Financial Markets Forecast and Analysis

By: Robert McHugh | Sun, Sep 19, 2004
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Summary of Index Daily Closings for Week Ending September 17, 2004

Date DJIA Transports S&P NASDAQ

Jun 30 Yr Treas

Sep13 10314.69 3223.22 1125.81 1910.38 111^14
Sep14 10318.16 3225.00 1128.33 1915.40 111^20
Sep15 10231.36 3215.75 1120.37 1896.52 111^07
Sep16 10244.49 3233.41 1123.90 1907.01 112^15
Sep17 10284.46 3257.39 1128.55 1910.09 111^28

(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 28.61, in line with last week's Shortterm TII reading of negative (49.25). Friday was quadruple witching, another options expiration date where options writers don't want puts to expire in-the-money. Seven of the last ten monthly options expiration dates have been "up" days. The DJIA declined the day after options expired in seven of the last nine months. It is tough to own puts. Nobody loves you. Options writers can cover calls (by owning the underlying security) but not puts. Puts are bad. For options writers, up days on expiration dates are good. Could they be getting a little help?

It looks like the short-term countertrend rally in the DJIA from mid-August is over. If so, its top occurred within our September 8th to 13th (+/- 1 day) Fibonacci trading-day cluster time target. The Dow Industrials hit a closing top on September 7th.

Volume has picked up a bit this past week, but remains below the average for 2004. The SPX/VIX Ratio sits at a Crash-warning level of 80.44 as of Friday, September 17th (see chart on page 4), after exceeding the 85.00 level on September 13th, the second highest reading in 6 years. Bearish.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
May 21, 2004 22.00 (67.23)   Scale
May 28, 2004 ( 3.50) (48.48)    
June 4, 2004 (55.75) (34.07)   (100) to +100
June 11, 2004 (77.75) (25.92)    
June 18, 2004 (40.25) (31.17)   (Negative)  Bearish
June 25, 2004 (34.00) (26.10)   Positive  Bullish
July 2, 2004 (41.50) (27.64)    
July 9, 2004 (32.50) (30.21)    
July 16, 2004 (33.75) (41.99)    
July 23, 2004 (59.00) (49.98)    
July 30, 2004 46.25 (52.18)    
Aug 6, 2004 (38.00) (50.40)    
Aug 13, 2004 (15.75) (49.03)    
Aug 20, 2004 9.25 (43.82)    
Aug 27, 2004 9.25 (39.81)    
Sep 3, 2004 (39.25) (40.06)    
Sep 10, 2004 (49.25) (45.78)    
Sep 17, 2004 (69.00) (44.73)    

This week the Short-term Technical Indicator Index comes in at negative (69.00), indicating a market decline, possibly severe, 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 (44.73).

One measure to project the long-term trend of the equity market is to chart the 20 month moving average against the 40 month moving average. Generally, whenever the 20 month MA moves decisively below the 40 month, it confirms a long-term downtrend is at hand. Conversely, whenever the 20 month moves decisively above the 40 month moving average, a long-term uptrend is confirmed. The Dow Industrials sit at a critical juncture at this time as their 20 month MA has caught up with their 40 month, converging around 9500 this week. It will be instructive to see if the 20 month can bust up through - in which case that would be very Bullish - or whether it will be repelled and turn back down, which would be Bearish. A similar convergence occurred in 1989 but was repelled and the then existing major long-term trend (up) continued for nearly another decade. The same convergence occurred in 1983 with similar results.

There has been only one decisive crossover in this indicator since 1980, and that occurred in 2002. This barometer has been accurate in identifying the Primary trend for twenty five years.

Under Dow Theory, the price action of the Transportation Average must be confirmed by the price action of the Dow Industrial Average for an "all clear" sign that the trend will continue. The two averages have been in a Primary Bear trend since 2000. The move up from October 2002's lows is a Secondary reaction in a Bear market. Secondary reactions were likened to safety valves in a steam boiler by the late William Peter Hamilton, former Editor of the Wall Street Journal in the early 1900s and one of the founding fathers of Dow Theory. They are necessary corrections inside Primary trends. The life expectancy of the Secondary rising trend since October 2002 is in jeopardy as the Dow Industrials have failed to follow the lead of the Transportation average. While the Trannies reached another new high for this 18 month rally on Friday, September 17th, the Industrials remained more than 400 points - and six months - from confirming. Without such confirmation, the rally is suspect. In other words, those who believe a new Bull market started in October 2002 should not have confidence that this rally has further to run unless and until the Industrials rise sharply and confirm the higher high of the Trannies. Conversely, a resumption of the Primary Bear cannot be confirmed until the Transports and the Industrials make lower lows together. Thus we sit in no-man's land. Hamilton saw such divergences as uncertainty concerning the business outlook.

What we can infer is that either the Industrials are about to rise sharply and confirm the higher high of the Trannies or the Trannies are about to come suddenly crashing down and confirm lower lows of the Industrials. Once both averages get back in sync, we can draw reliable conclusions about the next major trend in equities.

Leaving Dow Theory for a moment - one of the primary objectives of this newsletter is to analyze the markets from as many different technical analysis tools as possible in order to get the forecasts "right" - the above chart demonstrates that every time there was a major divergence between the Transports and the Industrials over the past five years, the result was a steep decline - crash - within a month or two thereafter. Dow Theory is saying the price action of the averages is currently deceptive, that the life expectancy of the secondary reaction rally since October 2002 is problematic. The analysis above says it is far more than problematic, it is down right Bearish with Crash potential.

The first chart on the next page (courtesy of shows the Dow Industrials are topping. This will make it very difficult for them to confirm the new highs in the Transports any time soon. We see the RSI has reached overbought levels seen at four consecutive tops. Also, the MACD reading is at the same level as two of the past three tops. Formidable resistance has formed at the 200 day moving average and the top boundary of the downward sloping trend-channel. Prices have broken south of their short-term rising trend-channel that started on August 13th. The next leg down will be important. If it makes another lower low, this market is in trouble. If it fails, it could signal the continuation of an extended Secondary wave Bull run from October 2002.

The NASDAQ Composite ($COMPQ) has formed a Bearish Head & Shoulders over the past twelve months - this pattern confirmed in August. The RSI has reached overbought levels seen at the last three tops. The MACD is topping. The minimum downside target per this H&S pattern is 1460.

The Economy:

The New York branch of the Federal Reserve reported that its Empire Manufacturing Survey rose from 13.2 in August (a very weak number) to 28.3 in September. Still, less than half the respondents to this survey reported that business conditions had improved.

The Labor Department reported that the CPI rose an anemic 0.1 percent in August. For the two month period of July and August, prices did not rise. Of course this measurement stick obviously does not include tuition and health insurance - two huge family outlays. The CPI excluding food and energy was the same, up 0.1 percent. The point here is the government doesn't have to raise pension and social security benefits as much with this sort of number.

Retail Sales fell 0.3 percent in August according to the Commerce Department. Most of the damage was in autos. August's Industrial Production figure was essentially flat, up a mere 0.1 percent, and Capacity Utilization remained weak at 77.3 percent. And as you would expect with a brewing slowdown, Inventories rose 0.9 percent in July after June's figure was revised up by the Commerce Department to 1.1 percent.

This week confirmed U.S. Air's bankruptcy filing, almost 3 years to the day when terrorists turned passenger jetliners into missiles. Harry R. Weber of the Associated Press reported that Delta Air Lines' independent auditor, Deloitte & Touche, has reissued a "going concern" report, doubtful the carrier can stay in business. And we learned that United Airlines CEO plans to cut a "significant number of jobs" as part of its restructuring plan to stay in business. It has already missed pension contribution payments to the tune of half a billion dollars.

CNNMoney ( reported Thursday that a Senate Committee voted Wednesday to "roll back the Bush administration's controversial new overtime regulations, which critics say would have deprived an estimated 6 million workers of overtime pay." Republicans controlled that committee. Let's face it, eliminating or curtailing overtime pay is nothing more than a productivity scheme. It would encourage employers to cut jobs and overwork surviving staff. The precious productivity numbers quoted so often as the great success of the 21st Century American Economy would skyrocket without overtime pay. Is there a more family unfriendly law on the books? Either you lose your job or give up your family and work 70 hour weeks. Think about this. His own party had to stop Dubya. He may not realize it, but this Senate action may have saved Dubya's job.

Speaking of jobs, Jobless Claims were reported to be at 333,000, up 16,000 for the week ended September 11th, according to the Labor Department.

And the sum of all the above is that according to the University of Michigan, U.S. Consumer Sentiment fell to 95.8 in September.

Money Supply, the Dollar, & Gold:

M-3 declined again last week, down $7.9 billion on a seasonally adjusted basis. Over the past 10 weeks, M-3 has dropped $30.1 billion, an annualized decline of 1.7 percent. On a non-seasonally adjusted basis, M-3 has fallen $20.0 billion over the past twelve weeks. Our research shows that whenever M-3 declines or plateaus over a two month period, equities subsequently decline over the next one to three months.

The U.S. Dollar has been tracing out a Symmetrical Triangle pattern which is now close to the vertex - breakout time. Symmetrical Triangles are continuation patterns and are considered Bullish in uptrends and Bearish in downtrends. The probability is high that the breakout will be in the same direction as the prior trend - in the current case down. Often what follows is an even stronger move in the same direction as the prior trend. What is happening here is buyers are not able to push prices into a new trend. As sellers see this weakness, they gain confidence that the past trend will resume, forcing a breakout to the downside. Once prices break below 87, a small Head & Shoulders Top will be confirmed with a decline to the low 80s expected. Should price action defy the odds, a decisive break above 91 would be Bullish.

Gold remains inside both its rising short-term and long-term trend-channels - barely - while battling a Bearish Double Top. A break below 397 is Bearish. The Mining Stocks ($HUI) also have a Double Top and are finishing corrective wave 2 up. They look to need one more thrust up to complete. A Fibonacci retrace of .786 of wave 1 would hit 224.60. Wave iii stopped exactly at .618 of wave 1.

U.S. Bonds and Interest Rates:

The Fed has the wiggle room to play it any way they want to at their next Open Market Committee meeting, Tuesday. Thank the Labor Department for that flexibility with this week's negligible CPI increase. Many economic numbers have been weak lately and we have that job-saving election coming up, so maybe this would be a good time to pause. Raise a quarter or pass? The Master Planners can go either way on this one. Another bump would mean Home Equity Loan payments will increase noticeably from last spring. That would have a cumulative affect that could curtail consumer spending.

The above chart (courtesy of shows a Rising Bearish Wedge pattern finishing up in the 30 Year U.S. Treasury Bond. This is a termination pattern. The convergence of the upper and lower boundary lines indicates that buying is being met with increasingly stronger selling pressure the higher that prices crawl. The rally since May has been impressive, retracing a Fibonacci 88.2 percent (sum of a Fibonacci 50.0 percent plus Fibonacci 38.2 percent) of the decline labeled "1." But exhaustion is settling in. The RSI is overbought and the MACD has lost upside momentum.

The larger picture for Bonds (not shown here) is a huge Bearish Head & Shoulders Topping pattern that will confirm once prices decline below 100. Should that occur, the minimum downside target is in the mid-eighties. Prices would have to rise above 118.50 to negate this Head & Shoulders top.

Best Buy Co., Inc. is Ready to Decline Sharply

A subscriber emailed me this week asking for my take on Best Buy Co, Inc (BBY). Well, here's a stock ready to tumble - which is not a good sign for the consumer outlook. This stock is forming a long-term Rounded Bearish Top (not pictured here) that looks ready to slide from north to east (picture a globe).

Intermediate-term, Best Buy Co., Inc. has completed an Elliott Wave five-wave impulse move down from April through August 2004, followed by a corrective three-wave retrace that nears completion. The corrective wave has formed a Rising Bearish Wedge termination pattern for wave "c" of it's a-b-c move up. This has almost taken on the look of a parabolic spike. Parabolic spikes and Rising Bearish Wedges portend sharp reversals that should take prices to the base of the Wedge at a minimum, to the 46 area. It has retraced a perfect Fibonacci 78.6 percent of the move down from April through August, another sign the rally is about over. Rising Bearish Wedges are one of the more reliable forecasting patterns.

The RSI is overbought and turning over. The MACD should follow suit over the next few days.

Bottom Line:

The major equity averages appear to have topped or are close to topping. There are some disturbing indicators in place that have been seen before just prior to stock market crashes. The major divergence between the Transports and the Dow Industrials, and the SPX/VIX ratio, are two key warnings. On the other hand, should the Industrials confirm the Trannies on the upside and the DJIA 20 month moving average break decisively above the 40 month, these would be indicative of an extension of the rally since October 2002. Short-term indicators are overbought so the immediate expectation is for a decline. Should new lower lows be achieved, this market could crash. A failure to hit lower lows in the DJIA would be bullish. Caution is warranted.

"Train up a child in the way he should go,
Even when he is old he will not depart from it."

Proverbs 22:6

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Key Economic Statistics
Date VIX Mar. U.S. $ Euro CRB Gold Silver Crude Oil 1 Week Avg. M-3
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 9230.2 b
5/14/04 18.47 91.81 118.69 267.00 377.1 5.72 41.38 9232.3 b
5/21/04 18.44 90.53 120.05 268.75 384.9 5.87 39.93 9278.0 b
5/28/04 15.52 88.98 122.10 276.25 394.0 6.11 39.88 9251.6 b
6/04/04 16.57 88.50 122.93 274.75 391.7 5.81 38.49 9255.6 b
6/11/04 15.10 89.23 121.01 269.25 386.6 5.78 38.45 9265.9 b
6/18/04 14.95 89.41 121.17 267.75 395.7 5.98 39.00 9294.9 b
6/25/04 15.19 89.22 121.41 270.75 403.2 6.12 37.55 9281.0 b
7/02/04 15.15 88.18 123.09 265.50 398.7 6.01 38.39 9308.3 b
7/09/04 15.78 87.41 124.10 269.00 407.0 6.46 39.96 9244.0 b
7/16/04 14.43 87.12 124.36 271.50 406.8 6.72 41.25 9239.4 b
7/23/04 16.50 89.23 120.88 269.50 390.5 6.33 41.71 9260.5 b
7/30/04 15.27 90.12 120.10 267.00 391.7 6.56 43.80 9273.0 b
8/06/04 19.34 88.45 122.69 268.25 399.8 6.77 43.95 9266.9 b
8/13/04 17.98 87.97 123.68 269.19 401.2 6.62 46.58 9248.9 b
8/20/04 16.00 88.22 123.03 279.50 415.5 6.87 46.72 9260.2 b
8/27/04 14.74 89.80 120.20 275.00 405.4 6.58 43.18 9296.9 b
9/03/04 14.28 89.56 120.66 275.25 402.5 6.59 43.99 9286.1 b
9/10/04 13.75 88.60 122.61 272.50 403.8 6.16 42.81 9278.2 b
9/17/04 14.03 88.10 121.76 275.75 407.6 6.28 45.59 -

Note: VIX Complacent, Dollar & Euro down, CRB, Gold, 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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