Bulls Fight for Life but Still Doomed to Fail

The bear market arrived in emphatic fashion on Tuesday, with the Dow Jones Industrial Average (DJI) falling 300 points to DJ 8487, a six-week low. Previously, the Dow had fallen nearly 550 points over a less than two week period. While market action on Wall Street on Wednesday, August 5 and Thursday, August 6 gave the DJI a respite from its falling trend, we have every reason to believe that trend will continue and that America's long and illustrious ride with the bull is finally over.

To reiterate our earlier commentary, we have been following an ongoing five-wave pattern in the Dow that has thus far unfolded according the technical parameters of the tried and true Elliott Wave Theory (our technical tool of choice). When used with care and precision, this theory provides the analyst an impeccable medium for forecasting future trends. Presently, three identifiable "waves" have unfolded since the Dow topped at 9338 on July 17. We are presently in the midst of a wave three down, and the Dow's minor rally over the past two days are nothing more than a bear market "correction" upward before the general downward trend continues. That trend should be underway again by Monday, Aug. 10.

The Gann support and resistance levels we have been following of late have held up remarkably well. Unfortunately, however, we missed three very important Gann support levels in our last commentary. Consequently, the Dow hit that very level we failed to recognize which led to the two-day rally on Wednesday and Thursday. Those levels are at DJ 8375 (almost exactly the level the Dow reached at its Wednesday low before bouncing back to close at 8550); DJ 8445; and DJ 8487 (the exact level the Dow closed at on Tuesday). This obscure but extremely effective form of analysis is known as Gann "swing charting" and allows short-term traders to follow the market's changing trends using support and resistance levels otherwise unrecognizable under classical technical analysis. This method, perfected by trader Robert Krausz, has proven remarkably effective in recent weeks on the DJI chart.

The Gann level at 8375 should be watched, but since it is a minor one, it will probably be penetrated with ease when the Dow commences its falling trend again.

After that, another Gann support level is found at slightly above DJ 8150. Since two of the three impulsive waves under Elliott Wave Theory tend toward equality (in this case waves one and five), we will assume that wave five will find support at that 8150 level. This calculation was derived by measuring the amplitude of wave one (which measures from approx. DJ 9350 to approx. DJ 8950 for a total of 400 points). The amplitude of wave three measures from its top at approx. DJ 9025 (another Gann resistance level) to its bottom at DJ 8487 (another Gann support level) for a total of 538 points (though this is not a precise calculation). Wave four, which began Wednesday, has probably run its course, though it may have a little more latitude to the upside. Since the Dow closed today (Aug. 6) at 8577, and since we expect the Dow to fall approx. 400 points in its fifth wave downward, that would bring us fairly close to the next Gann support level at 8150. If this level does not hold, look for a fall to the next closest major support levels of 7700-7800. Though we do not foresee any bullish reversal of trend, should a reversal take place our Gann sell-stops will inform us of any such reversal before any significant damage can be inflicted to our portfolios. We will apprise you of any such reversal (though a reversal would seem highly unlikely at this point).

As can be expected in days immediately following a major downturn, action on the NYSE has been exceedingly volatile. The Dow whipsawed during yesterday's (Aug. 5) trading session, with the Dow jumping over the last 30 minutes of the trading session by over 140 points to close up 60 points from its previous close. That was followed by today's (Aug. 6) market action which saw another see-saw battle between the bulls and bears in which the Dow closed up 30 points to 8577. Volume has been characteristic for an emerging bear market—heavy—with the Dow registering its second-highest volume reading during the Aug. 6 session. Market breadth, though barely positive during today's session, has been tremendously negative in recent weeks, with the number of declining issues far exceeding the number of advancing issues. This also confirms our incipient bear market.

On an intraday basis, the Dow's chart formed what we interpret to be an ascending wedge within an ascending triangle pattern during the Thursday, Aug. 6 trading session—bearish patterns both. The resolution for both patterns should be reached within one to two trading days; thus, we can expect falling to commence either Friday, Aug. 7 or Monday, Aug. 10. Candlestick traders should note an emerging pattern that most closely resembles the "Falling Three Methods" formation. This pattern comes from early Japanese futures trading history and is a vital part of the Sakata Method of Japanese Candlestick analysis. It is considered to be a bearish continuation pattern and again provides further credence to our forecast for another big decline in the next day or so.

From the standpoint of investor psychology, the bulls are proving feisty to the finish but simply no longer possess the strength necessary to push the market to significant heights. The market action over the past two days are a testament to this as each day, while breaking the two-week downtrend, lacked the "punch" of previous market rallies, particularly those days following the mini-crash of Oct. 27. On those days, the market demonstrated its immense upward bias with wild bounces of several hundred points at a time. This recent rally simply does not compare and is actually consistent with the early days of a bear market—the bulls are still alive but can't muster the steam to alter the market's new-found course: DOWN.

Wall Street was out in full force the day following the Dow's 300 point correction. Bull market guru after bull market guru came forward to assert their belief that the Dow was only experiencing a "necessary adjustment," and that the bull would continue in full force once the "minor correction" passed. The comments of one of Wall Street's leading bull market cheerleaders, Abby Cohen of Goldman Sachs, were proclaimed in every newspaper and T.V. station across America, as "Dear Abby" tried to calm and assure investors who are in it for the long haul. "Stocks are trading at undervalued levels," Cohen said on Wednesday. "We believe that market action in recent weeks represents an overreaction to incremental information." In an interview just after the market closed on Wednesday, she added that investors have been plagued by "misperceptions" about the health of corporate America. We heartily concur. Investors have indeed been deceived by "misperceptions" about corporate America's health—they have deluded themselves that corporate America is poised for a glowing future when its collective balance sheet reflects a fiscal disaster waiting to happen.

Two of our recommended bear market mutual funds performed exquisitely during Tuesday's big decline. The Rydex Ursa Fund, which is negatively correlated to the S&P 500, was the day's second-best performing fund with a 3.8 percent gain for the day (Tuesday's big winner was the Potomac OTC/Short fund, which is negatively correlated to NASDAQ.). Our Prudent Bear fund finished fourth, with a gain of 3 percent for the day. Investors should have full positions in either of these funds at this point.

We continue to be amazed at the rapid change in public attitude toward President Bill Clinton. His approval rating, which soared with the Dow earlier this year, is now plummeting just as rapidly as the Dow has been of late. Within days of the Dow's initial downturn, Clinton found himself in the midst of a newly revived Monica Lewinsky trial scenario. Clinton seems to have lost much of his "teflon" quality in just the past few days as first the FBI and now the Supreme Court have decided against his favor in forcing him to stand trial over sexual harassment charges. This is in stark contrast to the Clinton of just a few months ago who easily rode out the turmoil surrounding the Paula Jones sexual harassment suit (the suit was dismissed).