Financial Markets Forecast and Analysis

By: Robert McHugh | Sun, Apr 25, 2004
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Summary of Index Daily Closings for Week Ending Apr 23, 2004

Date DJIA Transports S&P NASDAQ Jun 30 Yr Treas
Apr 19 10437.85 2923.77 1135.84 2020.41 108^01
Apr 20 10314.50 2911.27 1118.09 1978.65 107^20
Apr 21 10317.27 2954.60 1124.09 1995.63 107^22
Apr 22 10461.20 3006.96 1139.96 2032.91 108^10
Apr 23 10472.84 3001.71 1140.60 2049.77 107^15

(Next Two Weeks)
Substantial Rise Low      
Market Rise High   Very High   80%
Sideways Medium   High   60%
Market Decline Medium   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      

In spite of the glorious rally on Thursday that gave new meaning to life for the perma-bulls, this week the Dow Jones Industrial Average merely gained 20.87 points, closing the week at 10,472.84. Last week's Short-term TII reading of negative (43.00) pointed toward the 134 point decline on Monday and Tuesday. Thursday's rally was symptomatic of a confused market that has essentially traded sideways since hitting 10,570 on April 6th. All good sideways patterns must eventually come to an end. Any further rallies from here should serve as further trappings for the innocent and good launch positions for the shorts.

Despite all the brouhaha, the fact is that most equity averages are having a devil of a time rising decisively above their 50 day moving averages. This is to be expected given the pattern of the averages since 1/14/00's grand Bull market top. Last week we showed how this 50 day MA struggle marks the final move up in a minor "V" pattern immediately prior to equity market plunges. Nothing has changed to negate this view.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
Dec 12, 2003 (5.83) (54.43)   Scale
Dec 19, 2003 (6.50) (47.03)    
Jan 2, 2004 (48.17) (40.33)   (100) to +100
Jan 9, 2004 (96.50) (39.28)    
Jan 16, 2004 (20.00) (40.65)   Negative  (Bearish)
Jan 23, 2004 (8.13) (32.15)   Positive  (Bullish)
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)    
Apr 23, 2004 94.00 (22.69)    

This week the Short-term Technical Indicator Index comes in at positive 94.00, meaning we can expect the equity market to move up over the next two weeks, perhaps to 10,600 in the DJIA before declining in earnest. Look for a small decline early next week to be followed by a wave 2 up completion rally. 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 (22.69), 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 reduced the severity of this reading.

We remain on a Dow Theory "sell signal." The SPX/VIX ratio remains on a sell at an unusually high reading of 81.41. We are entering the bad six months of the year. Insiders continue to dump stocks. A devastating wave 3 of 3 of 3 down in the Elliott Wave pattern is staring us in the face. Bullish Sentiment, a contrarian indicator, remains at extremes seen at tops. Interest rates are on the rise and so far we've seen hints that equities view such increases with the same affection as the Fed. The two things the market has going for it are that the 10 week cycle is now turning up and M-3 shows no signs of slowing. At best, these effect a postponement, not cancellation of the coming equity market decline.

There are Bearish topping patterns all over the place. We find Head & Shoulders tops in the Trannies ($TRAN), the NASDAQ Composite ($COMPX), the Philadelphia Semiconductor Index ($SOX), and the NYSE Financial Index ($NYK). Triple Tops appear in the S&P 500 ($SPX), Wilshire 5000 ($WLSH), and Amex Broker/Dealer Index ($XBD). Double Tops appear in the Amex Gold Bugs Index ($HUI) in the Morgan Stanley Consumer Index ($CMR). A Rounded Top is clear in the Retail Holders (RTH).

One index that has broken above its 50 day moving average is the Dow Transports. However it remains significantly below its 3080 high and looks to be completing a picture perfect Elliott Wave 1 down, 2 up wave that should soon lead to 3 down of an eventual 5 wave decline. Crashes come as wave 3's so the timing is interesting. The Trannies' Elliott Wave formation appears to be leading the Dow Industrial's pattern, which appears to need another up leg to complete.

The above chart shows that minute wave 2 up (red) has retraced a Fibonacci .786 of the price decline from (2) (blue) to 1 (red). Since 1/14/00's grand Bull top, most wave 2's have retraced .786 of preceding wave 1's so it is a good bet this up move is over. Further evidence of this fact is that minuette degree wave "a" (in blue), took 11 trading days, an exact Fibonacci 50 percent of the 22 trading days for wave 2 (red). Minuette degree wave "b" lasted approximately .382 of wave "a" and wave "c" lasted about .618 of wave "a."

Next should be the start of minute wave 3 (red) down which should lead most of the equity averages lower. Should this pattern fail and Trannies push above 3080, their 1/22/04 top, then it means massive M-3 creation has delayed the decline, perhaps into the summer. If this happens, June 15th's major Fibonacci turn date may prove to be the next top. At some point excessive M-3 will punish Bonds, driving long-term interest rates so high that equities are driven down hard. Either way you cut it, all M-3 can do is delay the inevitable.

Are we headed for a stock market crash? If we define a stock market crash as a decline of over 1300 points within a 48 trading day time period - using closing prices - then, the above chart indicates the answer is unequivocally yes. Every single time the DJIA hit a market top since the grand Bull market top on 1/14/00, a crash occurred starting within 17 to 67 trading days of each top. Here's how it shakes out:

Crash # 1 in the chart started 17 trading days after the DJIA's final peak of a quadruple topping pattern. The top was 2/12/01 and the crash began 3/8/01. Between those two dates the market bounced around, descended at a gentle slope, spiked up to a lower top, then plummeted 1,469 points (13.5%) in just 10 trading days. If you only watched price action, you'd never have known this kind of decline was coming.

Crash # 2 above started 67 trading days from another top at 11,232 on 5/21/01. Prices drifted lower, then spiked up to the delight of perma-bulls, until on 8/24/01 the market crashed 2,187 points (20.9%) over the next 15 trading days. Pre 9/11, the crash had already wiped out 818 of those points.

Crash # 3 began 39 trading days from the market top of 3/19/02, declining from 10,298 on 5/14/02 to 7,702 on 7/23/02 - a 2,596 point (25.2%) wipeout over 48 trading days.

Crash # 4 occurred 12 trading days from the 8/22/02 high, and fell 1,316 points (15.3%) from 9/10/02 to 10/9/02, a 21 trading day event.

Crash # 5 started 31 trading days from its top, lasted 38 trading days, and fell 1318 points (14.9%).

Crash # 6 is what we have to look forward to soon, now that another market top is in. So far the latest price action in the DJIA has followed the typical post-top, pre-crash pattern, hitting a high on 2/11/04 of 10,737, declining, bouncing around a bit, spiking up one more time, then . . . So far, 50 trading days have passed without a crash. If 67 trading days is the limit - and there is no compelling reason to suggest it has to happen within 67 trading days of 2/11/04 except that all the others since 1/14/00 have - then this baby is going downnnnnnnn sometime before 5/18/2004.

Interestingly, June 15th is a major Fibonacci turn date, 424 trading days from its phi mate, the reigning low so far for this Bear Market - 10/9/02 - which sits 687 trading days from 1/14/00, the start of this economic mess. Since June 15th, 2004 is 1111 total trading days from 1/14/00, its distance from 10/9/02 is .382 of the total 1111, while 10/9/02's distance from 1/14/00 is .618 of the total days to 6/15/04. If June 15th has significance in the next crash, we cannot be sure if it marks the date of the crash's beginning, or its end, or neither for that matter.

How long the next crash takes to complete and how low it carries prices is anyone's guess. However, judging by the previous five crashes, you can figure between 10 and 48 trading days and 12.0% to 25.0%. At today's price level, we're talking about a decline to between DJIA 7,800 and 9,200. Should the market drift lower slowly from here before launching into a crash, the ultimate decline could be much worse - no guarantees of course.

Given the length and height of this latest rally - since March 2003, I'm leaning toward believing this 6th crash will be both deep and long-lasting. And, like all the others, will catch everyone off guard, even the shorts who must cover on rally days like Thursday.

Speaking of Thursday, doesn't a rally like that mean the beginning of a huge Bull momentum run, and pretty much guarantee there won't be any crash for a while? No. Just the opposite. Let's take a look at what happened just prior to the past five crashes since 1/14/00, plus the crash of 1987.

1. Two days prior to the 10 day, 1,469 point DJIA crash that started on 3/8/01, the DJIA enjoyed back-to-back rally days of 128 and 138 points.

2. The very day before the 8/24/01 to 9/21/01 20.9% crash occurred, the DJIA had gloriously rallied 194 points (1.8 percent).

3. The day before crash # 3 started on 5/14/02, the DJIA rose 188 points. Two days before the crash, it had rallied another 170 points for a two-day 3.5% rally.

4. Crash # 4 started on 9/10/02 just after the DJIA had rallied for 3 straight days, averaging 106 points up per day, a 319 point, 3.85% pre-crash kickoff rally.

5. The market rallied 4 straight days, rising 247 points, just prior to the commencement of crash # 5 on 1/14/03.

6. In 1987, the market rallied 5.9% the 9 days leading up to the crash that started on 10/2/87.

Most folks attribute the 1987 crash as a one-day event, the infamous Black Monday, October 19th. Few realize that the DJIA fell 14.9% the immediate nine days prior to that Monday, and that October 19th was the last day of a 10 day crash that took out 34% of the market's value.

So, the fact is, rallies and spikes do not assure us that a crash is not imminent, but rather appear to be necessary psychological precursors that actually kickoff crashes. Why? The only thing I can think of is that they tend to push markets into short-term overbought zones, priming the pump for a steep decline.

You say you are tired of reading about "crashes" in this week's newsletter? Well, would you have preferred I use nomenclature like Dr. Bob Bronson (Bronson Capital Markets Research) used this week in one of his fascinating technical analysis pieces - a "Mass-Correlation, Hyper-Volatility, Illiquidity Event?" The anachronism is MCHVIE but that sounds too much like my last name so I think I'll stick with the term "crash."

The Economy:

Durable Goods Orders rose in March, according to the Commerce Department, up 3.4 percent on top of an upwardly revised 3.8 percent gain in February.

Wholesale Prices rose 0.5 percent in March, with core PPI up 0.2 percent according to the Labor Department. Hmmm. That's interesting since the CRB Index is up 15.1 percent over the past six months. Steve Saville put it best in his article "Stock Market 'On the Edge'" (April 20, 2004, "What we have is a massive US inflation problem with US policy-makers trying to 'fix' the problem by simultaneously creating a) more inflation and b) a smoke screen to conceal the effects of inflation. This is going to end very badly, but the goal is clearly to postpone the end for as long as possible in the hope that the problem will either miraculously right itself or, at worst, become the responsibility of a future set of policy-makers."

U.S. Mortgage Applications fell for the fifth week in a row, according to the Mortgage Bankers Association. The reason? Higher long-term interest rates as markets focus on the threat of inflation.

Fed Chairman Greenspan jawboned this week, and proclaimed the end of the " disinflation" (translation "deflation") threat as we know it. This set off Tuesday's market decline. He backpedaled on Wednesday, clarifying that there was no urgency to raise short-term interest rates in the " very near future" as "inflation remained dormant." So let it be written, so let it be done. And the markets rallied on Thursday.

Jobless Claims remained too high, at a reported 353,000 for the week ended April 17th, 2004 according to the Labor Department. The total of all good folks humbled into receiving unemployment benefits rose to 3,019,000, up 52,000 last week.

And of course, the net result of all this gobbledygook is that Consumer Confidence fell again last week, according to the ABC News/Money magazine Consumer Comfort Index, down 3 points to minus (–) 17.

Bonds and Interest Rates:

Below is a chart (courtesy of of the 10-Year Treasury Note Yield for the past three years. There are two points of interest I'd like to point out from this chart. First, over the near-term, the next month or so, Treasury yields should decline, given the RSI reading of 71.5. Since yields are the inverse of prices, it means T-Notes are oversold. There needs to be a short-term rally to relieve this oversold condition, pushing long rates down a bit, before rates can resume their long-term rise.

Second, how do we know long-term rates are likely to rise over the intermediate and longterm time horizon? Because of the massive Bullish Head & Shoulders bottom pattern. It is textbook perfect.

Short-term interest rates should also be going up if price stability still means anything to the Federal Reserve. Giving the Fed the benefit of the doubt, their hesitancy to raise short-term rates may not be political. Quite possibly, they may not believe the economic numbers being reported, may not be buying into the robust recovery rhetoric despite what they find flying off their lips. It just may be that they understand technical analysis perfectly, that they feel this economy is fragile, and that there is too much debt out there to raise interest rates without precipitating an equity event.

Money Supply, the Dollar, and Gold:

M-3 was up another 15.2 billion for the latest week reported, and is up an astounding $253.2 billion since the first of the year. The floodgates are open and given the recent supergrowth economic figures and headliner earnings announcements, allowing this sort of growth just doesn't make any sense - unless you are trying to get reelected, you have a genuine fear of an equity event, and you know something. Short-term interest rates should have been bumped a couple months back and M-3 should have been governed at a more modest 2 to 3 percent annualized rate. Watching the Fed is like playing defense against a basketball superstar - focus on his mid-section and don't get faked out by flailing arms, trash talk, and happy feet.

The Dollar is strengthening in the face of double-digit M-3 growth. I'm taking this as an early warning that all roads lead to price deflation. Real estate, equities, bonds, commodities and goods and services are set to depress. Inflation will lead to deflation as rates rise and everyone chokes on excessive debt loads.

Gold may correct, get caught in the downdraft initially (see Issue # 43, this past week's April 21, 2004 Mid-week Update in the archives at for a chart on Gold that explains this). However, once a major currency backs itself with the precious metal, Gold - in limited supply - should take off.

Bottom Line:

The technical landscape is ugly, one of the worst you'll see. All that is propping things up at this point is hyperinflationary liquidity infusion. If M-3 trails off, it's all over. Another week or two of rising prices should be enough to push equity markets into overbought territory, a potential kickoff to a significant decline. At that point, defensive strategies are warranted.

"I know that everything God does will remain forever;
there is nothing to add to it and there is nothing to take from it,
for God has so worked that men should fear Him.
That which is has been already, and that which will be has already been."

Ecclesiastes 3:14, 15

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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 8870.6 b
1/30/04 16.46 87.48 124.42 262.10 402.9 6.25 33.05 8901.6 b
2/06/04 16.00 86.15 126.83 260.50 403.6 6.27 32.43 8891.6 b
2/13/04 15.62 85.68 127.25 264.85 410.8 6.58 34.56 8904.2 b
2/20/04 16.05 87.40 126.96 264.50 397.5 6.53 34.25 8942.7 b
2/27/04 14.53 87.89 124.52 273.90 396.8 6.71 36.16 8959.1 b
3/05/04 14.52 88.75 123.28 274.00 401.6 6.99 37.26 8970.8 b
3/12/04 18.21 89.60 121.80 272.00 395.6 7.06 36.19 8961.7 b
3/19/04 19.15 88.56 122.47 280.20 412.7 7.56 37.62 9002.3 b
3/26/04 17.12 89.30 120.90 278.25 422.3 7.71 35.73 9013.0 b
4/02/04 15.81 88.80 121.12 280.00 421.1 8.15 34.39 9055.3 b
4/08/04 16.38 89.82 120.56 284.00 419.9 8.09 37.14 9045.2 b
4/16/04 15.00 90.18 119.50 276.75 401.6 7.14 37.74 9060.4 b
4/23/04 14.01 91.34 118.18 267.50 395.7 6.16 36.46 -

Note: Dollar at a new high; VIX at a new low; CRB, Gold, Silver, and Crude deflating.

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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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