One More Fling to the Upside?

By: David Chapman | Sat, May 7, 2005
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In its own odd way the year has played out largely as expected. Years ending in 5 have universally been up years since the Dow Jones Industrials (and its predecessors) started tracking in the late 1800's. Ah what's that we say? They have been up years? Yes that's correct even as we sit here right now with the Dow Jones Industrials down 4.9%, the S&P 500 off 4.2%, the NASDAQ slashed back 11.1% but lo the TSX is actually up 1.3%. So if things are down how can they possibly end up?

Well of course the year isn't over yet but our forecast for 2005 also noted that "If there is a note of caution it is the first half of the year. Cycles have shown that for the years ending in 5 the first quarter often stretching into the second quarter tends to be weak." Again we have not been disappointed as the first quarter ended on a down note and the weakness has thus far prevailed into the second quarter. But we are now in a period (May 1-20) of a potential bottom. If this period fails to find a bottom we would have to wait until June or even July for a low and that could come from sharply lower levels. Irrespective the year could still end on an up note as did the Tokyo Nikkei Dow of 1995 even if barely despite being down almost 25% into early July.

The two charts that have worked the best for the first decade of the new century has been the DJI of the 1930's and the Tokyo Nikkei Dow of the 1990's. No two cycles of course are exactly alike but cycles and patterns have a way of repeating themselves many years later and we follow the general trend of an earlier cycle. At times we even make highs and lows almost to the date of important highs and lows of an earlier era. Patterns in technical analysis repeat themselves over and over again with often the biggest challenge trying to interpret those patterns and cycles.

In the first few days of May the market has turned up breaking out over the key 1163 resistance zone of the S&P 500. This suggests that a bottom may be in irrespective of any negative news that may be lingering in the background. And there is negative news lingering behind the scenes. But in a period of positive cycles the negative news does not matter and the market will go up anyway. Of course when the down cycles dominate the market will fall no matter what positive news may come out or linger behind the scenes.

And it is here over the next two months where the cycles are mixed that does leave us as an analyst trying to figure out which way will we go. As a technical analyst one can say it will go up (or down) as long as we don't break any key trend lines (either up trends or down trends). Right now when we look at the big picture we know that the while the monthly trend (S&P 500) has been up over the past two years we have never taken out the down trend line that comes off of the highs of 2000. So in that respect we know we remain in a bear market but we are experiencing a cyclical bull. We also know that the weekly trend has turned neutral but has yet to give us an outright sell signal. But we just broke out above the weekly downtrend line so we now know that the short term trend has turned up.

Our two key cycle years show that in 1935 we made a low on May 2 and the market turned up for the entire month of May. But the Tokyo Nikkei Dow topped out on May 8 before it plunged to new lows that did not bottom until early July. It is these digressions that give us fits trying to figure which way next. If they were both in sync then we could say our odds favoured either the upside or downside. So as an analyst we try to look in other years to see if there might be a clue. Cycle analyst Michael Jenkins always cites the importance of the 60 year cycle. Well 60 years ago brought us the end of the war. Important ceremonies are taking place all over Europe to commemorate the 60th anniversary of the end of the war on VE Day May 8, 1945.

In 1945 the market fell sharply into March before starting a rally. The rally topped out on VE Day May 8 and was followed by a quick plunge then up then down again into around May 24 for another low. After another short rally that double topped in June and July we were weak again until August 8 when the US dropped the nuclear bomb on Hiroshima. The market rallied the rest of the year. So May 8 could be pivotal for a short term top. That is Sunday we may be making a short term top in here with another low to come sometime around May 20 to May 24 when we have important market turns. Weakness into that period should then be a buying opportunity. However, if instead we are showing strength into that period then we may be making another top and gearing for another collapse into June/July. Either way we should know which way we should go.

There are some issues lingering in the background or currently in the spotlight that are worth noting as having possible impacts on the markets. First is the S&P downgrade of Ford and GM bonds to junk status. The market and of course Ford and GM reacted negatively. The downgrade had been expected but the timing was not so it is still a jolt. The downgrade of companies such as Ford and GM has a negative impact on the entire corporate market. There are some $450 billion of bonds outstanding between the two giants. US Treasuries of course reacted positively to the news widening the spreads between corporate and government bonds.

In recent months spreads had been narrowing to levels that were considered expensive for most corporate bonds. Numerous funds can not hold junk bonds and while there will be a ready market for the bonds with junk bond dealers willing to speculate on the eventual outcome it still will remain a drag on the markets going forward. Even junk bond dealers have their limitations on how much to hold of any one name. There is the potential for job losses from these two huge employers. As well the derivatives credit market will be shaken. The previous day takeover specialist Kirk Kerkorian announced that he would bid to increase his share of the company. The drop to junk bond status does not appear to have changed his mind but he may wish to revaluate his price.

Another issue worth watching that could prove even more debilitating to the markets is the growing protectionism in the US particularly directed against China. China is being blamed for a host of US ills especially the trade deficit and the falling US Dollar. Also at the heart of the fight is the desire to get the Chinese to revalue their currency upward against the US Dollar. That China is being accused of causing the US Trade deficit is of course laughable but when the desire is there to blame someone there may be nothing stopping them.

Of course pursuing this course would cause more damage to the US economy then maintaining the status quo. That the current course being carried on in Congress is against all WTO rules also seems to be lost in the growing shrill. But breaking WTO rules (and NAFTA as Canadians know all too well in the lumber dispute) means nothing to the US. This is being pursued against the backdrop of the US being the world's largest debtor and China being a very important creditor. Add this to the list of growing conflicts with China. We described at length in our previous "Scoop" the potential for oil wars with China. And the Pentagon is growing louder in their complaints of the sharp increase in military spending being carried out by the China. That America itself dwarfs everyone else on military spending seems to be lost in the growing rhetoric.

But the growing protectionism is a direct result of America's huge trade deficit and disappearing jobs to plants and call centres in China and India in particular. In some instances entire towns have been devastated by the closing of plants that have been there in some cases for upwards of a century. Despite the higher than expected non-farm payroll that came out today America's job growth lags normal recoveries and the dubious way that non-farm payroll and unemployment is counted has numerous analysts citing that the actual unemployment rate is closer to 10% then the reported 5.2%. Announcements from IBM that they will slash 13,000 jobs do not help this perception despite the fact that most of them will be in Europe.

But the higher than expected numbers leaves the Fed between a rock and hard place on interest rates so the measured upward moves will undoubtedly continue. And not surprisingly US Treasuries were knocked back as well which will not help the corporate bond market as noted above. Higher interest rates did push up the US$ and in turn that sent gold tumbling. The US$ appears also between a rock and hard place holding above major 80 support but failing to break through key 85 resistance.

Our chart of the US$ index shows an interesting perspective on the US$ that could suggest higher prices first despite the fact that long term targets down to 60 still seems to be in place. Negative talk on the US$ Index is still strong and another major collapse in the US$ may not be in the cards until such time as the negative talk stops. None of that of course precludes another major test of the 80 zone before rallying once again. The arc we are showing can of course break to the downside and that would be very dangerous. In the interim it is providing major support.

The May 8th date appears to be some sort of pivot given the importance of the date from the anniversary of VE Day 60 years earlier and the high in the Tokyo Nikkei Dow 10 years ago. We are up into the date so expect at least a temporary high. Key will come around the period of May 20 that will determine whether we are headed for lower prices now into June/July or we are in the early throes of one more fling to the upside. We suspect the latter but must be prepared for the former. Targets on the upside remain either 1253 or 1325 on the S&P 500. On the downside targets could still be 1090 to 1100.


 

David Chapman

Author: David Chapman

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