Financial Markets Forecast and Analysis

By: Robert McHugh | Sat, Apr 17, 2004
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Summary of Index Daily Closings for Week Ending Apr 16, 2004

Date DJIA Transports S&P NASDAQ Jun 30 Yr Treas
Apr 12 10515.56 2933.82 1145.23 2065.48 109^24
Apr 13 10381.28 2890.71 1129.42 2030.08 108^17
Apr 14 10377.95 2909.35 1128.17 2024.85 108^03
Apr 15 10397.46 2913.94 1128.84 2002.17 107^25
Apr 16 10451.97 2939.47 1134.57 1995.74 108^08

(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 Very High      

This week the Dow Jones Industrial Average gained 9.96 points, closing at 10,451.97. Tuesday and Wednesday were distribution days in the NYSE, meaning the market went down on increasing volume as stocks moved from strong hands to weak ones. Tuesday and Thursday also were distribution days on NASDAQ. For the first time since August 2003, the number of stocks hitting new lows exceeded those hitting new highs, which occurred both on Wednesday and Thursday. Declines have exceeded advances by wide margins most of the week. While the net price action doesn't show it, the internals have been horrible as of late. The DJIA is struggling to break decisively above its 50 day moving average, around 10445, and has only been able to kiss it a second time - likely a kiss goodbye. There may be a brief rally to work off the deeply oversold condition of the market as evidenced by the McClellan Oscillator, but soon equities should begin to work their way down materially from the tops we saw in February. While the slope of the decline may be gentle at first, at some point look for panic selling to occur. Why? Because this has been the pattern of most Bear Market declines since January 14, 2004. Let's take a look.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
Dec 5, 2003 (31.75) (55.18)   Scale
Dec 12, 2003 (5.83) (54.43)    
Dec 19, 2003 (6.50) (47.03)   (100) to +100
Jan 2, 2004 (48.17) (40.33)    
Jan 9, 2004 (96.50) (39.28)   Negative  (Bearish)
Jan 16, 2004 (20.00) (40.65)   Positive  (Bullish)
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)    
Mar 19, 2004 (12.00) (27.60)    
Mar 26, 2004 73.00 (38.35)    
Apr 2, 2004 (3.00) (35.61)    
Apr 16, 2004 (43.00) (29.90)    

Our April 2, 2004 Short-term Technical Indicator Index reading of minus (-) 3.00 was accurate for the twelfth time in fourteen weeks as the DJIA fell 28 points during the week ended April 8th.

This week the Short-term Technical Indicator Index comes in at negative (43.00), meaning we can expect the equity market to move down over the next two weeks. Look for a small rally early next week to be followed by some healthy selling. This indicator is a useful predictor of equity market moves over the next two weeks, both as to direction and to a lesser extent 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 (29.90), warning that a significant reversal remains at risk over the next three months. Massive increases in M-3 may mitigate the damage or the timing, and recent liquidity buildups have reduced the severity of this reading.

We remain on a Dow Theory "sell signal." Bearish Triple Tops patterns are completing in the S&P 500 ($SPX), the Wilshire 5000 Index ($WLSH), and the Broker/Dealer Index-Amex ($XBD). Bearish Head & Shoulders patterns are completing in the Dow Transportation Average ($TRAN), the Philadelphia Semiconductor Index ($SOX), the NYSE Financial Index ($NYK), and the Retail Holders- Amex (RTH).

We begin the "bad" six months of the year cycle about now, which lasts into mid-October.

There are two key points I'd like to make from the above chart. Since this Bear market began in January of 2000, the near vertical sell offs we've seen have been red-flagged by preceding price action. The pattern has been that once the Dow Industrials fell decisively below their 50 day moving average (more than 1.5 percent), they then made an aborted move to go significantly lower and soon rebounded back up to their 50 day moving average. These "V" moves failed to penetrate decisively above the 50 Day MA, the "kiss of death" so to speak, and were quickly followed by panic selling with prices dropping anywhere from 1000 to 2500 points in a matter of months.

Brace yourself. We currently sit on the 50 Day moving average - our second touch, the completed rebound "V" move - and if we do not break decisively above this 10450 barrier, then expect a plunging equity market over coming months - perhaps a crash.

The second point of this chart is that April 22nd is a minor Fibonacci turn date. It is 1073 days from the top on January 14, 2000 and is 410 days from a minor bottom that occurred on September 5th, 2002. That works out to a perfect phi ratio, .382, with the time from 1/14/00's top to 9/5/02's bottom being 663 days or .618 of 1073. We can't be sure if it is a top or bottom, but my hunch is it will be a minor top as the current oversold condition gets worked off. It may not be much of a rally from a points perspective, but get ready for a turn down around then. Could it be a bottom? Sure. We'll have to let the markets tell us next week.

The next chart is an analysis made known by Wally Hertler. It is a comparison of the S&P 500 with a ratio that divides the S&P 500 (SPX) by the Options Volatility Index (VIX) on the S&P 500. In essence it correlates equity price moves with options writers' confidence.

By charting the two together, we see that there is near-perfect correlation. The SPX/VIX ratio shown in magenta can be interpreted to mean that whenever it rises above 68.00 (right scale), a market top in the S&P 500 is a pretty good bet. Conversely, whenever the SPX/VIX ratio declines below 35.00, we are likely at or near a bottom in the S&P 500. Options writers tend to get complacent (options premiums decline as measured by the VIX) as prices rise, thus increasing this SPX/VIX ratio.

Take note, this ratio as of Friday, April 16th, 2004 is at 75.64, signaling we are at or within a few weeks or months of a major top. In studying prior market tops since 1998 (which catches both Bull and Bear Market action) I'd say this top is very close to being in. Declines are usually sharp and fast, lasting only a few months.

The Economy:

Industrial Production fell 0.2 percent in March according to the Federal Reserve, and capacity utilization also fell (more idle plants), down to 76.5 percent. However, Manufacturing Indexes for March were up, both The Empire State Manufacturing Survey from the New York Fed and the Philadelphia Fed reporting significant jumps, from 25.3 to 36.05, and from 24.2 to 32.5 respectively.

The Commerce Department reported that Retail Sales for March rose a robust 1.8 percent.

We learned last week that the Service Sector "surged" (perma-bull media's term) to 65.8 in March, this according to the Institute for Supply Management. (Pssst . . . Ah-hem. It was 65.7 in January - surge?). Still, a figure above 50.0 indicates growth.

The Consumer Price Index was reported to have risen 0.5 percent in March according to the Labor Department. Core CPI, excluding food and energy, was up 0.4 percent. First quarter 2004's inflation rate was an annualized compounded 5.1 percent. That's starting to get up there if you manage the money supply (hello Federal Reserve). The Labor Department also reported that Import Prices jumped to 0.9 percent for one month, March.

The Commerce Department reported that Housing Starts were up a seasonally adjusted 6.4 percent in March, and that Permits were up as well. Yet New Mortgage Demand fell to a 3 month low and Refinancing Applications fell 31 percent in March, per The Mortgage Bankers Association. I hope all those housings starts aren't on spec, or we might soon hear the "pop" of the real estate bubble.

Apparently the International Monetary Fund folks are unhappy with the U.S. twin deficits, trade and federal budget. They expressed concern about the negative implications for long-term interest rates. The Trade Gap narrowed, we were told by the Commerce Department, coming in at 42.1 billion in February from 43.5 billion in January. That is still a half trillion plus annual pace.

Two weeks ago we were told by the Labor Department that a whopping 308,000 jobs were created in March, up from practically nothing for months on end. Yesterday we were told that Jobless Claims rose to 360,000, up 30,000 from the prior week. Quite an inconsistency. What gives? John Mauldin ( pointed out in his weekly piece that Lacy Hunt, a former Federal Reserve official and now investment advisor at Van Hoisington Management sifted through the data and discovered that 296,000 of the 308,000 reported jobs created were either temporary or part-time jobs! If this subject interests you, read John Mauldin's piece Employment Games and Other Silly Statistics. We're talking landscape laborers, stable attendants, circus laborers, shellfish shuckers, lifeguards, swimming pool servicers, golf range attendants, and camp counselors to give you a flavor for Dubya's great economic jobs recovery machine (see Eduardo Porter's article in the New York Times). There are 4.7 million workers settling for part-time work who seek full-time employ. This is a travesty - and even worse is the spin being put on it. We are watching the disintegration of the middle class, right before our very eyes. The U.S. is trading away our high-five/six figure positions in exchange for McJobs at 7 to 10 bucks an hour. It's the Walmartization of our economy. Hey, is there any truth to the rumor that Dubya's arranging for Labor Secretary Chao to count the electoral college votes in November?

Gee, shock. reported on Thursday that a poll conducted by Money magazine found sixty percent of respondents said the recent tax cuts did not personally help them, and seventy- six percent would have preferred those resources to have been spent on job creation instead. Good time for this survey, coming on tax filing deadline week. Respondents should know.

The University of Michigan reported that Consumer Confidence fell again, down to 93.2 in April from 95.8 in March. What? Those 308,000 jobs didn't help? Get out.

Bonds and Interest Rates:

Since we last showed this chart (courtesy of on April 2nd, U.S. Treasury Bonds declined a whopping 6 points to the 108 area, and are half way to completing a massive Bearish Head & Shoulders pattern that started two years ago to the month. This is one ominous looking creature and implies that prices will fall at least to 82, and quite possibly lower. This price target is arrived at by taking the distance from the head to the neckline (18 points) and doubling it down from the neckline. This pattern is not considered confirmed until prices decline below the neckline - below 100. We are only 8 points from there. This is a textbook-perfect picture of a statistically highly reliable Bearish Head & Shoulders pattern.

Prices never move in straight lines, but rather in stair step fashion. A close study of the Relative Strength Indicator (RSI) reveals an oversold condition this week - a reading below 30 - which means we should expect a small rally to develop over the next few weeks before the decline continues in earnest. The point is, over the next several months, barring unbridled market manipulation by the Master Planners, long-term interest rates are going higher - much higher. The risks of holding intermediate to long-term notes and bonds has increased. This chart is telling us panic selling is possible - and soon.

With reported CPI figures heading north fast, with all these new "jobs" being created, with reports of consumer buying and retail sales up, and manufacturing up, and the service sector up, you'd think the Fed would be raising short-term rates above 46 year lows some time soon. You'd think.

Money Supply, the Dollar, and Gold:

M-3 has gone crazy the first quarter of 2004, up about a quarter of a trillion dollars, an annualized growth rate of 11 percent. If the Fed wants to follow its mandate to maintain a stable currency, and if the economy is so rip-roaring terrific as Dubya's team claims, then M-3 just shouldn't be allowed to grow this fast. Could it be that the Fed doesn't believe the economic numbers? That it sees deflationary risks around the corner? Do all roads lead to deflation? Either we inflate ourselves to rising interest rates which causes a collapse in prices of everything, or we get directly there through economic slowdown. M-3 growth did take a breather last week, falling 12.6 billion. One week a trend doesn't make. We'll have to keep an eye on this.

In Deflation, cash is king. Dollars will increase in value as folks start selling assets to replace lost income. The dollar should decline initially if inflation comes before deflation, then the greenback should rise. If deflation comes first, the dollar should rise sooner. Gold could get caught in the initial downdraft of a deflationary spiral, but then turn up as its monetary intrinsic value becomes recognized and the first major currency backs itself with the precious metal.

Bottom Line:

About all that is holding this dour technical landscape together is massive growth in M-3. Massive liquidity has to go somewhere, and in the past it has found stocks. But at some point too much M- 3 will destroy Bonds and the Dollar which will lead to an equity event. So even M-3 growth has to be managed properly. Should it grow too fast, the strategy could backfire. As Richard Russell wrote recently in his daily remarks, "I believe the government has about "shot its load." (You can subscribe to his brilliant letter at, 4/13/04).

Defensive strategies may be warranted.

"Man does not live by bread alone, but man lives
by everything that proceeds out of the mouth of the Lord."

Deuteronomy 8:3

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Key Economic Statistics
Date VIX Mar. U.S. $ Euro CRB Gold Silver Crude Oil 1 Week Avg. M-3
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 8807.2 b
1/02/04 18.30 86.93 125.76 256.75 416.1 5.96 32.52 8819.8 b
1/09/04 16.79 85.40 128.19 266.50 426.8 6.49 34.31 8828.5 b
1/16/04 14.98 88.05 123.57 265.50 407.0 6.33 34.00 8850.4 b
1/23/04 14.88 88.81 125.81 266.50 408.0 6.36 34.94 8865.7 b
1/30/04 16.46 87.48 124.42 262.10 402.9 6.25 33.05 8896.8 b
2/06/04 16.00 86.15 126.83 260.50 403.6 6.27 32.43 8886.6 b
2/13/04 15.62 85.68 127.25 264.85 410.8 6.58 34.56 8899.2 b
2/20/04 16.05 87.40 126.96 264.50 397.5 6.53 34.25 8937.8 b
2/27/04 14.53 87.89 124.52 273.90 396.8 6.71 36.16 8954.3 b
3/05/04 14.52 88.75 123.28 274.00 401.6 6.99 37.26 8965.9 b
3/12/04 18.21 89.60 121.80 272.00 395.6 7.06 36.19 8956.7 b
3/19/04 19.15 88.56 122.47 280.20 412.7 7.56 37.62 8997.3 b
3/26/04 17.12 89.30 120.90 278.25 422.3 7.71 35.73 9008.0 b
4/02/04 15.81 88.80 121.12 280.00 421.1 8.15 34.39 9050.1 b
4/08/04 16.38 89.82 120.56 284.00 419.9 8.09 37.14 9037.5 b
4/16/04 15.00 90.18 119.50 276.75 401.6 7.14 37.74 -

Note: Dollar hits 90, Gold & Silver correct, Crude's up again.

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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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