Dow, NASDAQ Hang tough, but not out of Trouble yet

The broad U.S. equities market continues to display serious technical weakness on a short-term and intermediate-term basis, but the bulls of Wall Street continue to fight to keep the bull market intact. As the bulls are the predominant force within the marketplace right now their efforts must not be ignored, and they present a formidable obstacle to a bear market getting underway.

The principal U.S. stock averages-the Dow Industrials and the NASDAQ-are currently at plateaus trading within the confines of consolidation patterns. Consolidations occur when buyers and sellers exercise roughly equal trading power and use the influence to keep the averages bouncing between support and resistance (supply and demand) until one side finally emerges stronger and powers the Dow firmly higher or lower (as the case may be). In fairness to the bulls, it would be foolish to dogmatically assert that the market has topped. We (perhaps prematurely) intimated our belief that the top has been seen the Dow and NASDAQ but both averages may yet reverse to higher levels if buyers can gain control over the next few weeks. In short, it's simply too early to tell one way or the other which direction this market is headed once it completes its consolidation.

Most major indices have reached a plateau on their charts-a consolidation rectangle in the case of the Dow-and while this often indicates that the market has reached what technical analyst Stan Weinstein calls a "Stage 3" top, Stage 3 markets sometimes reverse higher and begin new uplegs. The key to ascertaining the market's position in this case is to look at the 30-week moving average (MA) for either the Dow or S&P 500 and note the direction the MA is trending as well as whether the market itself is trading above or below the MA. The 30-week MA seems to have an almost mystical forecasting ability, and this has been widely noted over the years and emphasized in the work of such legendary analysts as J.M Hurst, Weinstein and others.

When we analyze the Dow in reference to its 30-week MA we find that the MA, along with the Dow itself, has flattened out into a net sideways movement. This indicates some sort of plateau has been reached, one which will serve as either a base of support for another move higher or one that will serve as an area of distribution before a major decline gets underway. In other words, the 30-week MA doesn't provide a strong enough clue as to where the market may be heading in the weeks ahead.

Extending this analysis to the mutual fund sector, we find that the leading institutional bull market fund-the Rydex Nova Fund-is exhibiting characteristics similar to the Dow itself, but with a slight variation. In this case, the Nova Fund is actually tracing out a more pronounced rounding pattern and its 30-week MA is actually starting to trend lower, albeit very gradually. The leading institutional bear market fund-the Rydex Ursa Fund-is tracing out a pattern converse to that of the Nova Fund. In this case, the chart pattern seen is that of a potentially bullish rounding bottom, with the 30-week MA itself confirming this turn by gradually sloping higher. As well, technical indicators for each of these funds-including the MACD, Relative Strength Index (RSI) and Money Flow Index-are confirming the respective patterns in each fund. In other words, the leading institutional mutual funds are beginning to tell the story of a market that has reached a peak.

Looking at the shorter-term technical indicators yields a somewhat mixed message. The immediate implication of our technical work, however, remains bearish. Market momentum, as measured by the 10-day and 30-day Rate of Change (ROC) oscillators, is still technically negative; however, 10-day momentum is coming off an oversold reading and is acting like it wants to trend higher. Thirty-day momentum, meanwhile, is still hugging its equilibrium (zero) line. Whenever this happens, it almost always portends a massive breakout in one direction or the other for the stock market.

Volume indicators remain bearish for the most part. Five-day NYSE volume is still in an established downward trend; furthermore, a bearish descending triangle has appeared in its chart forecasting a further collapse in advancing volume. Five-day NYSE declining volume, while not as important indicator as advancing volume, is trading in a net neutral pattern. It has been very difficult to get a firm reading on declining volume over the past several weeks, as this indicator has not been of much help recently. Cumulative Volume as measured by the CVI is looking more and more bearish. It looks like it is ready to break below an important support line. CVI is an excellent measure of overall insider distribution/accumulation patterns and the trend in the CVI for the past two months or so has been one of net distribution. Until this indicators clears up we should avoid net long commitments in the stock market.

Interestingly, overall trading volume itself continues to be the wildcard in this market. As we have emphasized continually over the past several weeks, volume continues to be at uncharacteristically low levels, regardless of whether the market is trading higher or lower. This is perplexing to be sure, and while some analysts interpret this to mean that money managers are satisfied with their current stock market positions, we interpret it to mean that the "smart money" has already left the arena. Of course, this is conjecture on our part. But one thing is for certain-markets do not need heavy volume to trend lower as they can fall of their own weight. Markets do, however, need heavier volume to trend higher and until volume picks up considerably the bulls cannot assert their control of the market remains intact.

Since most Internet stocks continue to trend below their 30-week moving averages, we advise avoiding long commitments to this sector. A few exceptions exist-notably Dell and BroadVision, whose respective charts look spectacular on a near-term basis. But most Net stocks simply have too much overhead supply to contend with before they can be considered to be all-out buys. Let's continue to play it safe and avoid the long side of this sector until we get a bullish signal.

On the interest rate front, yields on the long bond continue to increase as Treasury bond prices decline. While there has been a correction from the recent falling trend over the past couple of weeks, the overall bearish trend remains in place. Currently, bond prices continue to trend below the 30-week MA, as yields conversely trend above it. Overall volume and open interest patterns also support our continued bearish outlook on bonds. Also, the chart of the Rydex Juno Fund-which tracks the yield on the 30-Year T-bond-looks superb, with the chart trading well above its 30-week MA.

Clearly, the picture developing now is that of higher interest rates in the months ahead, and this can only be interpreted as bearish for the stock market.

Meanwhile, the U.S. dollar also continues to exhibit weakness versus several major competing currencies, including the Japanese Yen. The daily dollar chart continues to trend lower within an established downtrend and trades below its declining 30-day MA. A weak dollar is also bearish for stocks.

Several months ago we wrote an article in this newsletter entitled, "The Internet, Oil and Y2K." In it we outlined our case that, despite the rhetoric concerning the "Information Age" and the obsolescence of industrial manufacturing, industrial groups such as steel and copper, and especially petroleum, are of vital importance to both the domestic and the global economy.

We pointed out that only a small percentage of overall business transactions actually take place over the Internet right now, and of those that do, approximately 85 percent involve the physical transportation of tangible goods as opposed to the electronic transfer of abstract information.

In other words, not much has changed from an overall business perspective, at least not yet. As such, oil continues to be the lubricant (no pun intended) of the international economy and is the single most important medium of exchange (direct or indirect) in the world. In fact, some consider oil to be an international currency, and we would agree.

The point we are trying to make is that oil still matters-in more ways than investors think. And our reading of the oil market is that of higher prices. Oil's daily bar chart shows a healthy and steadily advancing trendline that is above its 30-day MA. Volume, momentum and open interest patterns are also supportive of the incipient oil bull market (at least over the intermediate term). A rising oil market translates into higher transportation costs; higher transportation costs will put pressure on Internet commerce and on the stock market in general. This may account for the recent falling trend in the Dow Jones Transportation Average.

In fact, as one recent study of Internet commerce pointed out, a purchase of a book on the well-known Amazon.com discount book web site is not much cheaper than driving to an actual bookstore to make the same purchase when you factor in the shipping and handling (i.e., transportation) cost that Amazon currently charges. And with transportation costs likely to trend higher in the weeks and months ahead, shipping charges won't get any cheaper.

We are not trying to "down" the Internet in pointing this out. Instead, we merely wish to inject an element of reason to the inflated expectations most investors seem to have of the Internet. Ultimately, no one knows for sure what the future holds in store for the Internet. It certainly has a tremendous potential to revolutionize every aspect of our existence (as the article below contends), including day-to-day commerce. But let's not let the Internet bug bite yet. In time, the market itself will reveal all.

Our overall stance toward the market is a bearish one. We continue to advise readers to avoid long commitments to the market unless otherwise indicated within these pages.