The Bull is Back

We wrote in last week's commentary that a bottom may have been in place and that accumulation appeared to be broad-based. Our reading of the tape was such that almost all indications pointed to a recovery from this summer's bear market, and that we were likely on the verge of an advance that would carry us to new highs in the major indices. Based on the action of the markets this past week, it appears we were correct.

The Dow Industrials, the NASDAQ and the S&P 500 all rallied impressively on Thursday and Friday of last week to close above (in the case of the NASDAQ) or near (in the case of the S&P) previous all-time highs. This two-day rally was sparked by a series of positive economic reports from the Chicago NAPM and from the Federal Reserve. While one should never give too much credence to the effect of news on the stock market (since by the time it reaches the news ticker it is no longer really "news") it is nevertheless a bullish sign when the market rallies on good news. This indicates that the buying interests are still very much in force and that the bull market is intact. Only when positive news fails to move the stock market is there cause for concern.

The very fact that the market was able to rally impressively two days in a row without so much as a technical pullback, or "correction," is proof of the strong bullish position of the market. Simply put, the buyers are now in firm control and they aren't likely to relinquish that control any time soon. The bears had their chance at keeping the trend down but they failed. They probably will not get a second chance at cracking the market until well into the year 2000.

Richard Wyckoff, one of the great pioneers of technical analysis and a master tape reader, once wrote that the big-money stock manipulators who operate on Wall Street rarely engineer a bull move but that it carry -or even billions-of dollars, and the "big boys" will rarely push prices higher in a concentrated effort unless they intend to see a significant rise before taking profits. So it would appear based on this bit of Wall Street wisdom that the bull campaign that we witnessed this week was the beginning of a substantial move to new record highs. We are not "astro investors" and we eschew astrology, but we have taken note of a definite and undeniable correlation over the years between the lunar cycle and investor behavior. Specifically, we note that toward the end of each month when the lunar cycle typically peaks in a full moon, trading volume is at its heaviest, volatility tends to increase, and any impulsive move in one direction or the other tends to carry extreme momentum. In October of 1929, it was of course the great stock crash that coincided with the full moon. In October of 1987, a full moon was in force during the infamous "Black Monday." In October of 1997, it was likewise a full moon that accompanied the one-day mini-crash late in the month. In October of 1998, another full moon was out for the violent recovery of the summer slide in stock prices. This year's October "harvest moon" carried no less of a powerful impulse with it as investors decided once again it was time to buy stocks-and fast! So it appears that there is a definite correlation between trading volume, a measure of "tidal force" in the markets, and the lunar cycle, which has strong impacts on both the tides of the ocean and the tides of human affairs. (Incidentally, this is one reason why options expiration always occurs on the third Friday of each month as opposed to the end of the month. With the heavy volatility that frequently accompanies a full moon, the moneychangers want to make certain the average investor doesn't have volatility on his side so his options are more likely to expire worthless).

The CBOE Internet Index is still trading within the confines for a triangle pattern which indicates a breakout in one direction or the other is imminent. We are placing our bets on the long side. Our own Internet index (composed of the five leading Internet stocks) is likewise showing a coiling of prices within a triangle pattern and also points to a major breakout very soon.

One indication that the trend has now turned positive for stocks is that the Rydex Ursa Fund, which we use to track institutional money flow on the bearish side of the market, produced a clear-cut sell signal last week. The fund broken below its 30-day moving average, and its stochastics oscillator flashed a sell signal. The Rydex Nova Fund, which tracks bullish bets on the market, gave a buy signal as its price line broke above its 30-day MA, and its stochastics likewise gave a buy signal. The stochastics oscillator also diverged from the price trend by setting a higher low in October while the S&P made a lower low-that's a bullish divergence. The S&P is now a buy.

Most of our technical indicators have turned bullish. The five-day advancing NYSE volume chart is rising in bullish fashion, pointing to the immense accumulation of shares that has been underway the past couple of weeks. NYSE five-day declining volume is falling, which means fewer investors are taking the bearish end of the market. Cumulative volume, while still technically in a downtrend, broke out of its declining wedge pattern this week just as we predicted it would.

Market momentum still favors a continuation of the price rise; however, the chart showing 10-day momentum is at an overbought position; thus, we can expect a pullback of some sort probably early in the week. The chart showing 30-day momentum is still below the zero line but is rising from its low point and should continue to carry the market higher in the near term.

The two most bearish indicators over the past year have been the daily advance/decline line, which measures market breadth, and the daily high/low index. Even these indicators have started to rise and have just given us a buy signal this past week. Every indication is pointing in the direction of a sustained bull move and we should heed the message of these indicators.

One mistake we did make last week was in our interpretation of the wedge patterns in the charts of many leading banking stocks. While the pattern was clearly in the form of a rising wedge-normally a bearish pattern-the corresponding volume pattern did not conform with how this pattern should look. Instead of continually diminishing volume throughout the formation of the wedge, the volume patterns for these stocks were churning and in some cases rising considerably higher as prices neared the "apex" of the wedge. When this happens, it negates the bearish aspects of the wedge and instead becomes bullish since supply and demand (as represented by the two lines coming together to form the wedge) are being "squeezed" in a pitched battle between buyers and sellers, and when the point of equilibrium is reached (i.e., the apex), it necessitates a considerable breakout in one direction or another. Since volume has been increasing throughout the formation of the wedge, it tells us the move will likely be higher. For some reason, we ignored this clear indication last week (for which we apologize). Sometimes, when the analyst is bombarded with a multiplicity of conflicting indicators he neglects some of the most telling indications in performing his analysis, and this was definitely the case for us last week.

The Dow Industrials closed the month of October at 10729-slightly above a critical resistance level. This bullish move was confirmed by both the Dow Transports and the Utilities, which also closed above critical near-term resistance levels. The NASDAQ performed even more bullishly, closing above a previous record high. When an index makes a new high it is a very bullish indication and typically precedes further new highs.

Richard Wyckoff, writing under the pseudonym of "Rollo Tape" in his classic book Studies in Tape Reading, wrote that if a stock or market average is under distribution it will show up on the tape when the shares have been completely snapped up by the "dumb money" investing public. That's because shares have passed from strong hands to weak, and after the manipulation is complete the stock or index will typically break by a considerable amount. If this does not happen, but is followed instead by only a mild reaction and a resumption of the previous trend it means that no meaningful distribution has taken place and that the insiders have taken the side of the prevailing trend. That most emphatically appears to be the case now with the major indices approaching new record highs. In cases like this the appropriate course of action is to go with the flow.

Once again, bearish investors pushed the short interest ratio on the NASDAQ to a record high in October. According to the latest statistics, short interest on the NASDAQ rose 5.2 percent from the previous month with much of the short interest concentrated on Internet stocks such as Amazon.com, E*Trade, and Yahoo. With this much short interest on the tech stocks it was only a matter of time before a big short covering rally got underway. Such is what helped propel the NASDAQ to its new record high today (Oct. 29).

We wrote last week that IBM-a key NYSE stock-should be watched very closely as its reaction to having been dumped in a selling panic would shed important clues on the near-term direction of the market. We wrote: "…an important chart support zone ($85-$90) managed to hold up extremely well under the selling pressure. This indicates that, more than likely, the buying interests have already come in to pick up the battered stock, and this may account for the extremely high volume…If at any time IBM closes below $90, we'll know that further rough riding lies ahead for the broad market." Well one week later IBM continues to hold its own above $90. While it is by no means traveling far apace of this critical support, it at least has not threatened to penetrate below it. While the near-term direction of IBM is still up in the air, we believe the following words from the old tape master Richard Wyckoff will shed light on our subject: "[A]n exceptionally violent movement, after a protracted sag or rise, usually indicates its culmination."-[Studies in Tape Reading, pg. 91] IBM's "exceptionally violent" decline last week (which followed a sag of several points during the late summer and early fall) was checked on enormous volume and has held steady thus far. Until we see more evidence we are going out on a limb and calling the bear market in IBM complete-insider accumulation should now become evident.