Financial Markets Forecast and Analysis

By: Robert McHugh | Sun, Jul 18, 2004
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Summary of Index Daily Closings for Week Ending July 16, 2004

Date DJIA Transports S&P NASDAQ Jun 30 Yr Treas
July 12 10238.22 3091.29 1114.34 1936.92 108^06
July 13 10247.59 3079.79 1115.14 1931.66 107^25
July 14 10208.80 3085.22 1111.47 1914.88 107^26
July 15 10163.16 3125.39 1106.69 1912.71 107^28
July 16 10139.78 3088.33 1101.27 1883.15 109^11

(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 closed down 73.44, in line with last week's Shortterm TII reading of negative (32.50). Prices have been held hostage by converging 50 Day (declining) and 200 Day (flat to rising) moving averages. The 50 Day MA has been acting as strong resistance and the 200 Day MA has been acting as formidable support. Friday's price action may have broken out of this trading range to the downside, albeit not yet decisively. Still, the indicators and trends we follow suggest a decisive break south is close.

The story has been the NASDAQ Composite and the deterioration of the Techs. This index has broken below both its 50 day and 200 day moving averages. Bearish. Further, let us remember that it was this index that led the Big Cap indexes to dramatic declines from their 2000 highs by first falling in 1999 and 2000. The NASDAQ broke into the 1800's on Friday for the first time since May 21st, the decline coming on increasing volume, making it a distribution day where the pros get out. A chart of the NASDAQ Composite's price pattern is on page 7.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
Mar 12, 2004 ( 9.00) (14.70)   Scale
Mar 19, 2004 (12.00) (27.60)    
Mar 26, 2004 73.00 (38.35)   (100) to +100
Apr 2, 2004 (3.00) (35.61)    
Apr 16, 2004 (43.00) (29.90)   (Negative)  Bearish
Apr 23, 2004 94.00 (22.69)   Positive  Bullish
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)    
June 18, 2004 (40.25) (31.17)    
June 25, 2004 (34.00) (26.10)    
July 2, 2004 (41.50) (27.64)    
July 9, 2004 (32.50) (30.21)    
July 16, 2004 (33.75) (41.99)    

The S&P 500 to VIX ratio sits at 76.32 - the place where five previous crashes occurred. See Issue no. 65 in the archives at, page 11 for the chart.

This week the Short-term Technical Indicator Index comes in at negative (33.75), 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, or the Plunge Protection Team can come in and temporarily stop market slides, so it may be unwise to trade off this weekly measured indicator.

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 (41.99).

So far for the year 2004, the Dow Industrials are down 314.14 points, or 3.0 percent; the S&P 500 is down 10.63 points, or 1.0 percent; and the NASDAQ Composite is down 133.24 points, or 6.6 percent. The Trannies are up 81.25 points, or 2.7 percent, diverging with these other major averages, but appears ready to soon join the others.

We have been showing Bearish topping patterns for Dow Industrial component stocks over the past several issues. Tonight we include Intel Corp. on page 7. Intel sports a Bearish Double Top and Bearish Head & Shoulders top. It has ominously crossed below its neckline, its two-year rising trendchannel, and both its 50 Day and 200 Day moving averages. Plus the 50 Day MA has sunk far below its 200 Day MA. The intermediate forecast is for Intel to sink 40 percent, to $14. In the short-term, however, it is deeply oversold and a bounce back up to test the neckline, to $25, is probable.

For the Dow Industrials' 50 Day Moving Average to break decisively above or below the 200 Day Moving Average is a really big deal, an event not to be taken lightly by the market - which it has not. This is evidenced by the fact that as these two moving averages converge, the DJIA typically enters a period of sideways price consolidation, sometimes lasting a couple of weeks, sometimes lasting longer. The pause is justified because once prices break, and move sharply above or below the 200 day MA, they will likely break hard, impulsively. While this pause indicates the market often isn't sure which way it will go, the chart above indicates prices will almost always break in the same direction as the preceding trend of the 50 Day MA.

If you identify the points of convergence of the 50 day MA and the 200 day MA above, indicated by the pauses that occurred as the convergences took place, numbered 1 through 7, the preceding direction of the 50 day MA seems to dictate the future course of prices. The only variable seems to be how long the consolidation will take. There doesn't seem to be any rule of thumb we can hang our hat on to estimate the life expectancy of these pauses, except one trend I notice is that each pause is briefer than the one before, going back to 1999. Perhaps the market is becoming more and more aware of the importance of a preceding 50 day MA and thus is not as uncertain as to its future direction as before.

When prices converged simultaneously with the convergence of the 50 day MA and 200 day MA, events 2, 3, and 4, it appears that it meant the consolidation period was nearing its end, and the next impulsive move was imminent. If that is the case, then pause 7, now, should be about over.

* 3/7/2000's low is 38.0% of the total # of trading days from 1/14/2000's High to 5/26/2000's Low
* 5/26/2000's Low is 38.0% of the total # of trading days from 1/14/00's High to 12/20/00's Low
* 9/6/2000's High is 38.3% of the total # of trading days from 1/14/00's High to 9/21/01's Low
* 10/18/2000's Low is 38.8% of the total # of trading days from 1/14/00's High to 1/4/02's High
* 11/6/2000's High is 37.6% of the total # of trading days from 1/14/00's High to 3/19/02's High
* 11/22/2000's Low is 37.9% of the total # of trading days from 1/14/00's High to 4/29/02's Low
* 12/5/2000's High is 38.7% of the total # of trading days from 1/14/00's High to 5/14/02's High
* 1/3/2001's High is 37.6% of the total # of trading days from 1/14/00's High to 8/22/02's High
* 3/22/2001's High is 37.9% of the total # of trading days from 1/14/00's High to 3/11/03's Low
* 5/21/2001's High is 62.6% of the total # of trading days from 1/14/00's High to 3/19/02's High
* 9/5/2001's High is 38.0% of the total # of trading days from 1/14/00's High to 5/17/04's Low
* 9/21/2001's Low is 61.6% of the total # of trading days from 1/14/00's High to 10/9/02's Low
* 1/4/2002's High is 61.5% of the total # of trading days from 1/14/00's High to 3/31/03's Low
* 3/19/2002's High is 63.4% of the total # of trading days from 1/14/00's High to 6/17/03's High
* 7/23/2002's Low is 61.7% of the total # of trading days from 1/14/00's High to 2/11/04's High
* 8/22/2002's High is 62.1% of the total # of trading days from 1/14/00's High to 3/24/04's Low
* 10/9/2002's Low is 61.6% of the total # of trading days from 1/14/00's High to 6/23/04's Low

The preceding Fibonacci phi mate charts for the DJIA are updated to reflect the 6/23/04 top (a truncated wave 5 of C of 2 up in Elliott Wave parlance that failed to confirm the top in the Trannies) and the change in trading days for the Ronald Reagan memorial market suspension. The next key turn date according to this amazing indicator is September 7th, 2004. While we can't be sure if it will be a high or a low, most phi mates tend to be opposites, and most consecutive phi dates tend to be opposites. Applying this, 9/7/04's mate is 11/27/02, a high, and the immediate prior one, 6/23/03 is also a high. Therefore, it is likely 9/7/04 will mark a low in the DJIA.

To recap the concept here for first-time readers, every single significant high or low on the DJIA since this Bear market began on 1/14/2000 has occurred on a near-perfect Fibonacci phi ratio .618 or .382 of the total trading days from its mate. Those pairs are listed on the preceding page. Variances are only within a couple of days of perfection for the most part. The phi ratio is obtained by examining the relationship between each Fibonacci number with its two preceding sequential numbers. For example, Fibonacci numbers are 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, etc… Each number is arrived at by adding the preceding two consecutive numbers. 21 = 13 + 8. 34 = 13 + 21. 144 = 55 + 89. If we take the ratio of these preceding numbers to the total, one will be .382 of the total, and the other will be .618 of the total. Thus, 8 divided by 21 = .381, 13 divided by 21 = .619. 13 divided by 34 = .382, and 21 divided by 34 = .618, etc... Thus 8 and 13 are phi mates, as are 13 and 21, as are 55 and 89, etc… It is simply amazing that stock market tops and bottoms are predictable based upon this golden ratio, which is so evident throughout all of nature.

Going the next step, we can predict possible future tops and bottoms using this formula.

So where do we stand in the Dow Industrials? The above chart (courtesy of shows a pattern similar to the declines of March and May, but about only onethird complete if prices are destined to travel down to the lower boundary of the declining trend-channel. The daily Relative Strength Indicator above shows this index is not oversold, and in fact the weekly chart has an even higher RSI reading of 46.8 - plenty of room for more decline. Prices have finally closed below both their 50 Day and 200 Day moving averages, a lower low, with volume spiking on recent down days. The MACD is negative and falling, again nowhere near the extremes seen at the past two bottoms in March and May 2004. The weekly chart shows prices only at the mid-point of their 2 percent Bollinger Bands, not a place where significant bottoms normally occur. The conclusion here is that prices are breaking down, ready to start their next impulsive decline with a target of 9750 according to the downward trend-channel.

The next chart shows the NASDAQ Composite. Prices recently broke below the bottom trendline of a perfect two-year rising trend-channel, and decisively below both its 50 Day and 200 Day moving averages. Further, its 50 Day MA has broken below its 200 Day MA. All these developments are ominously Bearish. The pattern remains the same, a Bearish Head & Shoulders Top that completed its Right Shoulder on Friday. The minimum downside target projected is 1500. While the daily chart's RSI shows minimally oversold conditions, the weekly chart does not, leaving more room to fall. Perhaps a minor correction or consolidation will occur over the next month before this index declines in earnest, although that might not occur until prices fall further from here over the next week or so.

The Economy:

It continues to deteriorate. First the positives. According to the unbiased view of the Federal Reserve, the Philadelphia Fed Index, a measure of manufacturing activity, rose from 28.9 in June to 36.1 in July. The New York Fed's Empire Manufacturing Survey rose from 29.9 in June to 36.5 in July. Truly happy days are here again. If you are an unemployed factory worker, perk up, you should be getting called back any day now.

The Commerce Department reported that Business Inventories rose 0.4 percent in May. Does that mean sales are slowing or are expected to climb and producers/sellers are preparing for demand? Well, the Commerce Department also told us that Retail Sales fell a whopping 1.1 percent in June, autos taking a big hit. Gas station sales were off 1.2 percent. General Merchandise store sales fell a reported 5.6 percent.

Industrial Production fell 0.3 percent in June, the largest decline since April 2003 according to the Federal Reserve. Manufacturing output fell 0.1 percent, its first drop in 13 months. Capacity Utilization fell to 77.2 percent in June from 77.6 percent in May. Reconcile these figures with the manufacturing indexes above.

The Labor Department reported that the Consumer Price Index (CPI) rose 0.3 percent in June, with Core CPI (excluding food and energy) up only 0.1 percent. The Labor Department also reported that the Producer Price Index (PPI) actually fell 0.3 percent in June, with Core PPI (excluding food and energy) rising 0.2 percent. I haven't seen prices go up, have you? No, not around here. Nope. The goal here is to permit the Fed to hold back on any further short-term rate increases prior to Election Day. Yeoman's job, Labor!

Here's some bad news for the U.S. manufacturing base, if true. Import Prices declined 0.6 percent in June, the first drop since September 2003. Some of this was lower petroleum, but it also included a 0.6 percent decline in industrial supplies and materials. The source here: The Labor Department.

We learned that the U.S. Trade Deficit fell slightly from $48.3 billion in May to $46.0 billion in June. Yep, that's a one month figure. It still means we're on a pace to blow past last year's record deficit, past $496.5 billion. The deficit with China rose.

Jobless Claims came in at 349,000 for the latest reporting week, still too high and not declining.

The same week we learned plans are being made to push back the Election should a terrorist event of sufficient magnitude occur just prior to the election, we heard Treasury Secretary John Snow make headlines warning that the risk of a terrorist attack is a key danger for the U.S. economy, according to

Meanwhile, Consumer Confidence remained essentially flat according to the ABC/Money magazine Consumer Comfort Index for the week of July 11th, 2004.

Money Supply, the Dollar, & Gold:

The Federal Reserve made a significant adjustment to the Money Supply figures for the past three months so if you see them change at the end of this report, that is why. M-3 declined $60.2 billion last week, and was reported to be the same as a month ago. The Seasonally adjusted and non-seasonally adjusted figures came in about the same. While M-3 grew at an expansionary 11 percent annualized growth rate from April 12th through the end of June, it is actually down for the past seven weeks. Our research indicates that whenever M-3 declines or plateaus over a one to two month period, equity markets decline within one to three months thereafter. Thus, recent M-3 figures support our Bearish view for equities this summer.

So far, so good for Gold. It remains in its perfect two-year rising trend-channel and has fought back after its 50 day MA fell sharply below its 200 day MA. A rise above 420 would signal that the move up from May lows is more than a correction of the preceding 64 point down move from March 2004 as it would be greater than a Fibonacci .786 (square root of .618 and a maximum retrace), in all likelihood an indication that the Bearish Double Top will fail. Both the RSI and the MACD indicate more upside is possible. A break below the lower trend-line, below 380 would be Bearish.

Nothing has changed in our view of the $HUI or $XAU. These mining stocks indexes have much further to fall. See the chart in last week's newsletter, Issue no. 65, page 10, for the analysis in the archives at Price action this week has not altered the pattern in the chart. The mining stocks are behaving like most equity indexes we follow - Bearish.

The long-term U.S. Dollar chart looks a bit like the inverse of the Gold chart. While the Dollar remains inside its trend-channel, what is most bothersome is that it remains near the top and is headed down. Worse, the pattern that has formed inside this trend-channel is a Bearish Head & Shoulders Top. The pattern is textbook perfect and portends a further decline in the Dollar, probably over the next month or two max, to 82 or below. That is good for Gold and bad for financial assets in the United States.

Take a look at the RSI indicator. It too has formed a Bearish Head & Shoulders pattern, as has the MACD. Ouch.

Bonds and Interest Rates:

The chart on the next page shows a massive Bearish Head & Shoulders pattern in the U.S. 30 Year Treasury Bond. The two-year chart allows us to measure a minimum downside target of 82 by taking the distance from the Head to the Neckline and subtracting that from the Neckline. The rally since May 2004 appears to be nearing its end, with an upside target of 110.50, the 61.8 percent retrace of the down move from March through May 2004 that formed the right shoulder of this pattern. We cannot rule out the possibility that prices will soar beyond the 61.8 percent retrace to the 78.6 percent retrace, at 113. This would make sense should a severe equity decline occur any time soon.

The Relative Strength Indicator and the Moving Average Convergence/Divergence indicators suggest this short-term rally has run out of steam. Regardless, long-term interest rates are expected to climb per this pattern. That would make sense if the trade-weighted U.S. Dollar is destined to collapse. That would prove fatal for the real estate bubble and buoy precious metals.

Bottom Line: We remain under a Dow Theory Sell Signal. Intermediate patterns indicate equity averages are headed much lower. In the short run, we expect some additional decline to equities, to be followed by enough rally correction to remove oversold conditions. Fundamentals seem to be catching up to the technicals. Caution is warranted.

"Though the fig tree should not blossom,
and there be no fruit on the vines,
Though the yield of the olive should fail,
And the fields produce no food,
Though the flock should be cut off from the fold,
Yet I will exult in the Lord,
I will rejoice in the God of my salvation.
The Lord God is my strength,
And He has made my feet like hinds' feet,
And makes me walk on my high places."

Habakkuk 3:17-19

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Key Economic Statistics
Date VIX Mar. U.S. $ Euro CRB Gold Silver Crude Oil 1 Week Avg. M-3
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 9015.3 b
4/02/04 15.81 88.80 121.12 280.00 421.1 8.15 34.39 9071.5 b
4/08/04 16.38 89.82 120.56 284.00 419.9 8.09 37.14 9060.6 b
4/16/04 15.00 90.18 119.50 276.75 401.6 7.14 37.74 9115.2 b
4/23/04 14.01 91.34 118.18 267.50 395.7 6.16 36.46 9122.6 b
4/30/04 16.69 90.76 119.70 270.75 387.5 6.07 37.38 9171.5 b
5/07/04 18.13 91.30 118.83 270.40 379.1 5.58 39.93 9230.1 b
5/14/04 18.47 91.81 118.69 267.00 377.1 5.72 41.38 9232.2 b
5/21/04 18.44 90.53 120.05 268.75 384.9 5.87 39.93 9277.9 b
5/28/04 15.52 88.98 122.10 276.25 394.0 6.11 39.88 9251.5 b
6/04/04 16.57 88.50 122.93 274.75 391.7 5.81 38.49 9255.5 b
6/11/04 15.10 89.23 121.01 269.25 386.6 5.78 38.45 9265.8 b
6/18/04 14.95 89.41 121.17 267.75 395.7 5.98 39.00 9305.7 b
6/25/04 15.19 89.22 121.41 270.75 403.2 6.12 37.55 9296.1 b
7/02/04 15.15 88.18 123.09 265.50 398.7 6.01 38.39 9327.6 b
7/09/04 15.78 87.41 124.10 269.00 407.0 6.46 39.96 9267.4 b
7/16/04 14.43 87.12 124.36 271.50 406.8 6.72 41.25 -

Note: VIX complacent; Dollar down; CRB, Gold, Silver and Oil up.


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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