Financial Markets Forecast and Analysis

By: Robert McHugh | Sun, Nov 7, 2004
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Summary of Index Daily Closings for Week Ending November 5, 2004

Date DJIA Transports S&P NASDAQ Jun 30 Yr Treas
Nov 1 10054.39 3504.07 1130.51 1979.87 113^04
Nov 2 10035.73 3449.62 1130.58 1984.79 113^08
Nov 3 10137.05 3494.64 1143.20 2004.33 113^14
Nov 4 10314.76 3562.84 1161.67 2023.63 113^10
Nov 5 10387.54 3572.50 1166.17 2038.94 112^08

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

This week the Dow Jones Industrial Average closed up 360.07 points, in line with the direction of last week's Short-term TII reading of positive 39.50, a relief rally on the election news as Wall Street hates change. The rally necessitated a ton of short covering, fueling the largest one-week rise in over a year. The rally also did minor damage to the intermediate-term Bearish case, and increased the risks that the Secondary Trend Bearish outlook may be pushed back several months. However, a trademark of Primary Bear markets is that rallies are furious and declines occur over longer periods than rallies do. Thus, this week's rally fits the prototype of a Bear market correction, and we continue to believe we remain in a long-term Bear market that started in 2000. That said, in this issue we will hone in on how the technical analysis landscape has changed, with more attention to the Secondary Trend Bullish scenario. There are plenty of risks for both Bulls and Bears, so we will try to sort out both.

Coming Soon, in 2005, "Trader's Corner," a special feature for traders.

Equities Markets Technical Indicator Index (TII) ™    
Week Ended Short Term Index Intermediate Term Index    
July 9, 2004 (32.50) (30.21)   Scale
July 16, 2004 (33.75) (41.99)    
July 23, 2004 (59.00) (49.98)   (100) to +100
July 30, 2004 46.25 (52.18)    
Aug 6, 2004 (38.00) (50.40)   (Negative)  Bearish
Aug 13, 2004 (15.75) (49.03)   Positive  Bullish
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)    
Sep 24, 2004 (52.25) (42.02)    
Oct 1, 2004 25.50 (37.23)    
Oct 8, 2004 (58.50) (35.56)    
Oct 15, 2004 (24.50) (35.48)    
Oct 22, 2004 (15.00) (36.93)    
Oct 29, 2004 39.50 (40.06)    
Nov 5, 2004 5.50 (35.28)    

This week the Short-term Technical Indicator Index comes in at positive 5.50, indicating a sideways to slightly up move 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 (35.28).

The next three charts revisit the 20 month moving averages convergence/divergence with the 40 month moving average over the past ten years for the S&P 500, the Dow Industrials, and the NASDAQ Composite. These long term slow/fast moving averages have been excellent confirming indicators of major secular Bull and Bear markets. Secular markets are very long-term changes in the trend. They are infrequent, in fact there have only been two since 1994.

Of particular note is that in all three major indices, the 20 Month Moving Average has converged with the 40 Month Moving Average - but none have broken decisively above. Should the 20 Month MAs decisively crossover the 40 Month MAs, that would be confirmation that we have been in a secular Bull market for some time now, probably dating back to October 2002's bottom. A key point here is that these are confirming indicators that pick up the secular trend late - perhaps more than halfway through their expected life. Still, they would portend more upside should the decisive crossovers occur. Unless markets drop sharply - and soon - this is looking probable. The big question then would be, how much further will the Bull run? Or, a better question is, will markets plummet soon?

The chart on the top of the next page updates the SPX/VIX Ratio, a contrary sentiment gauge of major tops and bottoms based upon similar readings over the past six years. For nearly a year now, this indicator has been warning that the S&P 500 sits at an extreme high, a major top area that should devolve into an intermediate-term precipitous decline. As of November 5th, 2004, this ratio was back up to a crash-warning level of 84.26, one of the highest (most Bearish) readings of the past six years. This indicator is telling us that the chances of the 20 month moving average crossing above the 40 month moving average are not that good, for there is a sharp decline due at any time.

Backing up the SPX/VIX warning is the next chart, the 10 Day Average CBOE Call/Put Ratio. We have found that whenever this ratio approaches a value of 1.00, it is indicative of a bottom. Whenever this indicator rises above 1.40, it warns of a significant top. The last time this indicator warned of a major top was in January 2004. The DJIA peaked within weeks and then lost 1000 points over the next eight months. Now, after dragging its feet for several months, this ratio is pressing up toward 1.40 very rapidly. In fact four of the past ten daily readings were well above 1.40, including Friday's. This indicator - while not yet giving off a sell signal - is heading there fast, indicating we may be nearing a significant top.

Again, we have not seen an official signal that a intermediate-term Secular Bull market has begun - albeit we may be approaching a crossroad. There is considerable risk that such a Bull signal will not occur given the Bearish implications of the SPX/VIX and Call/Put sentiment gauges.

Analogs are valuable because they capture the investor psychology common to two or more like periods in equity market history. Patterns of supply and demand tend to repeat, especially during Secular Bear markets. The last two Secular Bear markets in equities were from 1929 through 1936 and from 1968 through 1975. The above chart simply averages the price patterns of the past Secular Bear markets and compares it to the current one that started in 2000.

Guess what? This week's extraordinary rally is right on schedule - not a surprise to past Secular Bears - a furious rally nearly tick for tick in sync with the past. If this similitude is going to hold up, in about a month we should see a 1,200 point decline begin that snowballs into a 3,000 point, six month collapse. No guarantees, but this is another sobering risk factor for those ready to jump aboard the buying-panic ship. This chart warns "long" passengers to strap on life preservers.

This week's price action has forced a change to the top Elliott Wave count in the S&P 500. Up until this week, it looked as though primary degree corrective wave (2) up of the Bear market had peaked on June 24th, 2004, and that the decline since that date was the start of primary degree wave (3). Because prices hit higher highs this week, June 24th's high now becomes minuette degree b up of an a-b- c minor degree wave 4 correction of intermediate degree wave C up of primary degree wave (2) up. Minor degree wave 4 was the gentle downward sloping decline bottoming August 13th, 2004. The rally from 8/13/04 to 10/6/04 was minuette degree wave i up of minor degree 5 up. The decline from 10/6 through 10/25 was corrective minuette degree wave ii. The sharp rally this past two weeks is minuette iii up. So we might only be a few weeks or perhaps a month away from a final primary degree wave (2) top that began in October 2002. Once minuette wave iii up finishes - and the oversold conditions suggest it will soon be over - a shallow minuette degree wave iv will correct and a minuette wave v will terminate this two year move. Again, for the Bulls, keep in mind that the Grand Top was 1,553 on March 24th, 2000, and that the S&P 500 is still 387 points below that level, 25 percent under it. Or, put another way, the S&P 500 would have to rally 33 percent to return to that level. Again, there is incredible risk to those who want to believe a Secular Bull market has begun when you see this index has failed to return prices more than 67 percent of the way back to the top.

Presuming this is still a Secular Bear market, a Fibonacci 61.8 percent retrace of the decline from 3/24/04 to 10/9/02 would allow for prices to climb back up to 1,257. Often, wave fives of the final corrective wave C of one lower degree truncate. We saw this in the Dow Industrials. So to expect minuette degree wave v to extend to 1,257 might be too zealous. The point is, there is a ton of risk to the Bullish case.

Shorter-term, a Bullish Head & Shoulders Bottom pattern has been confirmed with the decisive breakout above 1145. The upside minimum target is 1220ish. This is likely to be in the ballpark of the final top for minuette degree wave v up of 5 up of C up of (2). However, this Bullish pattern is inside and part of a larger Bearish pattern - a Broadening Top "Megaphone" that portends a major top is coming and a precipitous decline thereafter. So once the post-election honeymoon is over, and the awful fundamentals kick into the minds and hearts of investors' psyches, spirited selling should take over again.

The above chart (courtesy of shows what we believe to be the top count and the top alternate Elliott Wave count in the Dow Jones Industrial Average. The DJIA is not at the same place as the S&P 500 - not yet anyway. As things stand today, the S&P lags the DJIA. The DJIA completed its primary degree wave (2) up on June 23rd with a truncated fifth. Since then, minor degree wave 1 down of intermediate degree wave 1 down of primary degree wave (3) down finished on August 13th. Since then, an a-b-c zigzag minor degree wave 2 has unfolded with the minuette degree wave c still unfolding. Should prices exceed June 23rd's levels - above 10,487.54 - then our top count would shift to the alternate count shown at the bottom of the chart.

Prices remain 350 points from confirming the higher highs in the Transports and the S&P 500 for the rally since October 2002. So at this point we can consider the divergences in the major averages as Bearish - or at the very least can conclude that the rally since October 2002 cannot be trusted. The DJIA remains 1,362.43 points from their all-time high back on 1/14/2000. Hey, nice rally this week but in the words of William Peter Hamilton, "One sparrow does not make a summer." The speed of the rally is indicative of a Secondary Trend Bear Market correction.

The NASDAQ Composite sits a mere 39.7 percent of the distance from its all time high of 5,132.52 on 3/10/00, needing 3,093 points to recover all of its losses.

Not much change in the technical picture for the Trannies this week except "up" got higher. Trannies remain 260 points - or 6.8 percent away from their all-time high of 3,833 back in May 1999. The Dow Theory non-confirmation continues with the Dow Industrials, and in the past five years divergences such as we see now have led to stock market crashes. Back in 1977 we had a similar divergence where the Trannies were rising and the Industrials were falling over an extended period of time. That also led to a crash. The DJIA's rise this week cancelled out only one of the three divergences since February 2004.

Both the price patterns and the Elliott Wave count indicate this index is close to a significant top. If so, then the odds favor the Trannies joining the Industrials in further decline, harmony being achieved by confirmed lower lows. We believe the Trannies have - or are days away - from completing a significant top because not only have they traced out a terminating Rising Bearish Wedge 5th wave of C, but inside that 5th, a lower degree 5th (i.e. "v") wave has also traced out another terminating Rising Bearish Wedge pattern. Both patterns look complete, with a common "throw-over" in process of wrapping up as well. These patterns are also known as Ending Diagonal Triangles in Elliott Wave parlance. The MACD is overbought and at a level where we last saw a significant top. The RSI is also at an extreme overbought level, ripe for a decline. Further increase in prices without a correction will establish a Parabolic Spike pattern, increasing the odds of a crash in this index. Trannies also sit at an extreme 17 percent above their 200 day moving average, so a reversion to mean is likely.

The Economy:

According to the Institute for Supply Management, the Services Sector growth index increased to 59.8 in October from 56.7 in September. Above 50 indicates growth. However, it also reported that the Manufacturing Sector's growth decreased, the index falling to 56.8 in October from 58.5 in September 2004. It was the third month in a row of decreasing growth, and the worst reading in a year.

The Commerce Department announced that Construction Spending fell in September from August, the decline led by residential construction. September Housing Starts fell 6 percent.

A joint report by the International Council of Shopping Centers and the UBS noted that U.S. Chain Store Retail Sales fell 0.3 percent for the week ended October 30th, the third weekly decline in a row.

We learned this week that Business Productivity slowed in the third quarter, the slowest pace since 2002 according to a Reuters story posted at

The Labor Department reported Thursday that Jobless Claims fell to 332,000 for the week ended October 30th. Then on Friday, they reported that Non-farm payrolls increased by 337,000 in October. Challenger, Gray & Christmas had a slightly different take on the job market, reporting that employers planned in October to cut over 100,000 jobs, about the same they planned to cut in September. It is expected that more than 1.0 million jobs will be cut this year. The Labor Department uses estimates as a key ingredient in their figures.

The ABC/Money Confidence Index rose during the last week in October, to minus (-) 5 from minus (-) 11.

Money Supply, the Dollar, & Gold:

M-3 rose 18.0 billion last week, but hasn't budged since the third week of June. Our research indicates that whenever M-3 rises for two or more months, equities float higher. Whenever M-3 plateaus or declines for two or more months, equities decline. The liquidity environment is supportive of a further decline in equities.

The trade-weighted U.S. Dollar continues to follow its expected path, breaking south from a symmetrical triangle minor degree wave 2, and breaking decisively below the neckline of its Head & Shoulders Top pattern. The decline to the 83 area is a minuette degree wave v. Next is a minor degree wave iv up move. Prices should zigzag lower to at least its minimum downside target of 81, and possibly lower as it completes intermediate degree wave 5 down of primary degree wave (1) down. Big picture: After that should be a primary degree wave (2), A-B-C rally that could take six months to a year to complete, and send prices back toward 100. That rally may not start for several more weeks.

While the Dollar's RSI is deeply oversold, we expect it to remain so for a while, with some upward movement coming from the minor degree wave 4 correction. The MACD is not at oversold levels seen at prior bottoms during its long-term decline. The MACD is curling up, but that could end up being a Bear hook before one more thrust lower.

Gold remains solidly inside its long-term rising trend-channel. However, there are several conflicting patterns evident that make a short-term forecast difficult. Here are the scenarios. First the Bearish case. With prices hitting 433 this week, Gold has traced out a perfect Triple Top. This pattern has intermediate-term implications and suggests a multi-month decline. Another pattern, a Rising Bearish Wedge (magenta) has both intermediate and short-term implications. It is complete, with a throw-over. These are usually seen at intermediate degree tops. A suggested decline from this pattern would be to take prices back to the beginning of the wedge, to around 385. The RSI indicator is overbought, however in Bull markets that doesn't necessarily mean a decline is imminent. But the MACD has lost upward momentum, and may be about to turn over.

Now the Bullish Patterns: A larger, intermediate-term Ascending Bullish Triangle has formed (blue lines) with a nearly year-long series of higher lows converging into a horizontal cap formed by the Triple Top. These patterns are known as continuation patterns, meaning they are catch-your-breath spots in a Bull run. A breakout above 433 will confirm that this pattern is dominant and would portend a strong rally at a minimum equal to the distance of the widest part of the triangle added to the spot of the breakout. That would tack on 58 points to 433, pushing Gold close to 500. On rare occasions, an Ascending Triangle can act as a top. Prices have finally broken above the upper trend-line of the short-term rising trend-channel. A decisive breakout would be Bullish.

The key here is to watch for a breakout. If Gold pops above 433, it would be an all-clear sign for Bulls. We sit there now, so the moment of truth is at hand. Failure to do so could mean a shortterm period of correction is needed before another run at 433. The overriding pattern in play in our opinion is the long-term rising trend-channel. It remains intact, and therefore the long-term trend remains up.

The HUI is in a long-term Bullish trend. The question is, where does it stand in the intermediate trend? The Elliott Wave count is ambiguous and can be interpreted three different ways. The top count we have labeled above requires prices to decline from here. This week we saw the Mining Stocks rally for a third test of the 239 level. At present, this has created a Head & Shoulders Top formation at the .786 retrace point of minor degree wave A down. Any decisive move above 239 would mean one of the two other counts are in play. If the above count is correct, wave C down of corrective wave 2 down would likely take prices to a .786 retrace of Intermediate degree wave 1 up - to 138ish.

Should prices move decisively higher, a second possibility is that where we have labeled Minor degree wave A would in reality be Minor degree wave 4 of the rally from October 2002. That would mean we are rallying inside Minor degree wave 5 up, completing Intermediate 1 up. That would likely complete over the next two months, to be followed by a huge decline - corrective Intermediate degree wave 2 down, lasting half of 2005.

A third possibility is that should prices rise decisively from here, corrective Intermediate degree wave 2 completed where we labeled wave A down, and we are off to the races for a wondrous Intermediate degree wave 3 up to the stratosphere. Given the overbought conditions, this is the least likely scenario in our view. The RSI has formed a Bearish Head & Shoulders top pattern, and the MACD appears to be doing the same as its Right Shoulder rolls over.

Silver (chart not shown) continues its Parabolic Spike pattern and is likely to retrace at least .786 of the move down from April's high. However, we see a classic Rounded Bottom formation which is a Bullish pattern of accumulation. Inside this large Bullish pattern can be a series of smaller parabolic spikes where prices get ahead of themselves - all the while pushing Silver higher and higher.

30 Year U.S. Treasury prices fell hard from a Double Top pattern we noted last week, in line with what the Bearish Head & Shoulders Top pattern suggested, and in accordance with the Elliott Wave count we believe to be most accurate at this time. The H&S pattern will confirm once prices drop decisively below the neckline, below 101.5. In that case, the minimum downside target would be the low 80s.

The Right Shoulder looks complete, with minor degree wave 2 wrapping up a Fibonacci .786 retrace of Minor degree wave 1 - a common retrace point for wave 2s. Both the RSI and the MACD have formed Rounded Bearish Top formations and are headed lower.

Bonds are one of the key problems for the Equity Secular or Intermediate-term Bull Market argument at this time. Bonds are at risk of decline just as equities try to fly, and ensuing rising interest rates will snuff out the fundamental earnings and spending necessary to fuel higher PEs. Bonds are a governor over equity irrational exuberance. The twin deficits will keep pressure on the Dollar and that will also tend to push Bonds lower, keeping a lid on equities.

Should equities fall sharply, we would expect an initial flight to quality, pushing Bond prices higher. But in that event, the Master Planners would flood markets with liquidity, and Bonds would fall.

Bottom Line:

Most markets are approaching crossroads between intermediate-term Bull vs. Bear trends. Equities must soon decline or signals will suggest a short to intermediate-term rising trend may be underway. However, such a move - if it develops - would not be a primary trend change to Bullishness, but would rather be another Secondary reaction inside a Primary Bear trend that started in 2000. Because any new Secondary uptrend would be a terminal 5th wave of a terminal intermediate degree C wave or the Primary corrective (2) wave, there is the possibility that the final upswing could disappoint Bulls, could truncate, could be short-lived. Underlying fundamentals carry huge downside risks with PEs never reaching undervalued territory, Trade and Federal Budget Deficits unwieldy and widening, Middle East war tensions, terrorist threats, slowing economic numbers, etc... It is not a certainty that a new secondary Bull run is upon us. Should it occur, we will be eager to point that out. Caution remains warranted.

"Trust in the Lord with all your heart,
And do not lean on your won understanding.
In all your ways acknowledge Him,
And He will make your paths straight."

Proverbs 3: 5, 6

Coming Soon: In early 2005, we will be introducing a new feature for those who are interested in trading. Trader's Corner will document options trades only available on our website at Subscribers can contemporaneously follow our purchases and sales based upon what we believe to be high probability trading opportunities in the markets.

Special Note: Be sure to register under the subscribers' section at for e-mail notifications and password access of our new mid-week market analysis, usually available on either Tuesdays or Wednesdays. These midweek updates are only available via password access when posted on the web.

Key Economic Statistics
Date VIX Mar. U.S. $ Euro CRB Gold Silver Crude Oil 1 Week Avg.
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 9305.7 b
6/25/04 15.19 89.22 121.41 270.75 403.2 6.12 37.55 9296.2 b
7/02/04 15.15 88.18 123.09 265.50 398.7 6.01 38.39 9327.7 b
7/09/04 15.78 87.41 124.10 269.00 407.0 6.46 39.96 9273.9 b
7/16/04 14.43 87.12 124.36 271.50 406.8 6.72 41.25 9238.8 b
7/23/04 16.50 89.23 120.88 269.50 390.5 6.33 41.71 9259.9 b
7/30/04 15.27 90.12 120.10 267.00 391.7 6.56 43.80 9272.3 b
8/06/04 19.34 88.45 122.69 268.25 399.8 6.77 43.95 9267.9 b
8/13/04 17.98 87.97 123.68 269.19 401.2 6.62 46.58 9250.2 b
8/20/04 16.00 88.22 123.03 279.50 415.5 6.87 46.72 9261.9 b
8/27/04 14.74 89.80 120.20 275.00 405.4 6.58 43.18 9298.6 b
9/03/04 14.28 89.56 120.66 275.25 402.5 6.59 43.99 9288.7 b
9/10/04 13.75 88.60 122.61 272.50 403.8 6.16 42.81 9281.1 b
9/17/04 14.03 88.10 121.76 275.75 407.6 6.28 45.59 9275.7 b
9/24/04 14.28 88.59 122.57 278.50 409.7 6.42 48.08 9320.5 b
10/01/04 12.75 87.77 124.07 284.75 421.2 6.94 50.12 9336.5 b
10/08/04 15.08 87.55 124.13 287.60 424.5 7.29 53.31 9296.2 b
10/15/04 15.04 87.20 124.73 286.45 420.1 7.11 54.93 9260.9 b
10/22/04 15.28 85.97 126.46 287.00 425.6 7.33 55.17 9281.6 b
10/29/04 16.27 84.98 128.85 284.75 429.4 7.30 51.76 9299.6 b
11/05/04 13.84 83.89 129.46 283.00 434.3 7.50 49.61  

Note: VIX plummets; Dollar , CRB, and Oil decline; Euro, Gold & Silver rise.


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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