Financial Markets Forecast and Analysis

By: Robert McHugh | Sun, Nov 28, 2004
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Summary of Index Daily Closings for Week Ending November 26, 2004

Date DJIA Transports S&P NASDAQ Jun 30 Yr Treas
Nov 22 10480.42 3609.24 1177.24 2085.19 113^10
Nov 23 10492.60 3621.08 1176.94 2084.28 113^08
Nov 24 10520.31 3647.59 1181.76 2102.54 113^06
Nov 25 T H A N K S G I V I N G   H O L I D A Y   M A R K E T S   C L O S E D
Nov 26 10522.23 3647.99 1182.65 2101.97 112^21

(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 up 65.32 points, as Holiday Trading - although lackluster - was enough to overcome last week's Short-term TII reading of negative (50.00). Our Short-term TII readings have a time horizon of up to two weeks, and we view this week's Holiday rally as a parentheses between the indicator and the direction we expect markets to take next week. The DJIA finished up Friday's shortened session with a miniature Head & Shoulders top pattern and has traced out a larger Head & Shoulders top during the month of November. These patterns portend selling over the near term, perhaps lasting into the usual late December Santa Claus rally period.

The Trannies set a new five-year high today. The Industrials did not. The latest non-confirmation under Dow Theory warns us that something is seriously wrong with this rally that began back in October 2002.

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 30, 2004 46.25 (52.18)   Scale
Aug 6, 2004 (38.00) (50.40)    
Aug 13, 2004 (15.75) (49.03)   (100) to +100
Aug 20, 2004 9.25 (43.82)    
Aug 27, 2004 9.25 (39.81)   (Negative)  Bearish
Sep 3, 2004 (39.25) (40.06)   Positive  Bullish
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)    
Nov 12, 2004 (6.50) (27.63)    
Nov 19, 2004 (50.00) (23.18)    
Nov 26, 2004 (54.25) (26.88)    

This week the Short-term Technical Indicator Index comes in at negative (54.25), indicating a 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 (26.88).

Analogs capture the herd psychology common to different markets and times. Essentially the theory is that investors behave similarly in Bear and Bull markets given the phase of that Bear or Bull that the market finds itself in. It is a belief that markets move in cycles of like patterns and that because history repeats itself, we can project the likely course for prices based upon the past. The next page updates two analogs we have been tracking that have excellent correlation through November 26th, 2004.

The first compares the price movement of the Dow Jones Industrial Average from 1996 through the present against the price movement of Japan's Tokyo Nikkei from the period 1985 through 1998. At this stage of the analog, both indices have reached Double Top patterns. If this analog is to remain in force, then next is a stock market crash. While not guaranteed, this analysis presents a sobering caution flag to those wildly Bullish.

The second analog compares the average of the last two secular Bear markets in the U.S. with the secular Bear that began in 2000 and continues through today. Again, a crash signal is next.

The SPX/VIX ratio registered its highest reading ever this week - 92.91 on Wednesday, November 24th. It was about the same as was registered just after the grand cycle top in 2000, 91.54 on August 28th, 2000, which was followed by a two and one-half year 50 percent decline in the S&P 500. Friday's reading came in at a crash-warning 92.54. A sustained Bull market is unlikely until this ratio falls to below 35.00. Readings over 68.00 have warned of imminent crashes. The time taken to develop this top - about a year - is reminiscent of the time taken above 68.00 to warn of the grand cycle top back in 1999/2000. This analysis is over a relevant range with terrific correlation that should only be ignored at the investor's peril. To compare it with data from a prior relevant range - as some analysts have tried to do to disprove its utility - is invalid. Its similar path over the past year to that in 2000 ties into the Elliott Wave count warning that the ominous primary degree wave (3) down is close at hand.

The first chart on the next page shows that Friday, November 26th's 10 Day Average Call/Put ratio registered an overbought 1.46 reading. Historically, ratios over 1.40 indicate a significant top is at hand - sentiment is too Bullish - and ratios under 1.00 indicate a bottom. The last time we got this high was the top at the beginning of 2004. The last three times prior to then that we received a ratio this high, the DJIA crashed, plummeting over 15 percent within a few months, each time. So this reading is a serious problem for the Bulls.

The U.S. Dollar has been on investor's minds the past several months. The second chart on the next page correlates the U.S. Trade-weighted Dollar with the DJIA. Correlation was terrific from 2000 through 2002, however correlation was weak in 2003. It again was strong in 2004 until the past month. Fundamentally, a declining Dollar should put pressure on Bonds which should put pressure on Equities - especially if economic growth is lackluster as we have now. However, the correlation between the Dollar and Equities is not short-term tradeable in our opinion. That may be because from time to time investor thinking applauds a declining Dollar, hopeful for a resultant improved Trade Deficit. That said, we believe a declining Dollar over the long run is Bearish for Bonds and Equities.

The chart of the Dow Jones Industrial Average above (courtesy of shows an overbought condition with a declining wave in process from the November 17th intraday high. Micro degree wave 1 down finished November 22nd at 10,432 intraday. Micro wave 2 up may have finished Friday 11/26/04 at the intraday high of 10,543 - an approximate .618 retrace of micro wave 1 down. What is unclear is whether we have begun primary degree wave (3) down and the decline is part of a five wave impulse that will be minuette degree wave i down of minor 1 down or whether the top on November 17th was merely minuette degree wave i up of minor 5 of intermediate degree wave C of Primary degree (2) up - portending more rally likely into our February 13th phi turn date. In that case the decline starting will be an a-down, b-up, c-down corrective. We will know the answer to this question soon enough. If this coming decline fails to take prices below October 25th's 9,708 low, then the top count we have above is the correct one and the rally should last into early 2005 for a final primary degree wave (2) up to be followed by a swift, powerful, ominous decline with several crashes along the way - primary degree wave (3). Both the RSI and the MACD have turned down from tops. What is interesting is the DJIA has not confirmed the S&P 500, the Transportation Average, and the NASDAQ 100's new higher highs. Such divergences amongst major indices warn of major trend reversals - Bearish.

The S&P 500 hit an new higher high for the rally that started in October 2002, unconfirmed by the Dow Industrials. The intermediate-term picture is for this index to rally into a primary degree wave (2) top - a final minuette degree wave v up of minor degree wave 5 of intermediate degree wave C of primary degree wave (2), probably the Santa Claus rally that usually comes each late December. Between now and then is a corrective minuette degree wave iv decline that should last a few weeks and take prices to the 1,150 area. There is the possibility that the minuette degree wave v up of minor 5 up could truncate.

The patterns in play are a Bullish Head & Shoulders bottom that has been confirmed with a decisive break above the neckline and has a minimum upside target of 1,220ish which should be fulfilled at the final thrust up to complete primary degree wave (2) up in late December 2004/early 2005. Putting the brakes on any longer-term Bullish aspirations is a Bearish Broadening Top pattern, a " Megaphone." Here investors are becoming less and less certain what the correct valuation should be, shown by an increase in price volatility. The pattern shown above meets the requisite of at least two to three price swings that result in two to three lower lows and higher highs. This pattern was found in an MIT study by Dr. Andrew Lo of the Sloan School of Management to have a reliable outcome - in this case we expect a major reversal to the downside in a month or so.

The MACD is rolling over and the RSI is turning down from overbought levels last seen in January 2004, just prior to the start of minor degree wave 4's decline.

The Dow Transportation Average continues its Eveready Battery Bunny imitation, as its ascension never seems to reach an apex. Just when you think it has topped, it musters another dozen points and another new high, this time at 3654.93 intraday and 3647.99 closing on Black Friday, November 26th, 2004. This new high was of course unconfirmed by the Dow Industrials - a problem under Dow Theory. The Dow Industrial's last higher high was back in February 2004, nine months ago. How's that for a divergence?

The pattern's in play are a Parabolic Spike that morphed from a Rounded Bullish Bottom, and a smaller degree Rising Bearish Wedge inside a larger degree Rising Bearish Wedge - both ending diagonals (in Elliott Wave parlance) completing terminal 5ths, minuette degree wave v and minor degree wave 5. A major divergence has occurred between price (rising) and the RSI, MACD, and volume (all falling). Both the MACD and RSI are overbought and turning down from extremes. The Dow Transportation Average appears to have completed primary degree Elliott Wave (2). All of the above is Bearish.

What's happening with the Rising Bearish Wedge patterns is that demand is being met with stronger and stronger supply as prices creep higher. The reversal will be confirmed once prices break below the bottom boundary line of the larger Wedge. There may be some back and forth as prices attempt to bust back above the Wedge, but these patterns - once broken down - become formidable resistance. Parabolic Spike patterns do not resolve with soft landings. The next move after these is often a crash.

The Economy:

We have the slowest news week of the year. We learned that Home Sales remained unchanged in October.

Durable Goods Orders fell 0.4 percent in October including strong military orders, according to the Commerce Department. Excluding the defense spending, Durable Goods Orders plummeted 1.5 percent, the sixth decline in the last seven months. This is not the foundation for sustained economic growth, higher corporate earnings, and a long-term rising stock market.

Jobless Claims were reported at 323,000 by the Labor Department for the week ended November 20th, 2004. The prior week's figure was revised up - of course - to 335,000.

Money Supply, the Dollar, & Gold:

No M-3 figures this week. Last week M-3 sat almost exactly where it was on August 23rd, 2004. That's no growth over three months. Our research indicates that whenever M-3 plateaus or declines over two or more months, equities subsequently decline.

The trade-weighted U.S. Dollar remains on its track for a primary degree Elliott Wave (1) bottom. It is in the latter stages of this quest, finishing off an intermediate degree wave 5 down of (1) down. Inside that wave, the Dollar has completed minuette degrees i through iv, and is wrapping up v down of minor degree 3. There should be a bit more decline followed by a small minor degree wave 4 rise and then one final descent to a bottom - minor degree 5 of intermediate degree 5 of Primary degree (1).

The entire decline to the primary degree (1) has hit our target of at least 82 as we projected back in June 2004 (see issue no. 61 in the archives of when the Dollar was trading at 89. We determined this from the Head & Shoulders Top pattern formed by intermediate degree Elliott Waves 4 and the first half of 5. This pattern confirmed with the decisive break below the neckline - below 87 - which increased the probability of the minimum downside target of 82 being reached. It is hard to say how much lower the Dollar will slide before a sustained rally occurs. The Elliott Wave counts suggests the decline is not over, and based upon common relationships between waves, a target of 80 - our next support area - is not out of the question. Prices remain inside the long-term downtrend.

After a bottom is reached, look for a pretty strong A-B-C rally inside primary degree wave (2) that retraces a Fibonacci percent of primary (1) down's carnage - either .382, .500, .618, or .786. It is a rally that could consume a huge chunk of 2005. Then an awful primary degree wave (3) down.

Here's the problem with a falling dollar. As the value of our currency declines - due to high budget and trade deficits, and too much printing press action - the appeal of holding U.S. dollar denominated assets by foreigners diminishes. The longer foreigners hold assets of a deteriorating currency, the lower the value of those assets. The risk here is that foreigners start dumping our financial assets.

Gold (see chart courtesy of at the top of the next page) continued its rise to just under 450 this week, the power of the Bullish Ascending Triangle evident. This Bullish pattern is quite large and threatens to negate the smaller Bearish Rising Wedge pattern. That Wedge pattern's " throw-over" is moving further north than is normal, which means the Wedge pattern is close to breaking apart. We're not ready to declare the Bearish Wedge dead yet, but for it to be valid, prices need to decline from here. The Ascending Triangle projects an upside target of 500 before any significant correction. That target is arrived at by taking the distance of the widest part of the triangle and adding it to the spot of the breakout.

While Gold remains solidly inside its long-term rising trend-channel, there are some signs that a minor correction or breather is due. The RSI is overbought, as is the MACD, which looks like it is starting to curl over - a sign of slowing upside momentum.

The second chart on the next page shows that the HUI is in a long-term Bullish trend. The top Elliott Wave count we've been showing the past several weeks required prices to decline soon from here - a minor degree B top - and it appears they have. The count we believe to be most accurate has prices declining into a minor degree wave C down of corrective intermediate degree wave 2 down that would likely take prices to a Fibonacci retrace of intermediate degree wave 1 up. If wave 2 is a flat - which I suspect given the strength of minor degree wave B - then the decline should stop in the neighborhood of minor degree wave A down - around the 170 area - about a Fibonacci .382 correction. Should prices rise and exceed 258, then one of the alternate counts we presented in last week's issue is at play. One more up/down sequence to the 243 area would create a small H&S top for B.

Not much change from last week. 30 Year U.S. Treasury prices are forming a small Bearish Head & Shoulders Top pattern for the Right Shoulder of a massive long-term Bearish Head & Shoulders Top pattern that started in 2002. Bonds should break lower from the neckline of the smaller H&S pattern, perhaps as low as the neckline of the larger H&S pattern. Both H&S patterns will confirm once prices drop decisively below their necklines, below 110.5 for the smaller one and below 101.5 for the larger. Once the larger H&S neckline is breached, the minimum downside target will be the low 80s.

Looking at the Elliott Wave count that we believe to be most accurate at this time, minor degree wave c of intermediate degree wave 2 up looks to have completed at a Fibonacci .786 retrace of intermediate degree wave 1 - a common retrace point for wave 2s - at the Head of the small H&S pattern. Both the RSI and the MACD have formed Rounded Bearish Top formations and are headed lower. The MACD may be forming a Bearish Hook pattern that will lure in longs, only to get burned.

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. Record U.S. Federal Budget, Trade, and Current Account deficits will keep pressure on the Dollar and that will also tend to push Bonds lower, keeping a lid on equities, and eventually - if not sooner - contributing to their next major decline.

Japan's Tokyo Nikkei Is Poised to Plummet!

Japan's Tokyo Nikkei ($NIKK) is poised to plummet as it has formed a massive Bearish Head & Shoulders Top pattern and is very close to confirming by breaking below the neckline. Adding to the probability that this neckline will be breached is that the Right Shoulder is itself a Bearish Head & Shoulders Top pattern that is also about to break below its neckline, confirming its pattern. Should the Nikkei fall another 150 points, it will confirm the smaller pattern portending a minimum downside target of 9,950. A break south to that level would decisively cut through the neckline support of the larger pattern, portending a minimum downside target of 8,800.

A decline to 8,800 would represent a 2,050 point collapse, an 18.9 percent decline - a crash. The Moving Average Convergence/Divergence indicator is rolling over for a third time at the same level it did twice over the past six months. The third time could be the charm for Bears. The 50 Day Moving Average has now crossed a decisive 1.8 percent below the 200 day MA, an intermediate term Bearish development.

This is important for the U.S. Stock market because if Asia is in trouble, it will likely spill over into U.S. markets. Since we are at a Bear/Bull crossroads, the Nikkei's pattern provides a clue that the Bear is likely to win the current tug-a-war in the U.S. equity markets.

Bottom Line: The Blue Chips look like they want to rally into early 2005 - and they may after a correction between now and then. But if they do, that should be "the" top for quite some time. There are a host of problems in the technical and fundamental picture that make a long-lasting Bull run a very low probability. Bullish sentiment (a contrary indicator) is at all-time extremes. Price divergences between major indices, including a Dow Theory non-confirmation between Trannies and Industrials. Price/Volume divergences inside many indices. Bearish patterns cropping up on the charts. Completing Elliott Wave counts with the "Big One" on its way - primary degree (3) down. Long-term analogs pointing out that prior psychology at a similar point resulted in an imminent crash. Possible problem in Japan's key stock index that could spill over to the U.S. Bonds look ready to tank. The Dollar is tanking. Leading Economic Indicators pointing to a likely recession next year. Durables dropping month after month. Budget, Trade and Current Account Deficits growing every day. The unfunded liability issue. The Iran issue. Iraq. If wealth preservation is your objective, now is not the time to chase a possible last gasp 5 or 10 percent price spike by going long for extraordinarily high historic PE stocks that insiders are dumping faster than NBA Commissioner David Stern did Indiana Pacer Ron Artest. Caution remains warranted.

"Be anxious for nothing, but in everything
by prayer and supplication with thanksgiving
let your requests be made known to God.
And the peace of God,
which surpasses all comprehension
shall guard your hearts and your minds in Christ Jesus."

Philippians 4:6, 7

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 mid-week market analysis, usually available on Wednesdays or Thursdays. These midweek updates are only available via password access when posted on the web.

Key Economic Statistics
Date VIX Dec.
U.S. $
Euro CRB Gold Silver Crude Oil 1 Week Avg.
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 9261.8 b
8/27/04 14.74 89.80 120.20 275.00 405.4 6.58 43.18 9298.5 b
9/03/04 14.28 89.56 120.66 275.25 402.5 6.59 43.99 9288.6 b
9/10/04 13.75 88.60 122.61 272.50 403.8 6.16 42.81 9280.9 b
9/17/04 14.03 88.10 121.76 275.75 407.6 6.28 45.59 9275.2 b
9/24/04 14.28 88.59 122.57 278.50 409.7 6.42 48.08 9319.7 b
10/01/04 12.75 87.77 124.07 284.75 421.2 6.94 50.12 9335.4 b
10/08/04 15.08 87.55 124.13 287.60 424.5 7.29 53.31 9294.9 b
10/15/04 15.04 87.20 124.73 286.45 420.1 7.11 54.93 9259.8 b
10/22/04 15.28 85.97 126.46 287.00 425.6 7.33 55.17 9280.5 b
10/29/04 16.27 84.98 128.85 284.75 429.4 7.30 51.76 9297.8 b
11/05/04 13.84 83.89 129.46 283.00 434.3 7.50 49.61 9303.0 b
11/12/04 13.33 83.71 129.85 283.50 438.8 7.62 47.32 9300.4 b
11/19/04 13.50 83.32 130.13 287.25 447.0 7.60 48.44 -
11/26/04 12.78 81.81 132.93 288.75 449.5 7.59 49.44 -

Note: VIX drops; Dollar plummets; CRB, Gold and Oil climb.


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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