31.75) (55.18)    
Dec 12, 2003 (5.83) (54.43)   Negative  (Bearish)
Dec 19, 2003 (6.50) (47.03)   Positive  (Bullish)
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)    
Feb 27, 2004 (31.00) (20.17)    
Mar 5, 2004 16.00 (17.17)    
Mar 12, 2004 ( 9.00) (14.70)    

The past two week's Short-term Technical Indicator Indexes appear to have been looking out two weeks, rather than one. As mentioned in past newsletters, this indicator has a time horizon of approximately two weeks, and is a useful predictor of the direction of the equity market's next move, and to a lesser extent, the market's strength of move. Readings near zero indicate narrow sideways moves are probable. Readings closer to +/- 100 indicate with a higher degree of confidence that an impulse move up or down is likely over the short run. This week's Short-term TII reading comes in at negative (9.00), meaning that any near-term bounce should be short-lived and meet resistance at 10,360 (38.2% retrace of the move down so far) or at 10,511 (61.8% retrace of the move down so far) before turning down over the next week or two.

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 indicator has been warning of the current trend change for weeks. Many analysts have been writing that we are in a new Bull market and that the Bear ran its course on March 11th, 2003. Not true and this Intermediate TII has been sending this message all throughout this past year's rally. This week's Intermediate TII comes in at a negative (14.70), warning that the decline is not over and, far from it, has a long way to go. Rising M-3 is softening this indicator.

Let's take a look at how the technical landscape deteriorated dramatically this week. Last week's newsletter (available in the archives at explored the "what if" that prices break below their 50 day moving average. What we noted was, if the break out up or down was significant, more than 2.0 percent, then the probabilities were very high that a new trend was underway. The next chart shows that this in fact occurred on Wednesday, March 10th, 2004 and followed through more significantly again the next day. The Dow Industrials now find themselves 3.3 percent below their 50 day moving average, which portends further downside. The question we want to explore this week is, what is the likelihood that, given this break down below the 50 day MA, prices are headed below their 200 day moving average?

The answer is, the probability is quite high that prices are headed below their 200 day moving average. The above chart shows that in nearly every instance over the past five years, a 2.0 percent move below the 50 day means a move below the 200 day . . . and then some. This is useful in helping us determine reasonable downside targets. Currently the 200 day moving average is about 9,750 in the DJIA, thus there should be at least another 500 points left in this decline . . . at least. Note from the chart that it usually didn't take long, a few weeks at most, for prices to hit their 200 day MA once they blew significantly (more than 2.0 percent) through their 50 day MA. Also take note, and this is sobering for our forecast, that prices often moved significantly beyond their 200 day MA targets - they usually didn't stop there.

The price action of the Dow Transportation Average is a terrific leading indicator for price action in the Dow Jones Industrial Average and vice versa. Invariably, when one index moves in a direction, the other will also - eventually. This is why non-confirmations are so significant under Dow Theory. Because it means one index is taking the lead away from the other. They are like a pair of Siamese twins. Each may take turns leading their direction, but either way they have to stay together.

The next chart shows that the Trannies blew below their 50 day MA sooner than the Industrials did, but the Industrial have since followed. Now we see that the Trannies are just about at their 200 day moving average. Good bet the Industrials will hit their 200 day MA pretty soon too. The past few days, the 200 day MA is acting as support for the Trannies, but that shouldn't last too long, a week or two or three, tops.

But there is something else here in this Transportation Average chart that is disturbing. Notice that nearly every time prices blew through both their 50 Day and their 200 Day Moving Averages over the past five years, prices continued on for significant further moves in the same trend, whether that trend was up or down. What we're saying here is, if the Trannies move below their 200 day MA significantly, by 2.0 percent or so, this average's prices are headed significantly lower for a while, and you can book it the DJIA and most of the rest of the equity market will follow. Equity markets are merely a couple of bad sessions away from this ominous "sell" signal (or maybe we should call it a "bail out" signal).

The next two charts show that on Wednesday, March 10th, 2004 the concurrent price action of the Dow Transports and the Dow Industrials triggered an alarming Dow Theory "Sell" Signal of intermediate degree (meaning stocks are going down for a while). The trend has changed. This signal is quite rare and highly reliable. I urge you to read Richard Russell's daily remarks for a more in-depth analysis of what a Dow Theory sell signal means ( He is perhaps the best Dow Theory analyst on the planet and now may be a very good time to plug in to his thoughts.

In short, what has happened is that the Dow Industrials and the Transports reached new rally highs in late January 2004. Then they both hit lows on February 4th, followed by another new high in the Industrials that was not confirmed by the Trannies. Instead of reaching another new high, the Trannies began sinking lower, diverging from the Industrials. Before the Trannies could confirm the Industrials new high, both averages declined to new closing lows this week, a day apart. A sell signal.

Another sell signal is a clear break down below the bottom line of the rising trend channel since March 11th, 2003. It's been an impressive rally, but it failed at an exact Fibonacci 78.6 percent price retracement of the January 2000 to October 2002 Bear Market first leg decline, topping at 10,753 intraday on February 11th in the Dow Industrials, and topping on a closing basis on February 19th, 2004 at 10,737, the exact date (minus 1 trading day) of the Fibonacci golden rectangle demonstrated in a chart in this newsletter, issue # 35 (refer to archives on It continues to amaze me how Fibonacci ratios appear so often in nature and the markets. For an in-depth study of Fibonacci numbers and the markets, I recommend Robert R. Prechter, Jr.'s The Wave Principle of Human Social Behavior and the New Science of Socionomics (

The rally from March 2003 through March 2004 completed an Elliott wave 2 "up" countertrend rally, a Bear market rally, and we now find ourselves in the infant stages of a wave 3 of 5 "down" trend in the Bear market. Wave 3's are usually the most devastating, the swiftest, longest, and most powerful. While not a guarantee by any means, it is very possible we could see the first leg of this wave 3 down take the Dow Industrials to their 200 Day MA support around 9750, to be followed by a bounce to maybe a Fibonacci 38.2 percent or 61.8 percent retrace of the decline to the 200 Day Moving Average decline, to be followed by a sharp and powerful break below the 200 Day MA and the return of the Bear in earnest. It is just one scenario, but is based upon likely key support and resistance targets. One warning. Bear markets, especially Bear markets at the Elliott Wave 3 stage, do not have to show any respect for downside support targets. Prices can dive in near panic mode at any time. We saw a glimpse of this this week on Thursday. There are three index averages which appear to be wrapping up Bearish head and shoulders patterns - the Transports, the NASDAQ 100, and the Semiconductors. These patterns - once completed - are highly reliable with definitive minimum downside price targets of high probability.

February 27th's issue of this newsletter displayed a chart comparing the Michigan Consumer Confidence Index with the Dow Jones Industrial Average. That chart showed there is a remarkable direct correlation between the two and indicated that the DJIA would have to fall into the 9700 area for this correlation to continue. Today's preliminary release of the Michigan sentiment indicator reinforces this forecast.

The Economy:

The University of Michigan's Consumer Confidence preliminary March 2004 reading came in down from February to 94.1. The ABC News/Money magazine measure of Consumer Confidence fell 2 points to a minus (-)18 for the week ended March 7, 2004. It will be interesting to see these readings after this week's equity sell off is digested.

Retail Sales rose 0.6 percent in February according to the Commerce Department. But if you pull out auto sales, retail sales rose zero percent. The Commerce Department also reported that Business Inventories rose 0.1 in January after rising 0.3 percent in December. Does that mean business is up? Or does it mean business is down? If you don't sell a product, it sits in inventory. Or, if you feel sales will increase, you build up inventories in anticipation.

Meanwhile, let's look at the deficit figures. First the Trade Gap. It widened to 43.1 billion in January, setting an all-time record. The Current Account Deficit came in at an all-time high of $541.8 billion for 2003. And this during a period of time when the U.S. dollar plunged, making our goods and services relatively cheaper to the rest of the world? Oh boy. Can you imagine what will happen to the trade deficit if the dollar strengthens? The Federal Budget Deficit rose to 96.7 billion in February - that's a one month figure believe it or not - and rose to $226.8 billion for the first five months of the government's fiscal year. It's up 17 percent year over year.

Jobless Claims came in about where they have for the past several weeks, at 341,000 according to the Labor Department. This is John Kerry's ticket to the Presidency. Dubya's "who cares" dividend exclusion hasn't done much for jobs, but Helen Walton, the 84 year old widow of Wal-Mart founder Sam Walton is certainly happy with the tax break. She reportedly earned over $800 million in Wal-Mart dividends last year.

Money Supply, The Dollar, & Gold:

M-3 rose another 10.0 billion for the latest week reported, March 1st, and is now up 139.7 billion since the beginning of December. The fact that equities are breaking down in the face of all this M-3 growth, the fact that Bonds are rallying in the face of all this money growth, the fact that Gold and the trade weighted U.S. Dollar are rising together, well this spells d e f l a t i o n. We may not see it yet, but obviously the markets do. Markets are discounting mechanisms, the sum of all everyone everywhere knows. The markets are currently telling us we are on the deflation precipice. The Fed apparently agrees since they insist upon keeping interest rates, both long and short, low in spite of rosy economic figures, record-setting bullish sentiment, recovery rhetoric, and massive stimulus - both monetary and fiscal (huge tax cuts and record deficit spending).

In deflation, cash reigns. In deflation, Gold will be perceived as a monetary equivalent (it's been money for thousands of years), not just a commodity. In deflation, dollars will be in demand. Ergo, the Fed prints and prints. They have no other choice, really.

Bonds & Interest Rates:

Bonds rallied this week as equities fell, this in the face of rising trade and federal budget deficits. Foreigners sell more and more goods to us in exchange for dollars we create out of thin air and they then exchange those dollars for Treasury bills, notes, and bonds, guaranteed IOUs from our government. The risk to us is we become more dependent upon foreigners to maintain a stable long-term interest rate environment. Still, we have been assured, the Fed will buy long bonds if they have to to keep long rates stable . . . and low. With interest rates already at 46 year lows, it will be interesting to see how the Fed is going to stimulate our economy should equities decline sharply and another recession " officially" commences, since we're not that far from zero percent interest rates.

Bottom Line:

As of Friday March 12th's close, all the major averages were down year-to-date except the S&P 500, which was down year-to-date on Thursday before Friday's mini-corrective bounce. Bonds are up huge since year end, up almost six, count 'em, six full points in eleven weeks. The stock market is a reliable leading indicator of future economic activity. Both equities and bonds are telling us there is an economic setback coming. The technicals broke down big-time this week, telling us a major equity decline is in the offing. However, the Fed is aggressively growing the money supply and that has proven in the past to mitigate equity market damage. Still, it appears in spite of huge M-3 growth, equities are breaking down anyway. That may mean the Fed is losing its grip on this next leg of the Bear market which promises to be a doozy. Extreme caution is warranted.

"My God, My God, why hast Thou forsaken Me?
All who see Me sneer at Me; they wag the head, saying let Him deliver Him;
I Am poured out like water, and all My bones are out of joint;
My tongue cleaves to My jaws.
A band of evildoers has encompassed Me;
They pierced My hands and My feet.
I can count all My bones. They look, they stare at Me;
They divide My garments among them, and for My clothing they cast lots."

Psalm 22, 1,7,14-18

Key Economic Statistics
Date VIX Mar. U.S. $ Euro CRB Gold Silver Crude Oil 1 Week Avg.
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 8807.8 b
12/12/03 16.46 88.44 122.74 261.75 410.1 5.64 33.04 8812.9 b
12/19/03 15.71 88.53 123.58 259.50 409.9 5.72 33.02 8804.3 b
1/02/04 18.30 86.93 125.76 256.75 416.1 5.96 32.52 8816.2 b
1/09/04 16.79 85.40 128.19 266.50 426.8 6.49 34.31 8824.6 b
1/16/04 14.98 88.05 123.57 265.50 407.0 6.33 34.00 8845.6 b
1/23/04 14.88 88.81 125.81 266.50 408.0 6.36 34.94 8860.6 b
1/30/04 16.46 87.48 124.42 262.10 402.9 6.25 33.05 8891.4 b
2/06/04 16.00 86.15 126.83 260.50 403.6 6.27 32.43 8881.0 b
2/13/04 15.62 85.68 127.25 264.85 410.8 6.58 34.56 8890.8 b
2/20/04 16.05 87.40 126.96 264.50 397.5 6.53 34.25 8928.0 b
2/27/04 14.53 87.89 124.52 273.90 396.8 6.71 36.16 8942.6 b
3/05/04 14.52 88.75 123.28 274.00 401.6 6.99 37.26 8952.6 b
3/12/04 18.21 89.60 121.80 272.00 395.6 7.06 36.19 -

Note: The VIX is up , the Dollar is up, and Silver hit a new high

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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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