Financial Markets Forecast and Analysis

By: Robert McHugh | Sun, Jun 13, 2004
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Summary of Index Daily Closings for Week Ending June 11, 2004

Date DJIA Transports S&P NASDAQ Jun 30 Yr Treas
June 7 10391.08 3040.11 1140.53 2026.62 103^28
June 8 10432.52 3072.40 1142.12 2023.53 104^00
June 9 10368.44 3028.23 1131.29 1990.61 103^18
June 10 10410.10 3024.71 1136.47 1999.87 103^29
June 11 M A R K E T S  C L O S E D  I N  M E M O R Y  O F  R O N A L D  R E A G A N   

(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      

The Dow Jones Industrial Average rose 167.28, despite already overbought conditions. The rise was on extremely light volume, meaning the rally since May 17th may be nearing completion. The one down day this week was on increasing volume on both the NYSE and NASDAQ exchanges, a sign of distribution, meaning institutional investors are likely not part of the bullish camp at this time.

Next week, June 17th (pushed back since markets were closed Friday June 11th in memory of President Reagan) is a major Fibonacci turn date, the 1111th trading day since the Bear Market began on January 14, 2000. Its phi mate is the low so far for the Bear Market, October 9, 2002 which occurred 687 trading days from 1/14/00. June 17th, 2004 is 424 trading days from 10/9/02. 424 divided by 1111 equals .382, and 687 divided by 1111 equals .618. Together these ratios comprise the Fibonacci golden ratio that has identified every major top or bottom throughout this four-year Bear Market to date. By the looks of things, this time we will see a top.

Mathematically, June 18th also works out to an exact .618/.382 ratio as well, and interestingly it was on June 18th when 2002's crash began its decline in earnest, falling 2000 points through 7/23/02.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
Feb 6, 2004 11.75 (20.19)   Scale
Feb 13, 2004 (68.25) (22.19)    
Feb 20, 2004 (30.00) (22.36)   (100) to +100
Feb 27, 2004 (31.00) (20.17)    
Mar 5, 2004 16.00 (17.17)   (Negative)  Bearish
Mar 12, 2004 ( 9.00) (14.70)   Positive  Bullish
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)    
Apr 30, 2004 (33.25) (34.88)    
May 7, 2004 (28.75) (47.75)    
May 14, 2004 (25.75) (66.45)    
May 21, 2004 22.00 (67.23)    
May 28, 2004 ( 3.50) (48.48)    
June 4, 2004 (55.75) (34.07)    
June 11, 2004 (77.75) (25.92)    

This week the Short-term Technical Indicator Index comes in at negative (77.75), indicating a market decline is probable. 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. Market conditions can change on a dime, so it may be unwise to trade off this weekly measured indicator. While markets could rise next week as options expire, the Short-term TII, with a time horizon of two weeks, sees trouble. Last week's reading is wrong so far, but points to the same trouble this week's indicator forecasts.

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 (25.92), indicating that a decline is probable. Massive infusions of M-3 are respected by this indicator, and have reduced the severity of this reading.

Much has been written about the recent Bullish non-confirmation that occurred under Dow Theory between the Industrials and the Transports where the Industrials reached a new lower low on May 17th 2004 which was not confirmed by the Trannies. Well, the opposite has now occurred and we are staring at a Bearish upside non-confirmation between the Dow Industrials and the Transports.

The premise of Dow Theory is that the Dow Industrials and the Dow Transports should move in harmony to signal and confirm a trend. If one index hits a new high, then the other should as well if the trend is to continue. If one index hits a new low, then the other index should as well. A trend's likelihood to continue is jeopardized if one index hits a new low in a falling trend while the other fails to hit a new low, perhaps hitting a higher low. That defines a non-confirmation. Non-confirmations red flag the possibility of a coming trend reversal.

On April 6th, 2004, the Dow Industrials hit a lower high, below their February 11th, 2004 peak of 10,737.70. On April 6th, the best the index could hit was 10,570.90. Meanwhile, the Transports hit their peak on January 22nd, at 3080.32, then confirmed the DJIA's lower high with a top of 3006.96 on April 22nd. So far so good as Dow Theory confirmed the downtrend. Trouble started when the Industrials hit a lower low of 9906.91 on May 17th, but the Transports failed to confirm, instead hitting a higher low of 2810.01 on May 10th before turning up. This produced a Bullish non-confirmation, warning of the possibility of a new uptrend in both indexes. The Trannies then went on a tear, rising all the way to 3072.40 on June 8th, hitting a new higher high, beating their previous high of 4/22/04, but failing to better their January 22nd high. The Industrials followed suit by rallying, but failed to rise above their previous high. For the Industrials to confirm this higher high in the Trannies, they will have to better the April 6th high of 10,570.90. If the DJIA fails to confirm, then this would portend another decline - perhaps a significant one.

Which begs the question, how likely are the Industrials to rise above 10,570.90 before a downtrend begins? One hint is to look at volume. Volume has dried up during the latest rally. Since volume generally precedes price, volume's divergence with rising prices indicates the latest rally that began on May 17th may soon be over. Average volume per day on the NYSE since May 17th for this rally has been 1.23 billion shares. Average daily volume for the decline from April 6th to May 17th was 1.49 billion shares. When the latest rally started, daily volume started out at 1.35 and 1.52 billion shares. This past week volume on rally days failed to exceed 1.19 billion shares. Next week is an options expiration week. There tends to be at least one decent rally day each options expiration week. So there may be more light-volume upside in the offing. Let's look at the DJIA chart to see what shortterm patterns are completing and what they mean.

The above chart shows the Elliott Wave count that we believe to be most accurate in the Dow Jones Industrial Average at this time. The Industrials are wrapping up a pair of 1-2 counts, more specifically finishing up a micro wave c of an a-b-c up move within a minuette degree wave 2 up. The micro degree "c" wave has formed a Bearish rising wedge pattern, denoted in converging blue lines. This pattern suggests a minimum downside move to the start of the wedge, in this case approximately a retest of the May 17th lows. The Elliott Wave count suggests the decline should go far below that target. Interestingly, the rally since May 17th has retraced a Fibonacci .786 of minuette degree wave 1 down.

In a nutshell, Elliott Wave theory believes that impulsive moves occur in five waves, and corrective (retracement) moves occur in three waves. Impulsive declining waves form as follows: 1- down, 2-up, 3-down, 4-up, 5-down. Corrective waves in downtrends appear in stair-step fashion as follows: a-up, b-down, c-up. Corrective waves normally retrace a Fibonacci percent of the impulsive move down, usually either .382, .50, .618, or .786 (square root of .618) of the price decline.

The next chart (courtesy of analyzes the overbought condition of the Dow Industrials. Here we see the 10 day RSI reading is at the overbought level where three previous declines have started during the past six months. Further, prices have hit the upper 2% Bollinger Band, a place where significant declines usually begin. And the Moving Average Convergence/ Divergence indicator shows signs of tiring, ready to turn down. This rally should be about over.

The above chart shows the NASDAQ Composite wrapping up the right side of a Bearish Head & Shoulders pattern. The downtrend for the right shoulder remains in force. A decisive break below the neckline, below 1880ish, would portend a sharp decline to a minimum target of 1570ish. The minimum downside is arrived at by measuring the distance from the Head to the Neckline, then subtracting this result from the neckline. Also evident here is a Bearish Rounded Top pattern. Since we are on the right side of this arc (picture a globe), once prices decline below due east, we can expect a near-vertical decline with increasing acceleration. This is the place where crashes occur.

Speaking of crashes, I wanted to update the next chart below as of June 10th so we can see where the S&P 500 stands in the realm of crash risk. This chart correlates the price of the S&P 500 index with the ratio of the S&P 500 to the VIX. VIX is a measure of options volatility risk, primarily the risk of writing puts when markets are moving down. The ratio correlates equity price moves with options writers' confidence. We see that this chart is extraordinarily useful because it shows near perfect correlation. Whenever the SPX/VIX ratio (magenta line) rises above 68.00, a market top in the S&P 500 is nigh. Conversely, whenever the SPX/VIX ratio declines below 35.00, prices have fallen to an area likely to represent a bottom. Options writers tend to become complacent as equity prices rise, a valuable contrary sentiment indicator.

June 10th, 2004's ratio is back up into crash territory, at 75.26. The decline since March 2004 in the S&P 500 failed to send this ratio below 35.00, therefore a major bottom has not yet occurred. In fact the swings in this ratio are eerily similar to 2002's action, just prior to the June 18th to July 23rd 2000 point crash. The lowest the SPX/VIX ratio could fall back then was into the high 40's, warning of more decline. Looks like a rerun could be in the cards soon in 2004.

The Economy:

Slow week. According to Redbook Research, Chain Store Sales were up 0.7 percent in June over May. The Commerce Department reported that Wholesale Inventories fell in April, down 0.1 percent versus March.

Probably the biggest news was the announcement that the PPI number would be released early, on Thursday June 10th, then in a reversal of plans, the Labor Department announced the release had been delayed indefinitely due to calculation problems. Yeah, that is understandable. This is one of those numbers that could move markets and force the Fed's hand. Better think real carefully about what this number should look like before releasing. If inflation shows up, the Fed might have to increase short-term interest rates. Won't that make all those adjustable rate home equity and first mortgage refi borrowers happy? What is it that was said about Communism? The government pretends to give honest numbers and the people pretend to believe them?

The Labor Department reported that Jobless Claims were up to 352,000 for the week ended June 5th. Hmmm. Doesn't seem to jive with the terrific non-farm payroll jobs report they've been releasing the past three months. Maybe their estimates of startup business' new job creation isn't quite what the nice folks at Labor thought? Maybe this will be the excuse the Fed uses to "pass" on hiking interest rates later this month?

Consumer Confidence edged lower this past week, down to -19 from -18 the week before, according to the ABC News/Money Magazine Consumer Comfort survey.

"Government is not the solution to our problem; government is the problem.
I'm afraid I have to confess to you that one of the sins of government is that
the bureaucracy once created has one fundamental rule above all others:
preserve the bureaucracy."
Ronald Reagan

Money Supply, Gold, and the Dollar:

I wish I could report on the latest M-3 figures, but the Federal Reserve did not post them to their website this week. Guess they have calculation problems too.

The AMEX Gold Bugs Index ($HUI) looks to be in trouble, with more downside on the way. Last week it fell impulsively, losing 4.5 percent. The next chart (courtesy of shows a Bearish Rounded Top pattern, with prices at the vertical descending point, due east headed south. The RSI indicator is not oversold. Prices are falling rapidly away from its descending 50 day moving average which is decisively below its 200 day MA. And the MACD is breaking down fast. The recent rally retraced a mere 50% of the crash since April, only a Fibonacci 38.2 percent of the plummet since January 2004. That spells "corrective," meaning more decline is probable. If the decline from January to February was an Elliott Wave one down, and the next decline that just started is a wave 5, and both wave one and wave five will tend to equality, then that gets us a downside target of around 142ish. The downward trend-line from the bottom of waves 1 and 3 would also take us to the low 140s. Ouch. If you look at this pattern as a Head & Shoulders top, then downside is even worse. Wave 4 may not be complete, but rather it is possible subwaves a and b of an a-b-c correction may be complete, with a wave "c" up yet to complete. Regardless, this index likely has much further to go on the downside.

The next chart is an analog of the HUI with the S&P 500 since May 2002. While all analogs must be taken with a grain of salt, and eventually break down, this one is interesting enough to at least consider given the probability that the HUI is headed lower again. It appears that the HUI is leading the S&P 500 by about two months. If this holds up, next for the S&P 500 is a crash similar to what HUI went through from April to May.

Gold the metal is showing a potential Bearish Double Top and its rising long-term trendchannel is at risk as the MACD is turning down, the RSI is not at oversold levels, and short-term price momentum is negative. How can Gold the metal go south in the face of all the M-3 the Fed has pumped into the economy over the past several weeks and months? Answer: Deflation. The markets must see massive deflation about to arrive. That could take the form of bubbles popping, bond prices plummeting, stock averages crashing, and real estate falling. Gold sinking in the face of massive Fed liquidity infusions is consistent with our concerns about the risks of an equity market crash. However, should currencies competitively debase in their response to collapsing markets, and one nation back its currency with Gold, the rest should quickly follow suit and Gold should soar.

Bonds and Interest Rates:

The above chart shows that should bonds decline below 101, we will have a confirmed Bearish - to say the least - Head & Shoulders pattern, with a downside minimum price target in the low 80s. The MACD couldn't even rise above zero and is now turning down again. The one positive for Bonds is that the late May rally failed to even correct a Fibonacci 38.2 percent of the decline from March to May. Either the forces of deflation are so strong that it is not going to (a break below 101 will confirm this), or prices will rally back up to the 107 area (completing an Elliott Wave a-b-c corrective retracement) before turning back down in earnest.

All eyes are on the Fed and the mystery remains - will they raise short-term interest rates when they meet the end of June? Lots of numbers massaging going on to make sure whatever they decide can be backed up. Either the recovery is phony, deflation is right around the corner, and the Fed plans on keeping the M-3 spigot open wide - which means no rate increase June 29th - or they must raise rates, irregardless of the political fallout. Tough spot for the Master Planners.

My best guess, and it is strictly a guess, is that they will hold off raising rates. The massive, preemptive crisis M-3 infusions lead me to this conclusion. Gold's behavior in the face of hyperinflationary money supply growth also suggests deflation is the key risk. The inflation we see will cause the deflation we don't see. Just one man's opinion. To be honest, I hope I'm wrong. Inflation is without a doubt the lesser of the two evils.

Bottom Line:

I don't doubt the recent equity rally has been helped a bit by the Master Planners. Can't prove it, but it has been a pretty strong price move on extremely low volume at a time when a vast number of technical indicators measured and monitored by a broad spectrum of respected technical analysts warn of imminent significant downside risk. Of course, even manipulation just plays into the hands of our June 17th/18th major Fibonacci turn date. In spite of the recent rally, technical indicators remain quite Bearish, with market conditions overbought - fertile ground for price deflation. Defensive strategies are warranted.

"If you will forgive me, you know someone has likened government
to a baby. It is an alimentary canal with an appetite at one end
and no sense of responsibility at the other."

Ronald Reagan

"If you do not listen, and if you do not take it to heart
to give honor to My name," says the Lord of hosts,
"then I will send the curse upon you, and I will curse your blessings;
and indeed, I have cursed them already,
because you are not taking it to heart."

Malachi 2:2

"I believe this blessed land was set apart in a very special way,
a country created by men and women who came here not in the search of gold,
but in the search of God. They would be free people,
living under the law with faith in their Maker and their future."

Ronald Reagan

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Key Economic Statistics
Date VIX Mar. U.S. $ Euro CRB Gold Silver Crude Oil 1 Week Avg. M-3
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 8901.7 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 8962.4 b
3/05/04 14.52 88.75 123.28 274.00 401.6 6.99 37.26 8974.1 b
3/12/04 18.21 89.60 121.80 272.00 395.6 7.06 36.19 8964.0 b
3/19/04 19.15 88.56 122.47 280.20 412.7 7.56 37.62 9005.8 b
3/26/04 17.12 89.30 120.90 278.25 422.3 7.71 35.73 9017.3 b
4/02/04 15.81 88.80 121.12 280.00 421.1 8.15 34.39 9060.6 b
4/08/04 16.38 89.82 120.56 284.00 419.9 8.09 37.14 9048.6 b
4/16/04 15.00 90.18 119.50 276.75 401.6 7.14 37.74 9064.6b
4/23/04 14.01 91.34 118.18 267.50 395.7 6.16 36.46 9068.9 b
4/30/04 16.69 90.76 119.70 270.75 387.5 6.07 37.38 9115.3 b
5/07/04 18.13 91.30 118.83 270.40 379.1 5.58 39.93 9173.2 b
5/14/04 18.47 91.81 118.69 267.00 377.1 5.72 41.38 9175.9 b
5/21/04 18.44 90.53 120.05 268.75 384.9 5.87 39.93 9222.7 b
5/28/04 15.52 88.98 122.10 276.25 394.0 6.11 39.88 9197.5 b
6/04/04 16.57 88.50 122.93 274.75 391.7 5.81 38.49 -
6/11/04 15.10 89.23 121.01 269.25 386.6 5.78 38.45 -

Note: Everything is down except the Dollar.

Note: Ronald Reagan quotes from the book, Quotable Reagan, by Steve Eubanks, TowleHouse Publishing, Nashville Tennessee, Copyright 2001.


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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